During the Great Recession, GDP fell by 4.3 percent over a six-quarter interval, but other indicators document even greater hardship. Payroll employment fell by 8.7 million jobs in the recession and its immediate aftermath... The scale and scope of the loss in income and wealth experienced by Americans was far greater than anything seen in the previous 20 years. Given that experience, lenders are bound to re-evaluate the riskiness associated with extending credit to a typical household. Indeed, consumers themselves appear to be re-evaluating the riskiness associated with indebtedness, no doubt reflecting a sense that their income and asset returns may be substantially riskier than they had come to believe during the Great Moderation. Under these conditions, it's no surprise that credit is no longer available on the same terms. And it's no surprise that consumers have been paying off debt and building up savings in order to restore some sense of balance to their household finances... Businesses also appear to be quite reticent to hire and invest. A widely followed index of small business optimism fell sharply during the recession and has only partially recovered since then. Interestingly, when small business owners were asked about the single most important problem they face, the most frequent answer in the latest survey was "government regulations and red tape..." Adding to the uncertainty is the continuing cloud over our nation's fiscal policy. The most recent round of budget deliberations has certainly been a welcome relief from the recurrent legislative cliffhangers of the last several years. The lower odds of an imminent budget showdown may ease some business and consumer concerns, and that may aid growth. But overall government spending has been declining lately, and, given continuing fiscal pressures, that category is likely to make little, if any, contribution to GDP growth in coming years.

We are lean and mean.  Our balance sheets are in great shape in America.  There is a lot of liquidity out there.  I am eager to see the trigger, and I don't know what it is for that money to be spent putting Americans back to work, committing to capital expansion.  It's jobs and unemployment.  American businesses are in very, very good shape.

At this point, I am pleased to tell you that recent anecdotal evidence leads me to believe that conditions are improving for small businesses.

While credit availability seemed to improve for large companies throughout the past year, small businesses still complained of difficulty in gaining access to credit. Recent anecdotes lead me to believe that conditions are improving for small businesses.

The drag of uncertainty on economic activity persists as we enter 2011. That said, I would argue that the pall of uncertainty has lifted somewhat, and improved visibility could encourage more business risk taking and consumer spending.

The conventional wisdom is that the credit market disruptions we've seen over the last year or so impede the financial sector's ability and willingness to extend credit to households and business firms, thereby creating an additional drag on spending. But causation can flow in the opposite direction as well. When overall economic activity seems poised to contract, the outlook for household income and business revenues deteriorates as well. This implies that individual households and businesses will become less creditworthy, all else constant.

...

My reading of the history of U.S. business cycles is that the direct effect of credit markets on real activity – the so-called "credit channel" – accounts for only a small part of the variation in output over the typical cycle. This judgment may be of limited help in thinking about the rather atypical events we have been experiencing recently, but I think it means we have to give serious consideration to the idea that this episode of credit and financial market turmoil is part of the economy's natural response to the sharp decline in the underlying fundamentals in housing finance. My sense is that the deterioration of economic conditions is playing a more prominent role in the tightening of credit terms right now than the direct effects of financial market turbulence.

Although the current financial and economic situation remains quite difficult, I believe that the most likely scenario over the next year or so is one in which economic activity firms during the second half of this year and then gathers some strength in 2009. In the near term, consumer spending is likely to receive a boost from the rebates that are now flowing to taxpayers. Although the timing and the magnitude of the spending response are uncertain, economic studies of the previous experience suggest that a noticeable proportion of households respond reasonably quickly to temporary cash flows. Of course, the stimulus to domestic production will depend on the extent to which the additional demand is met by a temporary drawdown of inventories or an increase in imports rather than by an expansion in domestic output. But to date, businesses appear to be keeping tight control on inventories, and a reasonable assumption is that we will see a temporary lift to the economy in coming months.

Looking ahead, our outlook at the Chicago Fed is for continued weakness in real GDP over the near term. Activity is likely to remain weak for a number of reasons. Strains on intermediation and financial balance sheets mean that credit conditions will likely continue to restrict spending for some time. Businesses and consumers could limit their discretionary expenditures because of caution over the economic environment. And housing continues to be a downside factor. The unsold inventory of homes will continue to restrain residential investment, and it will take time for this overhang to unwind.

However, eventually the cumulative adjustments in house prices will bring more buyers into the market and activity will stabilize. While we don't expect any significant contributions to growth from residential construction for some time, the drag from the sector ought to at least diminish as we move through the rest of this year and next. Similarly, as financial market participants revalue portfolios and repair their balance sheets, the drag from credit conditions ought to diminish over time. Furthermore, even given the financial turmoil, the stance of monetary policy is accommodative and supportive of growth. Productivity growth, although below the lofty rates enjoyed in the late 1990s and earlier this decade, is still solid. Finally, the effects of the fiscal stimulus bill are likely to boost spending in 2008.

t’s really a question of, are we getting the bang for the buck? And clearly we’re not. The system was sputtering. And I began to feel that at 3.5%. After that, that’s when I dissented. Obviously for this next go-around, I have to watch to see if there is any change in signals. I’m just starting my briefings now for this.

What I’m hearing from CEOs is … the first quarter may have been positive, the second quarter’s probably not. There are real concerns about small businesses. Why? Because they’re not getting access to credit. … The credit system strikes me as being at the heart of the problem. And obviously the Fed has worked very hard on this. I’ve been in favor of every one of these [liquidity] initiatives. To me that’s where the priority is. To get the other to work the way we’re used to it working, it just strikes me that that has to get back to its efficient transmission mechanism.

Until recently, the deflating housing bubble had not spilled over to the rest of the economy. But now it has. Based on monthly data that cover most of the first quarter, it appears that growth in consumption and business investment spending has slowed markedly after years of robust performance, and, as a result, the economy has all but stalled and could contract over the first half of the year.

Business investment faltered late last year, with weaker sales of autos and construction materials apparently playing important roles. Most of the fundamentals for business investment are still quite positive, however; profitability is high and the cost of capital is still fairly low, despite recent financial market developments. Thus investment could well maintain momentum this year, I believe, and we have been seeing some favorable signs.

In fact, at least until quite recently when measures of business spending weakened, non-residential construction served to offset a portion of the impact of the housing investment slowdown.

Over the next year or so, the economy appears likely to expand at a moderate rate, close to or modestly below the economy's long-run sustainable pace. Core inflation is expected to slow gradually from its recent level, reflecting the reduced impetus from high prices of energy and other commodities, contained inflation expectations, and perhaps further reductions in the rate of increase of shelter costs and some easing in the pressures on capital and labor resources. However, substantial uncertainties surround this baseline forecast.

On the business side, I look for capital spending to continue to expand at a decent pace again this year. Stronger economic growth abroad will also boost American exports. These two sectors - business spending and exports - are likely to mitigate the effects of a slowdown in the consumer and housing sectors.

The outlook for business investment should remain quite favorable even as the pace of overall activity moderates. Against a backdrop of sustained growth in sales, businesses should be well positioned to undertake potentially profitable projects.