Regulators Anticipate Prolonged Recession, Warn of Deflation in 2009

The year-old recession will continue “well into 2009” before beginning a slow recovery in 2010, according to a budget and economic outlook published Wednesday by the Congressional Budget Office (CBO). Among other bleak forecasts was a marked contraction in 2009 with real gross domestic product declining 2.2 percent and gaining back only 1.5 percent in 2010. The CBO also said it expects inflation to decline to only 0.1 percent in 2009 and for unemployment to exceed 9 percent early in 2010. “[It] is too early to determine whether the government’s actions to date have been sufficient to put the system on a path to recovery,” the report’s author wrote. The slow financial recovery was forecast for a variety of reasons. The CBO warned that financial institutions will need time to recover from losses incurred from loan defaults. “As a result, borrowers will continue to find the terms and availability of credit tight, which will increase the cost of capital and hold back the growth of investment and consumption, dampening economic activity for several years,” the report read. The CBO said the 2009 deficit will reach a record high of 8.3 percent of GDP, despite President-elect Barack Obama’s plans to enact a stimulus package to assist struggling Americans. “Enactment of an economic stimulus package would add to that deficit,” the CBO report read.  Even without such a stimulus, the deficit for 2010 was estimated to fall to 4.9 percent of GDP, “still high by historical standards.” The CBO estimated continued home prices to decline an average 14 percent between the third quarter 2008 and second quarter 2010. It acknowledged lowered mortgage rates led to a boom in refinance applications, but that the number of purchase applications remains low. “The correction in the housing market will probably continue for most of this year,” the report read, in part. As home prices decline and settle, homeowners have more and more negative equity and become increasingly underwater on their payments — meaning they owe more on their homes than the homes are worth. This, the CBO said, will affect their ability to secure mortgage refinancing loans. “Foreclosure rates are likely to remain high while house prices continue to fall and the economy remains in recession,” the report read. Read the outlook report. An all-out depression? Economic outlook was bleak elsewhere on Tuesday, when the Federal Reserve released minutes from the mid-December meeting of the Federal Open Market Committee, which revealed fears about prolonged recession and continued moderation of inflation — and eventual deflation. Some meeting members were indicated to have seen “the distinct possibility of a prolonged contraction, although that was not judged to be the most likely outcome,” according to the minutes. The FOMC acknowledged inflationary pressure has “diminished appreciably,” but the question remains whether Fed efforts will put so much downward pressure on inflationary mechanics as to foster deflation in 2009. Several meeting members went so far as to indicate they “saw significant risks that inflation could decline and persist for a time at uncomfortably low levels” and perhaps “drop for a time below rates they viewed as most consistent over time with the Federal Reserve’s dual mandate for maximum employment and price stability.” The FOMC minutes suggested the economic outlook will remain weak “for a time” and hinted that economic activity might be at substantial risk. “In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters,” the minutes read, in part. “In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” Read the meeting minutes. Write to Diana Golobay at

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