Federal Reserve Bank of Chicago

I’m at the Federal Reserve Bank of Chicago to try and understand the ecomomic situation in the good old USA. I’m here at the invitation of Northwestern University and grateful for the opportunity. Since the topic is economics, I’ll translate it into everyday language and reduce it to the points that impact you and me.

I step off the elevator into a huge crowd of well-heeled CEOs and bankers—all fellow Northwestern Grads. There must be 300 people here, eating, drinking, making a ruckus. I meet so many people, I can’t remember a single one of them. Since they’re drinking wine in huge goblets, I figure they won’t remember me either. I find a seat in back and stretch my neck to see the podium.

I’m in for a treat. Morton (Morty) Schapiro PhD, president of Northwestern University is a lively and witty–an entertaining speaker. And what about economist-speak? He does most of the translating for me. The crowd sits in silent attention except when laughing at one of his jokes. He’s a professor in Microeconomics at Kellogg and he characterizes the field as a branch of psychology. Here’s the short version of his speech—the parts that hit home:

First, he gets introduced this way: “He’s purple, he’s short, and he’s here.” He points out that Chicago is what it is—a center for research and teaching. The Chicago Fed benefits from that. “Two of the top economics PhD programs are here,” he says, “Two of the best business schools are here.”

Then he tells us what we all know—this is an extremely severe recession. But what he’s interested in is its curve. The steep drop. TheFED Logo agonizingly slow recovery. Unusual. Very unusual. One might see him as a perplexed MD clucking his tongue and shaking his head while the patient dies. He’s got my interest.

Yes, GDP is back to 2008 levels but that’s misleading. “Getting back to where we were isn’t the same as getting to where we would have been.” We’ve diverged from the long-term trend. “Compared to growth with no recession we’ve lost 10% or $1.5Trillion. If GDP had recovered to the long-term trend as is usually the case, it would be 10% higher than it is now. 1.5 Trillion dollars is a lot of money that could have paid for a lot of things. That’s what we lost as a result of this recession.”

No Inflation

“There is no sign of inflation,” he says. “Not anywhere.” He cites some studies:

1—The Private Market Forecast calls for 2% inflation. That just happens to be exactly the Fed’s target. So, Morty says, “Maybe these guys are crazy, Who else can we ask?” And it turns out that there are other predictors we can look to:
2—The 10-Year Note vs. the TIPS yield: TIPS are protected against inflation so this comparison tells a powerful story. The spread suggests 2% inflation. So the Market Itself is betting that inflation will be low. And I don’t like to bet against the market. Again Morty asks, “Are bond traders crazy, too? Let’s go ask somebody else.”
3—He cites the Survey of Professional Forecasters, who expect about 2% as well. “Is the world crazy? Let’s ask some ordinary people.”
4—There’s the Survey of Households. They come up with about 2%. We keep running into that same number.
So maybe inflation really isn’t a problem in our country. Maybe we really shouldn’t run out and buy gold after all.

Lots of Downside Risk – Little Upside

Morton Shapiro“This is not a normal recovery,” he says. “A recession’s rebound is usually as steep as its drop. We should be seeing a 14% growth rate, not a 2% rate.” Turns out there’s a reason. This is a financial crisis, not a normal recession like an oil shock. Historically, after a financial crisis, employment recovers very slowly. Even so, the Great Depression had a faster employment recovery than this recession does.

What about the unemployment numbers? Aren’t things getting better? As we all know, it’s hard to measure how many people are out of work. Some have reached the end of their unemployment benefits. Some have given up. Some are under-employed.

Turns out, it’s a lot easier to measure how many people actually have jobs—the Employment Rate. So, instead of focusing on the unemployment numbers, his tables and graphs zone-in on the Employment Rate—the simple counting of how many people actually have jobs at various times in history. This is a more accurate way to measure where we stand. The Employment Rate has dropped from 85% to 75% during this recession. Ten percent. Huge by historical standards and it hasn’t changed much since the crash. It hasn’t improved significantly in all this time. That matches the real world outside the Federal Reserve building—the world that you and I see every day.

Banks Aren’t Lending

Banks are in trouble and are running scared. Your credit rating and collateral has to be really good to get a banker off his duff. According to Morty, “If you don’t have assets, you have few options. You can’t say to some banker, ‘Hey, I’m going to Kellogg. Invest in me!’ That’s because indentured servitude is illegal. You can’t collateralize yourself. So how do you get a loan?” Well…you don’t. And business doesn’t thrive. And the recession grinds on.

The Fiscal Cliff

He points out the coming fiscal contraction. It’s huge but short-term. It occurs to me that it’s like a train wreck as opposed to a nuclear war, which would have longer-term ramifications. But in both cases, you’re dead. If our government fails to act we are slated for a massive “fiscal cliff.” The economy will contract even more—to the tune of $600B. A large part of this is tax cuts that will expire next year if we do nothing. Here’s roughly how that breaks down:

1—The Bush tax cuts will expire—that’s $166B out of the economy.
2—The payroll tax cut ends—another $125B.
3—The alternative min tax patch ends—another $119B
4—The dividend tax rate will return to 35%. So talk to your investment advisor about the value of dividend-yielding investments.
5—The health care act, inheritance tax, and other smaller factors bring it up to a total of $494B in Federal tax increase. (That doesn’t take into account the effect it will have on State taxes, many of which are tied to your Federal tax.)
6—Then he factors-in spending cuts: Defense—$50B. Non-defense—$50B. Morty sarcastically points out, “…the characteristic precision of government numbers.”

