Last February, Sandra Pianalto, president of the Federal Reserve Bank of Cleveland offered this view of the year to come:
What about the outlook for 2006? Most forecasters are expecting another solid performance. Forecasts published by Blue Chip Economic Indicators, the Congressional Budget Office, and NABE economists generally call for real GDP to expand by roughly 3-1/4 to 3-1/2 percent this year. Housing investment is generally expected to slow, while business fixed investment is expected to increase. These forecasts call for interest rates, the unemployment rate, and core inflation to remain steady...
I was thinking about that as I processed the flurry of economic news at the end of last week. The basics were covered well, as usual, by The Nattering Naybob (here and here) and The Skeptical Speculator (here and here), but there's no doubt that the slow housing investment part of the story is on track. Calculated Risk covers both the quantity side (for July) and price side (for Q2) of that particular equation, but the big question remains (of course) how deep the bottom lies. John Smith reports on this opinion, from A. Gary Shilling at Forbes...
I expect at least a 20% decline in median single-family house prices nationwide, and that number may be way understated.
... but as Arnold Kling notes, Shiller-Case futures on home prices suggest "a rate of decline of 5% a year... by May 2007." And that is for 10 of the most bubbly -- er, frothy -- markets in the country. Not trivial, but still, it seems to me, in the realm soft-landing expectations. I'm reminded of these words, from Chairman Bernanke, also last February:
... a number of indicators point to a slowing in the housing market. Some cooling of the housing market is to be expected and would not be inconsistent with continued solid growth of overall economic activity. However, given the substantial gains in house prices and the high levels of home construction activity over the past several years, prices and construction could decelerate more rapidly than currently seems likely. Slower growth in home equity, in turn, might lead households to boost their saving and trim their spending relative to current income by more than is now anticipated.
If we've reached that level in the housing market (in fact and in expectation), it did not show in the consumer spending numbers for the first half of the year (which not everyone is happy about). And despite Nouriel Roubini's insistence of the pervasive influence of the residential housing market on employment, I just don't see it:
In her February speech, President Pianalto made this observation:
Perhaps the most interesting trend is the pattern of labor-force participation - that is, the fraction of people who either have a job or are actively seeking a job...
Has this episode of slower employment growth resulted from demand conditions, supply conditions, or some combination of both?
If it is defined as a demand condition, perhaps poor job prospects have discouraged people from even attempting to find work. Will another year like 2005 reverse the recent trend? And does that mean that monetary policy should be accommodative until the economy is once again generating substantially more than 2 million new jobs per year?
Alternatively, if the lower labor-force participation rate is defined as a supply condition, then it may be driven by younger workers' deferring entry into the labor force - perhaps to obtain more schooling and skills. If that is the correct explanation, then potential employment will be calculated much differently from the number we saw in the 1990s. In that case, attempting to spur more rapid job growth with an accommodative monetary policy is exactly the wrong thing to do. It will not accomplish the goal of maximum sustainable growth in the long run, and it may threaten our goal of price stability.
William Polley agrees that the million person (or so) question is how to interpret a net job creation number like the 128 thousand, and so do I. But here is a pretty reasonable stab at a ballpark answer, from knzn:
Payroll growth at 128,000 is right in the middle of the range of values that are typically given as being sufficient to absorb the expected population growth. If you think the long-term trend in labor force participation is accelerating downward, then 100,000 might be enough, but if you attribute the decline since 2000 to a weak job market, then something like 155,000 are necessary. I tend to lean toward the high end of that debate, meaning I think that the August growth was a bit weak, but there is room for disagreement. Interesting that construction employment was up. Given what builder confidence indicators are saying, I expect that will change in coming months. Other than that I haven’t yet found anything interesting in this report.
Given that, if 128k is weak job growth, it isn't really that weak.
What of the other part of the storyline -- that business investment will help ease the pain of falling investment in residential structures (and any collateral impact on consumer spending)? The headline report on manufacturer's shipments, inventories and orders for July wasn't great, but the details were morecomforting. From MarketWatch:
Demand for U.S.-made factory goods fell 0.6% in July on a large drop in orders for transportation goods, the Commerce Department said Thursday.
Excluding the 10.1% decline in transportation orders, factory orders rose 1.1% in July, the government said. The 0.6% decline was slightly stronger than the 0.9% drop expected by economists surveyed by MarketWatch. In addition, June's increase was revised higher to 1.5% from 1.2%. See Economic Calendar.Shipments of factory goods were unchanged in July. Shipments of durable goods fell 1.3%, led by the 6.7% drop in transportation goods.
OK, the auto sector is struggling. But overall manufacturing activity is holding up pretty well:
Almost everyone acknowledges that the economic growth projections made at the beginning of the year were higher than now seems plausible. In her speech, President Pianalto warned...
No one, of course, is expecting that every detail of these forecasts will prove to be precisely accurate. We have to acknowledge reality: Any forecast is only as good as our ability to look into the future and foresee the unforeseeable.
... and Chairman Bernanke suggested
The possibility of significant further increases in energy prices represents an additional risk to the economy; besides affecting inflation, such increases might also hurt consumer confidence and thereby reduce spending on non-energy goods and services.
That, it seems to me, is the real story. The general pattern of economic activity thus far this year has played out about as expected, excepting the negative influence of yet another round of energy price shocks. If there is part of the forecast that really does seem out of whack, I think it can found in how broad-based the influence on inflation appears to have been.