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February 27th, 2012 - Steven C. Agee

Economic Update


The good, bad and ugly: A snapshot of the economy and outlook for 2012




Steve Agee 177mh_10-58x13-37cm

THE GOOD
The domestic economy appears to be gaining momentum in the first quarter of 2012. This is a continuation of progress that was made in what appeared to be a rather lackluster 2011, until you break it down quarter by quarter. In retrospect, real GDP grew in the first half of 2011 by about 1%.

In the third quarter it improved mildly to just under 2%, and then to a more robust 3% at an annualized rate in the fourth quarter. The labor market has improved, with job gains accelerating to around 200,000 per month, which was sufficient to lower the unemployment rate to a nearly three-year low of 8.5%.

Manufacturing and consumer confidence are showing signs of sustained upward movement and we continue to operate in an extraordinarily low interest rate environment due to the accommodative policies of the Federal Reserve.

THE BAD
The unemployment rate is falling principally due to the fact that non-farm payrolls are increasing, while labor force participation stays flat to lower. Economists would like to see a growing labor force to accompany faster job growth and falling unemployment.

It appears unemployment will continue to be a drag on the economy since there are nearly 6.4 million individuals in the United States that are currently not in the labor force, but say they want a job. This represents almost 2 million more than at the start of the Great Recession.

Over time, these individuals will likely re-enter the workforce, be counted as unemployed, and thus either put upward pressure on the unemployment rate or reduce the likelihood of it falling much below its current level.
The housing market also continues to be a drag on the domestic economy. Most economists think we are near a bottom, but prices continue to fall and likely have further to go before they turn up. Average nationwide home prices have fallen about one-third from their peak; and fell about 4% in 2011.

There are a large number of individuals whose homes are either in the foreclosure process or delinquent by more than 60-90 days in their monthly payments. The chart shows that although we peaked in these categories in 2010, there is still more than a 14-months’ supply of homes in distress versus an average three-month supply prior to the start of the contraction.

THE UGLY
Outside a completely exogenous (unexpected and unpredicted) shock, there are two major items that could turn what most economists predict to be a suitable recovery year (2.6% GDP growth) into an ugly scenario.
The first is the turmoil in Europe. The debt crisis in Europe is very real and extremely difficult to resolve, given the makeup of the European Union.

The European crisis affects the United States in several ways.

First, and not necessarily in order of importance, it weakens global trade, which negatively impacts U.S. exports to that and other regions of the world. Second, the U.S. stock market reacts to financial events in Europe mainly due to the fact that U.S. multinationals are big players in Europe. Gyrating stock prices affect consumer confidence and create uncertainty. Third, we must keep a wary eye on the availability of credit from European banks.

According to the Federal Reserve, foreign banks have tightened their commercial and industrial lending standards, but the impact on credit flows has yet to show up.

The second major item is the uncertainty, in a presidential election year, of how Congress will deal with our deficit and debt situation.

The payroll tax cut and emergency unemployment insurance benefits were extended through February. It is expected this will be further extended, but doing so will cost about $175 billion for a full year. Paying for these extensions is the central question that will have to be resolved.

In addition, as the stimulus plan originally passed in February 2009 continues to wind down, and as spending cuts agreed to last August kick in, it will have a definite drag on GDP growth. Further reductions in government spending, including federal, state and local, will have a negative impact on the prospects for a continued recovery.

It is certainly the case that 2012 will prove to be an interesting year for the economy. We will have much to watch, but the U.S. recovery has shown a great deal of resilience and it is expected we will continue our slow trajectory of growth in employment output with moderate inflationary expectations.

Agee is Dean and a Professor of Economics at Oklahoma City University.

Photo by Mark Hancock

 
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