Financial Perspectives – Spring 2009

Economic Outlook: A Recovery of Sorts
Timely Commentary from Raymond James Chief Economist Scott Brown

Recent data have suggested that the U.S. economy has likely bottomed. However, the recovery is not expected to be especially strong – at least, not initially. Fiscal and monetary policy will continue to provide ongoing support into 2010.

By the summer, economic reports generally indicated that the worst of the decline was behind us. Housing was showing some signs of stabilization (granted, at very low levels). Consumer spending had been a bit uneven, restrained through the summer by serious headwinds (a weak job market, tight consumer credit), but was not in freefall as it had been in the second half of 2008. Manufacturing activity also showed signs of improvement following a substantial inventory correction.

In past recessions, pent-up demand for housing and automobiles contributed to healthy rebounds in GDP, and there should be a little of that in the current recovery. However, the strains of a weak job market, tightness in bank lending and general restructuring of the economy are likely to make the initial recovery relatively soft. Bank credit for all types of borrowers (and especially for small businesses) is expected to remain abnormally tight for some time.

The impact of the $787-billion fiscal stimulus package, approved in February, has been slow to arrive. By mid-August, only 10% of the stimulus had gone out; half will arrive in fiscal year 2010. Federal Reserve policymakers have kept short-term interest rates down and indicated that rates are likely to remain low “for an extended period.”

The fiscal and monetary policy stimulus has generated some fears among investors. One is that runaway budget deficits will do long-term damage to the economy, boosting interest rates and weakening the dollar. However, much of the eye-popping increase in the federal deficit has been due to either cyclical (tax receipts fall in recessions, but rebound in recoveries) or temporary (the result of the bank rescue and the fiscal stimulus) factors. Yet, even after the economy recovers and the temporary spending fades, we will still face a structural deficit. Some combination of entitlement reform and tax increases may be needed to reduce the deficit, but in the current economic environment, federal tax rates are unlikely to be raised any time soon.

Many worry that the Fed, through its aggressive response to the financial crisis, has sown the seeds of higher inflation. However, given the large amount of slack in the economy, inflation pressures aren’t going to build any time soon. The Fed’s special liquidity and lending facilities will decay naturally over time. In addition, the Fed now pays interest on excess bank reserves it holds, which will more easily allow it to tighten monetary policy when the time comes.

Both Fed Chairman Bernanke and Chairman of the Council of Economic Advisers Christina Romer are experts on the Great Depression, and are acutely aware that a common mistake in shepherding recoveries from severe recessions in the past has been to remove policy stimulus too early.

There is no assurance any of the trends mentioned will continue in the future.

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