Friday, January 14, 2011

Fed's Rosengren: Two Key Questions about the Economic Recovery

by Bill McBride on 1/14/2011 02:31:00 PM

From Boston Fed President Eric Rosengren: Two Key Questions about the Economic Recovery

The first question is, what role will housing play in the recovery? ... housing has traditionally been an important sector of the economy for generating recovery. ... I expect housing will not provide as much support to this recovery as it has in previous ones. My sense is that residential investment, consumer durables, and services related to housing will be less robust than is usual in many recoveries, thus playing a role in what I think will be only a gradual improvement in the economy and employment.

To put it plainly, these housing-related headwinds are part of why I do not expect growth greater than 4 percent this year. And while 4 percent is not terrible, at that rate it will still take a very long time to get back to full employment.
The real laggard in this recovery has been housing. While housing is a relatively small component of GDP, it can be quite volatile – and often grows rapidly during an economic recovery. In addition, purchases of appliances, home furnishings, and housing-related services are impacted by slowed housing activity. Given the problems that flow from the bursting of the housing bubble, Figure 5 [below] shows that residential fixed investment is roughly where it was at the trough of the recession – and thus not providing its more usual contribution to growth in the early stages of a recovery.
Residential Investment
The above graph is from Rosengren (PDF version here).

This shows the lack of contribution from residential investment in the current recovery. If Rosengren had included earlier recessions, many would like the 1982 recovery!

And on inflation:
A second key question involves the concerns about Fed actions stoking inflation. ... Some observers and analysts have voiced great concern that the nascent economic recovery, combined with the actions of the Federal Reserve that have expanded its balance sheet, will lead to significant inflation. However, Figure 11 [see previous post for similar graph] provides a variety of different measures of core inflation; core CPI, core PCE, trimmed core CPI and trimmed core PCE. It is striking how much all four series have declined. In fact many of these series are at their historical lows.
While we have been experiencing disinflation generally, it is not the case for all prices. ... some prices have risen rapidly. Energy prices in particular have been rising, in response to robust growth in emerging markets. But outside of energy prices, most prices have shown little increase, and in fact a number of the major categories in the CPI index have experienced declines in prices. ... my primary concern about rising energy prices is not so much that they will lead to higher inflation, but that they will subtract from household income and thus weaken the economy.
I've highlighted this many times: residential investment is usually a strong engine of recovery, but not this time because of the large excess inventory of vacant housing units. I think residential investment will finally add to GDP and employment growth this year, but the increase will not be robust.