Weekly Economic Commentary by Scott J. Brown, Ph.D.
The Long Road Back
March 3 – March 7
Five years ago, the economy appeared to be in freefall. Monetary policy and fiscal stimulus helped to halt the downslide, but a full economic recovery was still expected to take years. This wasn’t your father’s recession that we went through; it was your grandfather’s depression. We have made progress, but we still have a very long way to go.
The economy entered 2009 experiencing massive job loss. We were shedding nearly 800,000 jobs per month. It’s still frightening to think about. By the end of the year, job losses had ebbed. Job destruction has remained relatively low in the last few years, but hiring has been slow to pick up.
While some might joke that we simply ran out of people to fire in 2009, the truth is that monetary and fiscal policies played important roles. In a recession, automatic stabilizers kick in. Taxes fall. There is usually some recession-related increase in spending. The budget deficit rises (but is in no danger of crowding out private borrowing). President Obama pushed for an $800 billion stimulus package. The American Recovery and Reinvestment Act eventually cost $831 billion. John McCain, had he been elected, would have put forth a somewhat smaller-sized package. Some criticized the plan as wasteful; others criticized it as being too small given the magnitude of the economic contraction. A third of the stimulus was tax cuts, which did little to spur growth (a shift from spending to tax cuts was made to gain three Republican votes in the Senate). Spending was spread out mostly over just two years.
Rather than pump-priming, the ARRA can be thought of as simply plugging holes. It was large enough to stem the decline in economic activity, but not large enough to ensure a more rapid recovery. In hindsight, the ARRA reinforced what economists had generally believed – fiscal stimulus can have a rapid, positive effect on growth, but it is politically difficult.
The bank rescue and monetary policy also played important roles in halting the downturn. However, these efforts were never going to restore the economy’s strength overnight. Large firms were soon able to borrow from the big banks or go to the corporate bond market. For smaller firms, bank credit had tightened considerably in 2008. Five years later, credit is easier but still relatively tight. Small, newer firms typically account for a lot of the job growth during an expansion. Tight credit has limited the pace of recovery. However, it’s not simply an issue of the supply of credit. Many small firms with good credit don’t want to take on additional financial obligations until they see stronger demand for the goods or services that they produce.
The slow economic recovery has taken a toll. The longer cyclical weakness goes on, the greater the chance it becomes structural weakness. The Congressional Budget Office estimates that potential GDP has slowed in recent years. The output gap has partly closed, but the gap would have been a lot larger if potential GDP growth has remained at its previous trend. For the long-term unemployed, the stigma of being without work for a long time and the deterioration of work skills makes it ever more difficult to find a job. Many teenagers and young adults aren’t acquiring the skills that they would normally, which tends to have a long-term impact on their lifetime earnings.
In recent weeks, the economic data reports have reflected weather-related softness. More importantly, many of these reports (retail sales, industrial production, factory orders, real GDP) also showed significant downward revisions to figures for November and December. Hence, there appears to have been less positive momentum at the end of the year.
Poor weather was also an issue in February, but not as much as in January. Still, it may be another month or two before we get a good, clear picture of the economy. As noted previously, the March to June period will be critical to this year’s outlook.
February 24 – February 28
Harsh winter weather often shows through in the economic data. Large seasonal adjustment can magnify that impact. Snowstorms happen every year, of course – the key is whether they are worse than usual. This year, bad weather has been relatively widespread, affecting many areas of the country and much of the economic data for December, January, and February. None of the bad weather has had a significant impact on the longer-term outlook and investors have begun to take the economic news with an appropriate grain of salt.
Prior to seasonal adjustment, nonfarm payrolls fell by 2.87 million (-2.1%) in January. Retail sales sank 19.3% (with clothing stores down 52.2%, department store sales down 54.4%), reflecting the end of the holiday shopping seasonal. Housing starts fell 15.0%, following a 17.1% decline in December. These seasonal swings are huge, but they haven’t been significantly outside the usual winter patterns.
It’s not that the various government agencies don’t do a good job with the seasonal adjustment. For the statisticians, the methodology is about as good as it can get. Rather, seasonal adjustment is a difficult task in the winter months. Storms can have mixed effects depending on where they hit (Midwest, Northeast, South, West) and when then hit (weekday, weekend). All of this is taken into account in the adjustment.
