Which Do You Want First?

The good news or the bad news?

Good: "Fed vows to fight against deflation"

Bad: There isn't really anything much the Fed can do. The effective Funds rate has been near-zero for a good while now. Oh, and core CPI slipped for the first time since 1982, so we're already experiencing deflation despite the Fed's best efforts. We can only hope it doesn't spiral.

Of course, the Fed can still work to recapitalize banks while the Congress/Treasury engage in massive fiscal stimulus in an attempt to resuscitate the real economy. But that task will be very difficult; the one sector of the economy which had kept us out of a recession was the export sector. Now that sector is slipping fast as well. As Brad Setser says: "Ut-oh".

The problem is that recapitalization of the banks doesn't address the demand-side concerns (unless it frees up cash for cheap debt used for consumption spending). And fiscal stimulus doesn't address the supply-side concerns. Meanwhile, the currency won't depreciate (which would boost exports) because the global demand for dollars has gone back up, while global demand for our exports has gone down. We're getting hit from all sides right now, and it is unclear which policy mix is capable of stemming the tide.