Summary
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A good many forecasters continue to predict that the Federal Reserve will not hike its key rate in 2010 but should do so instead next year, that is, only in 2011. The argument is predicated on the high level of excess capacity in the economy.
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Surprisingly, real output in the service sector, the heavyweight component of the U.S. economy, is no longer in recovery mode but clearly already back in expansion mode.
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In the goods sector, the dynamics is just as surprising. After only two quarters of recovery, real goods production has already bounced back two-thirds of the way to its level at onset of recession.
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The implicit assumption made by the Congressional Budget Office is that the longest recession since the crisis of the 1930s will in the end have been an aggregate demand shock with no negative impact on aggregate supply.
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On the basis of our measure of the output gap, which is much closer to the situation that prevailed during the 1991 recession, not because the downturn was less severe this time but rather because of the unusual occurrence of capacity destruction in the economy, monetary policy in the United States seems overly accommodating right now.
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Under the circumstances, the recovery under way in the U.S. economy should spur the Federal Reserve to action early in the second half of 2010, that is, sometime around August.
