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| Author: | Roger M. Kubarych, Henry Kaufman Adjunct Senior Fellow for International Economics and Finance |
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June 30, 2008
Nikkei Financial Daily
A funny thing happened on the way to the recession: US economy has continued to expand. First quarter real GDP went up by 1% per annum, a mediocre result though a little faster than growth in Q4 2007. What’s more, the available monthly data indicate that real GDP may have advanced by as much as 2% per annum for the just-completed spring quarter. The US economy is once again demonstrating remarkable resilience to a string of enormous shocks. But can it last?
Many would argue that it can’t, and with some justification. The financial sector is a mess, with the big banks recording huge losses and the stock market selling off their shares. On average, the equity prices of large commercial and investment banks have lost more than half their value since the financial crisis hit a year ago. Nearly all banks say they are tightening loan standards, and credit availability has shrunk for households and businesses alike. The adverse impact has been limited so far, because most US corporations are still profitable and have relatively strong balance sheets. But in some sectors, notably commercial real estate, the sudden loss of credit has led some firms to postpone or even abandon major building projects.
In addition to the credit crunch, the US consumer is burdened by sky-high gasoline prices, a genuinely scary slide in housing prices, weak income growth, a heavy debt load, and an upturn in unemployment. Various surveys of consumer sentiment show a persisting erosion of confidence, in a couple of cases to the lowest levels ever recorded.
Yet, real personal consumption expenditures this spring are running sharply above the levels of the first three months of the year. So while consumers say they are worried, their actual spending behavior has held up remarkably well. One important reason is that receipt of $100 billion in tax rebates has given a big lift to retail sales, even as demand for autos, SUVs, and other gas-guzzling vehicles has plunged. When that injection in financial resources is used up, the US consumer will have difficulty maintaining, let alone expanding, their purchases.
However, it would be wrong to exaggerate the downside risks to the US economy:
First, US industry is benefiting from growth in the rest of the world, while the lower US dollar has made US exports more competitive. Solid increases in economic activity abroad are spurring demand for US products and services, especially in the high-tech area. While some US industries are deeply threatened by the persistence of record-high energy prices, especially autos and airlines, others benefit from increased energy exploration and development that will utilize US equipment and technical expertise. Moreover, the large US farm sector is a net beneficiary from the significantly tighter markets for grains and other agricultural commodities. Plus, farmers throughout the world will be rushing to increase output by acquiring new equipment, improved seeds, and more fertilizer. US firms are highly productive in all of these areas. US net exports, though still in deficit, have improved by about two full percentages points as a share of GDP over the past few years. There is an excellent chance that they will continue to contribute to GDP growth.
Second, the housing collapse is still ongoing, and there is little hope that a rebound will materialize this year. But the rate of decline in residential construction is almost certain to taper off, with less of a negative effect on GDP.
Third, the Federal Reserve is committed to providing adequately liquidity to the troubled banking system. For their part, the banks are taking steps to rebuild their capital. These efforts will not show immediate results, but they will reassure investors that the big banks will survive.
Fourth, monetary policy remains highly accommodative, and the Federal Reserve seems comfortable expressing its anti-inflation inclinations through rhetoric, rather than through an early shift to higher official interest rates. Moreover, the success of this year’s fiscal policy stimulus package will encourage Washington to adopt a similar bipartisan fiscal program after the November presidential election if personal spending appears to be weakening substantially then.
Over the past twelve months, the combination of a wrenching energy shock and an extraordinary banking crisis was not enough to trigger a recession. But it would be wrong to ascribe the resilience of the US economy and financial system solely to the healing powers of the marketplace. Timely, bold, and often controversial official policy actions helped stave off a recession so far. But it is by no means certain that a recession over the next year or so can be avoided without ongoing policy support from both the monetary and the fiscal side.
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