Transcript Slide

The Outlook for the Economy and Challenges
for Monetary and Fiscal Policymakers
The Outlook for the Economy
Dallas, Texas
July 8, 2011
Mark Thoma
Department of Economics
University of Oregon
The GDP Gap
Is the Recent Slowdown Temporary or
Permanent?
• GDP grew at a 1.8% in Q1 of 2011, a significant slowdown
from the fourth quarter of 2010.
• How much is due to temporary factors: effects of the
supply chain disruptions caused by the earthquake in
Japan, the recent tornadoes and floods in the South and
Midwest, and the spike in commodity prices, especially oil?
• But, the pace of hiring slowed in May, with only 54,000
jobs added to nonfarm payrolls
• The unemployment rate stalled
• Growth of household spending has tapered off
• Housing prices continue to fall lowering consumer wealth
• Manufacturing growth has slowed
FRBSF Forecast of GDP Growth
IMF Forecast of GDP Growth
FRBSF Forecast of Employment Growth
FRBSF Unemployment Forecast
Employment Recovery Likely to be Slow
Weak Links
Real Private Residential Fixed Investment
Real Private Non-Residential Fixed Investment
Real Personal Consumption Expenditures
Real Personal Consumption Expenditures
Net Stimulus Small, and Set to Contract
To summarize, our results indicate that, so far, the federal fiscal expenditure
stimulus has mostly compensated for the negative state and local stimulus
associated with the collapsing tax revenue and the limited borrowing
capacity of the states. While this is a significant accomplishment, the net
effect is that the consolidated fiscal expenditure stimulus is small, at a time
when the private sector’s deleveraging has reduced private consumption.
“On the ease of overstating the fiscal stimulus in the US, 2008-9,” by Joshua
Aizenman and Gurnain Kaur Pasricha, NBER Working Paper No. 15784,
February 2010
Real Net Exports (Ex-Im)
Housing Prices are Still Falling
Nominal House Prices
Real House Prices
Inflation Remains Subdued
Key Challenges for the Economy
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Continued weakness in housing markets, with further house price declines a
possibility (likely). The resulting fall in wealth will cause households to devote
more resources to balance sheet rebuilding and less to consumption.
Short-run fiscal risks: debt ceiling not raised (interest rates spike, stay high, loss of
credibility in longer run leading to higher interest rates, global repercussions due
to loss of safe asset), lower demand due to deficit reduction.
Long-run fiscal risks: deficit not brought under control (higher interest rates, less
ability to respond to a crisis, deficit monetization and inflation)
Additional commodity price shocks. This could impact both growth and inflation
(though the effects on inflation are generally transitory).
Tight credit supply conditions. I don’t think this risk is large. To the extent this is a
problem, it’s lending standards not the availability of funds.
Though things are looking a bit calmer recently, events in Europe could create a
new global financial shock.
Inflation, property bubble, etc. problems in China. There are lots of uncertainties
here, and a slowdown in China would have global consequences.
Upside: Perhaps pent up demand kicks in, and we takeoff. But I hope monetary
and fiscal policymakers aren’t counting on this (even though they seem to be
doing just that).
Short-Run Policy Differences: Austerity
versus Stimulus
• There are two competing views, austerity and stimulus
• The austerity advocates want immediate deficit reduction. They argue that
such reductions will increase business confidence and spur the economy.
• Those who admit that austerity will be painful in the short-run make a
different argument, that pain now avoids even more pain later.
• The other side says we tried this in the Great Depression, they’ve tried it
in Europe, and it’s clear it doesn’t work.
• Our long-run debt problem is really a health care cost problem, and the
real acceleration in these costs won’t occur for many years.
• Thus, we have time to sort this out without wrecking the economy.
• What we need is short-run stimulus and a credible plan for long-run debt
reduction.
• But in any case, reducing deficits and reducing demand right now would
be harmful to the recovery, and harmful to long-run growth.
Short-Run Policy Differences: Cyclical
versus Structural Unemployment
• In normal times, we think of full employment as being equal to the
level of frictional and structural unemployment, and this is
generally in the 4%-5% range.