That adds up to about a $600B in economic contraction—a drag on GDP of 3.8%. What does that mean to us? We won’t grow by 2% like theMorton Shapiro forecasters say. No, nothing like that at all. Our growth will fall by at least -1.8% and probably as much as -3.2%. So forget what you hear from politicians and the news media. The country’s about to slow way down.

What can we do about it? Well, obviously take action before we go over the financial cliff. But to climb out of our long-term crisis, cut the big-ticket items. Entitlements. People are gonna love that option.


I’ll list the important takeways from his speech:

1—The downside risks loom large. Little upside in sight.
2–Don’t expect inflation. There’s no sign of it. To make that personal, he says, “Don’t expect housing prices to rebound to pre-recession levels. They are where they belong.” But he doesn’t hold out any hope for healtcare costs to improve. “There’s no evidence that the Obama’s healthcare program will cause healthcare to be more efficient. No evidence whatsoever.”
3—”This isn’t a normal recession,” he says, “It’s a financial crisis.” Then he points out that employment dropped 10% and it’s still near that level. “Recovery is slower than the Great Depression.”
4–Solution: He warns that we need to take action before we drive off the Fiscal Cliff and suffer a 600B burning wreck. We have to hit the brakes right now. Will we? I wonder.
5—Solution: A 10% value-added tax (a sales tax) might solve the short-term problem, “But,” he says, “You can only do it once.”
6—Solution: He suggests that, “A short-term stimulus might be beneficial.” But only if the long-term problems are addressed. And we know that nobody really wants to address those.
7—Solution: Turns out his answer is simple, but it hurts: “The real long-term crisis at home is the ratio of US debt due to entitlement spending,” he says. “You gotta cut medicare.”

That makes me shudder. Not good news. I brace myself for the next speaker. The topic will be Europe.


Prof. Morton SchapiroPhD email: nu-president@northwestern.edu

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Find Chicago Venture Magazine at www.ChicagoVentureMagazine.com Comments and re-posts are welcomed and encouraged. This is not investment advice – do your own due diligence. I cannot guarantee accuracy but I give you my best.

Copyright © 2012 John Jonelis – All Rights Reserved


  1. seems to me the expiration of most of those tax cuts will put MORE money in the economy, not less…

    1. That’s what so many politicians forget about taxes. Raise taxes and the money goes into the government. That’s short-term revenue for government programs but there’s less money in the private sector so the free economy shrinks. The long-term result is a smaller and smaller tax base and fewer and fewer revenues for the government. So the politicians raise taxes again and it gets worse.

      Now take the opposite approach. If you lower taxes and the free economy grows, by definition the tax base expands. That means, long term, the govenment gets more revenue even though individual tax rates are lower. It’s not theory. It was proven under Reagan and others around the world.

  2. no sign of inflation??!! has he BEEN to the market (and by that i mean grocery) lately? there are signs of inflation everywhere, but NOT in the price of goods…rather the signs of inflation are blindingly evident in the size of goods. have you picked up a “big” box of cheerios lately? pretty soon they’re gonna have to lay individual o’s side by side in one layer to fit them in the box they’ve gotten so skinny. dove bars now come three to a box (instead of four). milk, meat, eggs, bread are all 25 – 50% + more expensive. candy bars are smaller…that the american public doesn’t see this doesn’t surprise me one bit…americans will only notice when their six packs turn into five packs.

    1. A five pack of beer? That’s a cheap shot. How about smaller kegs in Germany? I agree with you about inflation except I think people are well aware of it, as you are. It’s the economists that are fixating on aggregate data with a severe lag. This is the most severe economic downturn since the Great Depression and they have yet to declare it an official recession.

  3. John; Excellent recap of Shapiro’s speech….however, I find the (seemingly) eternal search for the “silver bullet” (#7 – Solution) disconcerting and short-sighted. Also, inlfation may not be apparent according to cost trends of the current market basket but outside of economist philosophers who derive their opinion from data, the average consumer is well aware of inflationary trends in commodities.

    Excellent post and I look forward to reading more.

    1. Another weakness of economists is their reliance on aggregate trends. Details get swallowed up in the averages. There is always a huge lag that makes for bad decisions. In Mark Twain’s “A Connecticut Yankee in King Arthur’s Court,” the king could not make intelligent decisions from the isolation of his court and therefore went on the road and see what was going on firsthand.

  4. Speaking from Europe, I can say that pretty much the same causal factors apply and the same fiscal dilemmas pertain. In response to your excellent synopsis, I would suggest that this is more than just a [train-crash-style] crisis. This is a re-structuring of society, both in America and Europe, with all the gravity that those words imply. The changes being made now will last longer than 50 (fifty) years. I would recommend looking at the economic records for Britain, 1830 – 1880. But then,I would say that ‘cos I’m an economic historian. You can tell by the elbow patches on my jacket and my ability to nod, knowingly…

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