Market Update – Jan. 3, 2012

Richmond Fed President Jeffrey Lacker gave a speech two weeks ago concerning lessons from the past year of US macroeconomic performance.  He made several interesting points that I’ve tried to summarize below.  President Lacker had overestimated how much the economy would grow in 2011.

Persistent Factors Impede Growth

“The most significant lessons learned over the course of this past year, in my view, concern the importance of relatively persistent impediments to economic expansion in the US.”  He described the following persistent impediments:

1. “The still-overbuilt housing market tops the list of persistent factors that continue to impede growth.”  Residential construction normally expands during recovery, but it’s been flat.  The fact that there is low demand for new homes despite low mortgage rates indicates that home building is likely to remain depressed for some time to come.  All gains in residential construction have been in multi-unit rental properties – indicating a shift away from home ownership.

2. Consumer spending is expanding at a more moderate pace than in past recoveries.  There are diminished income prospects and tighter credit terms.   These factors have resulted in consumers paying down debt and building up savings.

3. Labor market conditions improved at a disappointingly slow pace.  “Evidence suggests that one impediment to more rapid employment gains is the magnitude of the skills mismatch between the unemployed and the needs of the growing segments of the economy.”  It is possible that this accounts for one percent of our unemployment rate.

4. “Another impediment to growth cited by a wide range of observers is the array of changes in tax and regulatory policy, both actual and anticipated.  There are persistent anecdotal reports that these policy changes are discouraging firms from making new hiring or investment commitments.”

5. “The murky federal budget outlook also imposes significant uncertainties on consumers and businesses.  Realistic projections under current law show federal debt outpacing our national income for decades to come, with no bound on the ratio of debt to GDP.  This simply is not feasible.”  “Any sustainable configuration of fiscal policy” will affect a broad range of citizens either through higher marginal tax rates, cuts in programs’ benefits or reductions in government payrolls and supplier contracts.

Other Lessons

1. Inflation can accelerate despite elevated levels of unemployment.  As of last December (2010), the twelve month inflation rate was 1.4%.  To date (2011), inflation has averaged 2.8%.  This was more than just food and energy; it was broad based.  Core inflation was .9% last December and has averaged 1.9% this year.

2. “Monetary policy is often credited with entirely too much influence on real growth.  Monetary policy is about inflation – that is, the value of money.  Growth is governed almost entirely by the evolution of a society’s technology, skills, resources and trading opportunities.  This might be consistent with everything else already discussed – maybe monetary policy was able to increase inflation, but not improve employment.”

Future Risks

President Lacker anticipates growth of 2% – 2.5% for 2012.  He sees three risks to his forecast:

1. “The accretion of consumer confidence in their economic prospects could proceed either more or less rapidly than projected.”

2. “The pace that which businesses have invested in equipment and software has surprised on the upside throughout the recovery.  While some moderation in the rate at which that investment is expanding seems likely, we could easily miss on that forecast.”

3. “The trajectory of economic activity in Europe is likely to hold significant implications for US growth in the coming year.  Euro areas governments are grappling with the financial market volatility that inevitably follows from ambiguous commitments to protect creditors using taxpayer funds.  In this case, the ambiguity surrounds protection that might be forthcoming, both for sovereign debt holders and the creditors of large European banks.  The rapid fiscal and balance sheet adjustments, and the accompanying uncertainty regarding prospective tax policy, appear to be dampening euro zone growth, and that is likely to cut into US export demand in the year ahead.”

If you enjoy this blog, please forward it to others who may be interested.

If you want to receive these emails, here’s how:

1. click on this link  (or type www.leedsonfinance.com into your browser)
2. toward the top right corner is a place to click on for email service — click and enter your email address
3. you will receive an email which will require you to click on a link to confirm that you want to be on the list

IMPORTANT: if you don’t receive the email in step 3 or you don’t click on the link, you won’t be on the list.  Sometimes, people who use corporate emails get blocked (it’s probably 50% of the time).  So if you don’t get the email, you know you need to use a personal email.