In the last few years, there has been some concern that the seasonal pattern in nonfarm payrolls may have been distorted by the Great Recession. Job losses were at their worst in the first quarter of 2009, which may have altered the estimated seasonal pattern. As a consequence, adjusted first quarter job figures in later years would look somewhat better than they would otherwise. However, the seasonal adjustment will balance that out over the course of the year and any impact of one bad season would wash away over time.
While much of the recent economic data have been distorted by the weather, the economic outlook for 2014 as whole has remained optimistic. This is largely a story of reduced headwinds and increased tailwinds. Consumers are in generally better shape. Banks should gradually ease terms and lending conditions. Monetary policy will remain accommodative. Lawmakers have finally gotten their act together. We have a budget for both FY14 and FY15. The debt ceiling has been waved until March 15, 2015. Long-term budget challenges remain, but there’s no chance of a government shutdown.
Still, there are a few worries. The turmoil in emerging economies bears watching closely. In comparison to the Asian financial crisis of 1997, countries generally have adequate currency reserves and better technical expertise in how to deal with financial strains. However, capital crises are notoriously hard to predict (at least in magnitude, if not in direction).
Another concern is whether consumer fundamentals will remain supportive. Fourth quarter income and spending numbers will be revised on Friday. As the numbers stand now, the pace of spending was well beyond what would be justified by the growth in personal income. Spending figures are expected to be revised lower and income numbers often see relatively large revisions. However, inflation-adjusted income gains for the typical worker have remained relatively weak. You can still get aggregate gains in real income through job growth, but your average worker is simply running in place. Increases in housing wealth help to some extent (not through equity extraction – rather, consumers “feel” wealthier). Consumer debt picked up in 4Q13, which is not necessarily a bad thing.
The minutes of the January FOMC meeting showed “a clear presumption” of a steady pace of tapering. It would take a “substantial” deviation in the expected path of the economy to alter that plan. We’re still far from that at this point.
The New and Improved Producer Price Index
February 17 – February 21
For the financial markets, Fed Chair Yellen’s monetary policy testimony was largely about appearances. She did not rock the boat, pledging continuity in monetary policy. She was cool, confident, and in charge. However, her written comments contained only one brief mention of the inflation outlook. While some people are still worried that inflation will “take off” at some point due to the Fed’s accommodative policies, others are worried that the low trend in inflation could continue.
When Ben Bernanke became a Fed governor in 2002, he led the Fed’s fight against the possibility of deflation (a fall in the overall price level). The Fed feared deflation more than anything else. Deflation would reduce incentives to spend and invest, leading to even weaker growth and more deflation – “a death spiral.” However, by the end of his tenure as Fed chairman, Bernanke was a lot more complacent. What changed? Japan’s experience with deflation – moderate price declines, but no deflationary spiral – and the anchoring of long-term inflation expectations reduced the Fed’s fear. Expectations of inflation have remained remarkably steady in recent years, largely because the Federal Reserve had fought hard to achieve credibility. That’s not going to change under Yellen’s leadership.
Still, there are a number of concerns that a continued low trend in inflation could hurt the economy. For one, real interest rates are what matter. Lower inflation implies higher real rates and slower economic growth (than would have occurred otherwise). Some prices rise or fall more than others. A low inflation trend means that we’d likely see outright deflation in some industries, which could create a number of problems for business fixed investment. Borrowers naturally get some debt relief over time through inflation (this should be factored in for lenders as well as borrowers). A lower trend in inflation means less debt relief through inflation. Finally, a low trend in inflation could be signaling broader economic weakness.
Inflation is always a monetary phenomenon, but we observe it through pressure in resource markets. On Wednesday, the Bureau of Labor Statistics will expand the Producer Price Index to include services (in fact, 63% of the new headline figure will be services). The BLS has already released these data on an experimental basis, so we have some idea of what it looks like.
Up to now, the PPI report has been comprised of three separate gauges: finished goods (consumer goods, capital equipment), intermediate goods, and crude materials. The idea was to be able to observe inflation pressures marching through the pipeline. However, much of the growth in the economy over the last few decades has been in services. The new report will contain more detail on inflation in trade, transportation, warehousing, and other business services. Prices related to intermediate demand will be divided into four stages. It will be some time before economists and financial market participants develop a full appreciation of the details in the report. However, it seems unlikely that pipeline inflation pressures are going to be much of an issue in 2014.
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