I think the economy has a good chance to look like it's holding up fairly well, with what appears to be decent year-over-year GDP growth at least through the end of this year, since policymakers can probably keep it on what's tantamount to a caffeine and sugar high for a while longer. The Fed -- with ZIRP and massive quantitative easing -- has flooded the economy with more monetary stimulus than at any other time in history. I'm very concerned about 2011 and beyond, though. The Fed will eventually have to implement an exit strategy, and we obviously can't keep running gargantuan fiscal deficits for much longer.
History shows that recovery from the aftermath of financial crises tends to be painful and difficult. Asset price collapses tend to be deep and prolonged. For anyone who may be interested in the topic, Reinhart and Rogoff wrote an excellent short paper on the topic:
http://www.economics.harvard.edu/fil..._Aftermath.pdf
No one should get too excited about the 5.7% GDP "first take" for Q4 2009. Most of it resulted from the typical inventory bounceback you see following a deep recession, and from the method by which government spending is tallied in the national income accounts. What's called "real final sales to domestic producers" actually declined slightly from Q3 to Q4.
In other words, the economy is not exactly robust.
And no one should be surprised that the unemployment rate remains stubbornly high. Just look at what managers and small business owners who make hiring decisions see when they take a look around the landscape: The most anti-growth economic agenda in many years. This uncertainty overhang gives pause to many decision-makers.
I believe it's necessary to take a look at the last nine years to fully understand what a difficult spot we're in. Beginning in early 2001, the Federal Reserve stimulated our way out of what probably should have been a far more significant recession (in 2001-02). Instead, we had an extremely mild recession in 2001. After 9/11/01, the Fed pumped even more liquidity into the system, and followed up by shoving the policy rate all the way down to 1% in early '03 and leaving it there for over a year. Of course, that provided the fuel for the housing boom which busted so calamitously a few years later.
At the same time, congress removed PAYGO rules in 2002 and jettisoned any semblance of fiscal discipline. A massive expansion of government spending ensued. We saw a huge entitlement expansion (the prescription drug benefit plan of 2003), a trillion-dollar war, huge transportation and agriculture bills, the corn ethanol boondoggle, and all sorts of other expensive goodies -- all while cutting taxes (across-the-board, not just for the "rich"). Tom DeLay and his associates porked up the budget to a then-unprecedented degree. And George W. Bush didn't veto any of it. In fact, his administation actively called for much of the spending.
Ten years ago, the federal budget was about $1.8 trillion. By 2008 it approached $3 trillion. The budget just proposed by the Obama administration weighs in at approximately $3.8 trillion.
The problem is that there is a giant disconnect between the current level of spending and the ability of our present tax system to cover it. Most of the deficit is structural, not cyclical. I doubt seriously that any prominent politician is going to confront this. The solution would be painful for the nation and political suicide. So we'll probably try to stimulate, stimulate again, and then stimulate some more -- just kicking the can down the road.
I don't believe for a minute that it will work very well. If you try to cure the aftermath of the bust following a credit-fueled, consumption-fueled, cheap-money-fueled boom by mixing up a stronger cocktail of all the ingredients that got you there in the first place, you'll risk just building a bridge to the next crisis.
The painful, unvarnished truth is that someone eventually has to pay for all this. Demand for Treasury issuance is not unlimited, and attempts to just start monetizing trillions of dollars of debt would likely have disastrous consequences.
In the not-too-distant future, you're likely to see tax increases. And they could be really, really big.
Reasonable argue both sides of a point
You really have to be versed in the phrase "On the other hand..."
