The Macroeconomic Outlook Deteriorates

Paul Krugman is not yet ready to forecast a recession--not quite:

The Bubble Bursts - Krugman - NYT Web Journal: Paul Krugman: Just a wonkish note about how bad the macroeconomics of all this could be:

If you look at the most leading of the indicators on housing, stuff like new home sales and applications for permits, they're off more than 20 percent from a year ago. If that translates into an equivalent fall in residential investment, we're talking about a fall from 6 percent of the G.D.P. to 4.8 percent. And this may be only the beginning; I wouldn't be surprised to see housing investment drop below its pre-bubble norm of 4 percent of G.D.P., at least for a while.

Add to this the likely effect of a housing bust on consumer spending and you've got a direct hit to G.D.P. of, say, 2.5 percent or more. That's bigger than the slump in business investment that led to the 2001 recession. And the main reason the 2001 recession wasn't as deep as some feared was that the Fed was able to engineer... a housing boom. What will the Fed do this time?

Maybe rising business investment and a declining trade deficit will soften the blow. But it's remarkably easy, playing with the numbers, to come up with scenarios in which the unemployment rate rises above 6 percent by the end of 2007. That's not a prediction, but it's well within the range of possibility...