‘Animal spirits’ and the election cycle

Just for kicks I have forecast unemployment to rise to over 12 percent over the next 18 months on the assumption that the NBER will declare an end to the recession to have occurred in about mid-2009 and for unemployment to rise another 18 months after that, somewhat more than after the last recession.  Unemployment then declines at a typical rate through April 2013.

“Animal spirits” climb to about zero in time for the next presidential election.  It will probably be a bitterly contested election, perhaps with a third party spoiling the Republicans again.  With soft labor markets and excess capacity in manufacturing, the only inflation threat is a supply shock that will not require the Fed to raise rates. 

Any double-dip recession coming before the next “scheduled” recession in 2014 will be signaled well in advance (as in 1981) by an inversion of the 1/10 Treasury yield curve.  Such an inversion will be caused not by inflation but by failing Treasury bill auctions requiring the Fed to raise short-term rates.  Just as one of the largest tax increases in history followed Ronald Reagan’s massive tax cuts in 1981, when the “supply side miracle” didn’t happen, so Barack Obama and his Congress will probably be obliged to make some of the largest cuts in government spending in history when his stimulus fails to convince our external funders of its success (sse previous post).  There is no “recession” in the NBER sense in sight in the next 12 months or more (see last update).

What comes after April 2013, the last month in the forecast period?  That looks to me like the set-up to a short expansion as in the early 1970s, when inflation surged, the Fed tightened, and the economy fell into deep recession. 

The danger of the increasing though still negative "animal spirits” over the next four years is to foster a sense of complacency that precludes real action on the fiscal problems America faces.  The next slump may qualify as a depression by anyone’s definition.

Reference:  Animal spirits in America, April 2009