Some analysts were predicting a recession would hit the U.S. economy in the fourth quarter as consumers, hurt by falling house prices and the high cost of gasoline, cut spending.
It didn’t happen, and there is no reason to think it’s going to this year either.
Economic growth will be slow in the first half of 2008, and the unemployment rate, which was still a low 4.7 percent in November, is likely to rise. Housing sales and construction will continue to be a drag for months to come.
On the other hand, economic growth should accelerate in the second half of the year as financial-market conditions and the U.S. trade deficit improve, the housing drag lessens and the effect of the 100-basis-point cut in the Federal Reserve’s overnight lending-rate target in recent months begins to kick in.
Some optimistic analysts believe growth might rebound to a 3-percent rate in the second half.
Given the turmoil in financial markets, the risk of a recession is hardly zero. Nevertheless, the current state of the economy simply doesn’t show the signs usually associated with one.
In a forecast released last Wednesday, Mickey D. Levy, chief economist at Banc of America Securities, said most recessions have begun after the Federal Reserve raises interest rates and “generates a slump in aggregate demand.”
“As a result, expansion peaks tend to be characterized by overhangs in inventories, too many employees and excess capital stock relative to output,” Levy said.
None of those conditions exists in the U.S. economy today and the Fed has eased to the point that rates are “now consistent with sustained growth in demand,” he said.
Many of the forecasts calling for a recession are based on an assumption that large losses associated with subprime mortgages and the securities backed by them will force banks to reduce lending big time. The resulting credit crunch will undermine business investment and consumer spending, the forecasters say.
There are scant signs of that happening.
The summary of the most recent survey of economic conditions conducted by the National Federation of Independent Business and released on Dec. 11 said, “There is no ‘credit crunch.’
“Only 3 percent of the owners cited the cost and availability of credit as their No. 1 business problem,” the summary said.
According to Levy, the same is true for many customers of big institutions hurt by subprime losses.
Large banks have adjusted their portfolios, yes. And they have cut back the leverage and lines of credit to hedge funds, venture capital funds, mortgage brokers and the housing sector.
In addition, instead of a slump in consumer spending and the beginning of a recession, households increased their outlays at a 2.5 percent annual rate in the fourth quarter, possibly more, according to estimates by economists.
Levy also expects Fed officials to cut their lending-rate target to 3.75 percent, 50 basis points lower than the current 4.25 percent.
The next meeting of the Federal Open Market Committee is Jan. 29-30 – and on Dec. 31, investors in Fed funds futures contracts put a 92-percent probability on a 25-basis-point cut by the committee.
Some more pessimistic analysts, such as Paul McCulley, fund manager at Pacific Investment Management Co., expect the economy to be so weak this year that the Fed will be forced to reduce the target several times.
Whatever Fed officials do, however, they will continue to have one eye cocked on inflation.
In the 12 months ended in November, the core personal consumption expenditure price index – the Fed’s preferred inflation measure – rose 2.2 percent, more than the 1.6 percent to 1.9 percent goal of various FOMC members.
The core consumer price index, which excludes food and energy items, rose 2.3 percent over the same period. With energy costs up a huge 21 percent and food higher by 4.7 percent, the overall CPI increased 4.3 percent.
Levy offers some solace, saying he expects the change in the core PCE index to drop to only a 1.7 percent gain this year.
Such a slowing of inflation and a rebound in economic growth would bring a deep sigh of relief at the Fed. •
John M. Berry is a Bloomberg News columnist.
