2009 Recession Will Be Severe: 'There Is a Global Deflationary Risk,' Roubini Says

Central bankers around the world are pulling out all the stops in order to combat a severe economic downturn that threatens to get even worse.

"There is a global deflationary risk," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor. "That's what central bankers are worried about."

In Europe today, the ECB and Bank of England slashed rates by greater than expected levels. Meanwhile, the Fed and Bank of Japan are taking "unorthodox actions" to pump liquidity into their economies. Both central banks are engaged in "quantitative easing," meaning rates are effectively zero regardless of what the official policy is.

"The Fed is trying to preemptively avoid a deflation trap [which] is very dangerous," Roubini says. "Whether they'll be successful or not, I don't know."

The problem, he says, is there's going to be a "severe recession" both in the U.S. and globally in 2009. That means falling demand for goods and increased slack in the labor markets. That will put further downward pressure on prices and raise the risk of outright deflation, which is defined as: A persistent decline in general price levels, typically accompanied by a severe contraction in employment and economic output.

"It's hard to undo the structural factor" of falling demand meeting a supply glut of goods and services, he says, recommending the following policy actions to try and stem the deflationary tide:

• A "huge" fiscal stimulus package: $500-$700B.
• Recapitalize the banks faster, i.e., get TARP money distributed sooner.
• Rather than focusing on mortgage rates, reduce the face value of debt owed by "insolvent homeowners" in order for them to be able to spend again and avoid a "tsunami of foreclosures."