Bet Your Bottom Dollar
The authors explain that the past few months have seen monetary and fiscal authorities grow more aggressive in combating the less-than-robust recovery. While gradual progress remains the theme of their forecast, the authors recognize that recent positive developments have given them cause to upgrade their near-term outlook.
In November, the Federal Reserve announced a second round of quantitative easing (dubbed QEII). With the purchase of $600 billion in government bonds, the Fed aims to spur investment – and thus, the economic recovery – by lowering borrowing costs and reducing uncertainty around deflation. The policy has been mildly successful so far. Real interest rates have fallen from their pre-announcement levels, and TIP spreads – a measure of inflation expectations – have risen. President Obama followed suit by announcing another round of fiscal stimulus earlier this month: a three-part cocktail of Bush-era tax cut extensions, payroll tax cuts, and unemployment insurance extensions. All together fiscal and monetary stimulus will boost real GDP by close to a full percentage point in 2011.
The Sun Will Come Out, Tomorrow
However, beyond the near-term, Caranci and Marple stress that growth over the next two years will come less from additional bouts of stimulus and instead from a gradual weakening of the very forces that have been dragging on growth to begin with. The economy will not be "stuck in neutral indefinitely," they write. "We will undoubtedly see stronger growth the further along the economy moves in the process of correcting these imbalances."
Indeed, signs of improvement are already peeking through the data. In October, job openings rose to their highest level in over two years. November's weekly jobless claims hit a low not yet seen during this recovery. Constraints on credit appear to be easing as well. The authors explain that improved credit conditions will act as a boon for business investment, whose dramatic pull-back during the recession resulted in the first outright decline in the nation's stock of machinery and equipment since 1943. "The combination of an improved growth outlook, low real interest rates, and tax incentives provides a strong incentive for businesses to reinvest in capital and increase hiring," they write.
Despite this bright spot in the outlook, household deleveraging will continue to temper consumer spending growth, which accounts for sixty percent of U.S. economic activity. With the personal savings rate hovering around six percent, up from 1.8 percent in 2007, it is clear that the deleveraging process is well underway. "A high savings rate may limit growth today, but it will pay dividends down the road," says Caranci, "and our outlook reflects that."
Still Thinkin' About Tomorrow
Still, "we must admit that not all developments since September have been positive," write Caranci and Marple. Recent government stimulus does little to combat the root cause of America's economic ills: a still-distressed housing market and weak household balance sheets. As long as the inventory of existing homes remains elevated and households continue to deleverage, the U.S. economy will continue growing below its potential.
The supply of seriously delinquent mortgages is now roughly as large as the inventory of unsold existing homes. Working through this supply is a process that will take years, not months. Until then, home prices and, by extension, household wealth will remain constrained. According to Caranci, "Stimulus measures may provide a temporary boost to GDP, but it is not going to help a struggling homeowner keep up with mortgage payments."
Furthermore, Europe's sovereign debt problems could have negative implications for the U.S. recovery. A weaker Euro would hurt American exporters, who will have to contend with cheaper European products. And should financial markets seize up again, or investors get nervous over America's own fiscal position, the resulting increase in borrowing costs would extinguish any hope of a speedier recovery.
Nevertheless, the further along the economy moves from 2008, when everything came crashing down so spectacularly, the more will economic activity pick up, they reason. But, it will be a long slog. "The U.S. economy is certainly moving along the road to recovery, but the path is a long one and, as before, fraught with perils."
