Aperiod of economic sluggishness may soon arrive, with plenty of import for the 2008 election. Federal Reserve Chairman Ben Bernanke warned Congress’ Joint Economic Committee on Nov. 8 that the Fed “expected the growth of economic activity would slow noticeably in the fourth quarter from its [annualized] third-quarter rate,” which the Commerce Department reported to be 3.9 percent. Mr. Bernanke, who later in his testimony acknowledged that he and the Fed had significantly underestimated the depth of the ongoing housing recession, projected that growth would remain “sluggish during the first part of next year.” He added that the Fed expected the economy to strengthen later next year “as the effects of tighter credit and the housing correction began to wane.”
The Fed’s projection of a rebound next year following anticipated sluggishness may be overly optimistic. For example, it seems at odds with Morgan Stanley’s economic forecast, which predicts that the economy will grow by an anemic 1.8 percent in 2008. Morgan Stanley recently observed that “ eal U.S. growth near zero over the next few months is possible” — just as voters head to the polls to select presidential nominees.
On Oct. 31, following relatively positive reports on economic growth and employment, the Fed lowered its short-term target interest rate by a quarter-percentage point. That reduction, which followed September’s aggressive half-percentage-point cut, brought the federal-funds rate to 4.75 percent. In his testimony on Nov. 8, Mr. Bernanke hinted that the Fed was unlikely to lower this rate again this year.
When the Fed cut short-term rates so aggressively in September, it did so in part because nonfarm employment had declined by 4,000 jobs in August, following lackluster employment growth of 69,000 jobs in June and 68,000 in July. However, subsequent revisions lifted job growth in July to 93,000 and reversed August’s initial job loss into a gain of about 90,000 jobs. The initial September employment report reflected a gain of 110,000. This, then, was the employment situation confronting the Fed at its Oct. 30-31 meeting: Recent employment growth certainly wasn’t torrid, but it was treading above previously reported levels that would have signaled a possible recession.
Also on Oct. 31, the Commerce Department reported that gross domestic product (GDP) increased at an annual rate of 3.9 percent during the third quarter. However, there is good reason to believe that an unusual quirk significantly understated the annualized increase in the third-quarter GDP price index. The effect of an understatement in inflation would be to overstate real growth. The GDP price index for the third quarter increased at an annual rate of only 0.8 percent, which seemed to defy reality. The last time this price index rose slower than 0.8 percent in a quarter occurred in 1963. So, third-quarter growth was probably overstated by at least 1 percentage point, perhaps more. In any event, as noted above, the Fed and private forecasters expect an imminent slowdown.
Financial markets remain quite fragile, as the debacles at Merrill Lynch and Citigroup demonstrate. (And check out the “ABX cliff-diving” graphs at the Calculated Risk blog.) Meanwhile, as the dollar continues to decline and the price of oil continues to soar, inflationary pressures mount.
On Nov. 2, two days after the Fed lowered the overnight rate, the Labor Department reported that the economy generated 166,000 new jobs in October. However, given the ongoing fragility in the financial markets and the likely imminent slowdown, the Fed was right to ease a bit two weeks ago. But that insurance policy continues to exact a big toll on the dollar. The Fed remains perched on its tightrope.
The Republican Party is performing its own high-wire act. An election-year growth rate below 2 percent would likely be accompanied by a rising unemployment rate. Congressional Republicans and the White House recently have been ecstatic in hailing the “Bush boom,” even as prospective voters have been telling pollsters that they trust Democrats more than Republicans to “do a better job” handling the economy (50 percent to 35 percent), taxes (46 percent to 40 percent) and health care (54 percent to 29 percent), according to the latest ABC News/Washington Post poll. A recent Pew poll revealed the biggest two-party gap in 20 years (29 percentage points: 54-25) as respondents said they believed the Democratic Party “is more concerned with the needs of people like me.”
There are good reasons for voters to be cranky. As the 2007 Economic Report of the President reveals, median family income (measured in constant 2005 dollars) peaked at $57,508 in 2000 but languished at $56,194 in 2005, the latest year for which data were available (and the fourth year of the Bush expansion). Meanwhile, during the fifth year (2006) of the “boom,” median earnings of full-time, year-round workers declined for the third year in a row for men and the fourth year in a row for women. A high-wire act indeed.