• The unemployment rate is currently 9.1%, and there is a debate
about how much of this is structural and how much is cyclical (think
of this as supply versus demand factors).
• If the problem is mostly structural, there’s not much that
policymakers can do to help (though they aren’t completely
helpless).
• If the problem is cyclical, there’s quite a bit that can be done
through policies that stimulate demand.
• I think that the problem is mainly cyclical. There has been some
structural increase, but I agree with the FRBSF that it’s probably less
than 2% of the increase.
Short-Run Policy Differences: The Debt Ceiling
Debt Levels Around the World
250
200
150
100
50
Japan
Greece
Singapore
Sri Lanka
Belize
Dominica
Malta
Jordan
Ghana
United States
Guyana
India
Malaysia
Tunisia
Aruba
United Arab Emirates
Serbia
Sweden
Bolivia
Bosnia and Herzegovina
Lithuania
Macedonia
Senegal
Indonesia
Algeria
Zambia
Ecuador
Uganda
China
Bulgaria
Qatar
Estonia
Azerbaijan
0
• Previous bar graph was for 2009
• This graph is for 2010
• Note that the US moved from 65th place to 37th in one year, and as a
% of GDP from 36.8% to 59.9%
• The change is partly due to the fall in taxes and increase in spending
on the recession, but it reflects LR trends as well
• But in the LR, debt expected to grow to 175-200% of GDP by 2035
Sources of Recent Changes in the Debt
CBO’s Long-Run Debt Projections
Long-Run Policy Difference: The Size and
Role of Government
• In the long-run , and it’s at the heart of budget negotiations
over health care costs and other social insurance programs,
is the size and role of government.
• Will taxes be increased to support new and existing social
insurance programs, or are we headed for a smaller
government sector in the future? Should government do
more or less?
• My own view is that as societies grow wealthier, they tend
to purchase more insurance for their citizens, and I expect
we’ll do the same.
• But it won’t happen without a fight over how to pay for it,
and who controls the government in the next decade or
two will have a large impact on how this plays out.
Monetary Policy Challenges for the
Federal Reserve
• The biggest challenge is reducing the size of the balance
sheet to prevent inflation without killing the recovery
• Because of the long and variable lags in monetary policy –
estimates of 9-18 months to reach the peak impact are
common – the Fed will be inclined to tighten before it
knows for sure that the economy is on solid ground.
• If it gets this wrong and begins too soon – and some Fed
official seem to have an itchy trigger finger – it could
hamper the economy’s ability to recover or even help to
send it into a second dip.
• They could get this wrong, but right now it’s far from my
biggest worry.
The Fed’s Balance Sheet
Signals the Fed is Beginning to Tighten
• First step will be to test the waters by stopping the
reinvestment of the proceeds from maturing
securities
• Next will be actual asset sales, and I think the pace
will be “measured.”
• Finally, they will raise the federal funds rate, again at
a “measured pace.”
When Will This Happen?
• I don’t expect the first step for several months, and it
will likely be longer than that.
• I don’t expect interest rate increases until the new
year, and that is conditional upon the economy
showing it is determined to maintain the recovery.
• That brings up the next point…
Will There be a QE3?
• Not unless there is clear evidence we are headed for
a double dip.
• But even that won’t be enough for some if it isn’t
accompanied by evidence of a deflation threat.
• That’s the key – if deflation is a threat, then I think
the Fed will respond.
• But the bar for this is high.
What Does This Mean for Banks?
• Interest rate risk from default, LR budget gap. Risk is
one-sided, rates already at rock bottom
• Inflation risk
• Regulatory uncertainty (e.g. cap req?)
• Commercial real estate
• Risk of slow recovery or second dip
• Commodity price spikes
• Yield curve – Hedge the risk of flattening?
• Change in status for the dollar
• Overzealous search for yield as things Improve (i.e.
watch for the next bubble)
Commercial Real Estate Prices: Indexes from
Moody’s and Case-Shiller
Commodity Price Indices