WE KNOW A LOT more about financial conditions than we did a few days ago. First, it is clear that the Fed’s decision to make the discount window more accessible succeeded in calming the financial waters. But no more than that: it has not sufficiently eased the liquidity problem to allow money to flow where it is most needed. That is partly due to the banks’ reluctance to use the window, historically a stopover place for the halt and the lame for whom even a trip to the financial equivalent of Lourdes would provide no cure, and partly due to a reluctance to allow the Fed to put a value on their assets, a value certain to be below that shown on their books.
Second, we know that there are fewer degrees of separation between financial markets and “the real economy” than most experts thought last week, with Larry Lindsey the notable exception. Not that the real economy isn’t relatively healthy: it is. Businesses are still making money, consumers still have jobs, incomes are still rising, and as Jeffrey Lacker, president of the Richmond Fed points out, “the fundamentals for broader household and business spending continue to look fairly sound.” But the seizing up of credit has exacerbated the problems of the housing market, with unsold new and existing homes creating a glut in most markets; layoffs in the financial sector will add at least a bit to the rolls of the unemployed; and there has to be some nervous sweat in the air-conditioned board rooms of America. All in all, the turmoil in financial markets now seems likely to discourage “real” economic activity, but probably only enough to reduce the growth rate in the rest of the year, with a worst case being a modest negative for a short period of time. The world of long-term continued economic growth is not coming to an end.
