Sunday, May 25, 2008

When the economy revives, how will we know?

The following appeared on page 7D in the Sunday May, 25, 2008 issue of the St. Paul Pioneer Press.

By Jeannine Aversa
Associated Press

WASHINGTON - With any luck, the second half of this year will be better than the so-far rocky first half. The Federal Reserve chief hopes that is the case. So does President Bush.

For the rest of us mere mortals, it feels like the pain is getting worse.

When the economy begins to snap out of its funk, how will we know?

Like calling a recession, pin-pointing the turnaround can be as much art as science. Economists agree there could be some strong signals to look for, however: A calmer stock market, an end to falling home prices and more jobs being created.

We're not there yet.

The economy by all accounts is suffering through difficult times, although some economists have backed off the recession talk. Economic growth has slowed sharply and employers have cut jobs for four months in a row as problems in housing, credit and financial markets forced skittish people and businesses alike to hunker down.

Even though a Labor Department report last week showed the number of newly laid off workers filing for unemployment benefits dropped to the lowest level in a month, claims remain high enough to indiate the labor makret is sluggish.

Still, there's hope that the economy's growth will begin picking up later this year.

Experts will be looking at a variety of barometers to mark the arrival of a rebound, but it's by no means definitive or foolproof.

One important indicator is the stock market. The turbulence taht has engulfed Wall Street since last summer and hit a crisis point with the near collapse of investment firm Bear Stearns, has calmed somewhat, but the situation is still "far from normal," Fed Chairman Ben Bernanke recently observed.

The Dow Jones industrial average, for instance, has clawed its way out of a recent bottom - 11,740.15 - hit in March. However, the index is still under 13,000, well below its peak of 14,087.55 set in early October of last year. Financial markets remain fragile.

Investors are looking ahead - at the economy's prospects and individual businesses - when they make investment decisions and are buying or selling stocks.

"The canary in the coal mine is really financial markets," said Sung Won Sohn, an economics professor at California State University. "The stock market recovery almost always precedes the economic recovery by about six months or so. The exception was in the 2001 recession. Because of the dot-com crisis, the stock market was so badly battered it took a while for it to get back to full speed," Sohn said. By his count, after the 2001 recession, the stock market lagged the economic recovery by one year.

In the current bout of economic troubles, though, fallout from the 2-year-old housing collapse and subsequent credit and financial problems has driven the pullback by consumers, businesses and Wall Street.

That's why economists - this time around - will be looking for signs of stabilization in the housing market. Specifically, house prices will have to stop falling or at least decline at a slower pace in many parts of the country. As many Americans have watched their single-biggest asset - their home - shrink in value, they have become much more cautious in the spending, contributing to the economy's slowdown.

On Thursday, the Office of Federal Housing Enterprise Oversight said U.S. home prices fell 3.1 percent year-over-year in the first quarter, the largest drop in the 17-year history of tracking the data.

House-price improvements also are important to a return to stability because house prices figure into the value of a host of securities, such as mortgage securities and derivatives.

And, improving house prices also would ripple through credit markets, making lenders more willing to make loans to people and businesses. That, in turn, would help bolster confidence in financial markets, economists said.

"Until the housing and credit markets improve, businesses and consumers will be doubting Thomases - there is not question," said Brian Bethune, economist at Global Insight.

Forecasters at the National Association for Business Economics believe the worst of the housing slump and the credit crunch might end this year. The forecasters are hopeful that home sales will hit bottom this year. House prices, though, are still expected to drop this year and next. Some predict house prices won't turn up until the spring selling season of 2010.

Analysts also will be looking for zooming gasoline and other energy prices to settle down. Gasoline is approaching $4 a gallon on average nationally and oil has blown past $130 a barrel, from $100 at the beginning of the year. An easing of high food and other commodity prices also would be welcomed. High prices, especially for energy, are taking a bit out of paychecks, undermining consumer purchasing power, and putting a squeeze on businesses' profits.

Unlike the recessions in 2001 and 1990-1991, people, more so than businesses, are bearing the brunt of the economy's current woes.

"It is almost unprecedented in the post World War II perioud to have a recession be driven by a pullback in consumer spending, versus a pullback in business spending," said Mark Zandi, chief economist at Moody's "This one is unique in that sense. Businesses are pulling back but they are more reacting to consumers." He's among those in the recession camp.

U.S. households are more in debt and under greater pressure to restrain spending. Zandi said the share of households' after-tax income that goes to serving their financial obligations was 19.3 percent in 2007. That was up from 17.9 percent in 2000 and 17.2 percent in 1989 - the years preceding the last two recessions.

In contrast, a debt-burden measure for nonfinancial businesses shows that 10 percent of their cash flow is going to interest payments on debt, Zandi said. That's down from around 25 percent in 2001 and 30 percent in the 1990-1991 recession, he said.

Against that backdrop, another barometer for economic revival would be a turn-around in sagging consumer confidence. The hope: if people cast off their gloomy mind-set, they'll be more likely to boost spending, which would energize the national economy.

The Fed has been hoping to turn consumer psychology and thus heal the economy through its most aggressive rate-cutting campaign in decades. The Bush administration is counting on those powerful rate reductions along with billions of dollars worth of rebate checks to lift the U.S. out of its slump in the second half of this year.

Fed officials viewed economic activity as "likely to be particularly weak in the first half of 2008; some rebound was anticipated in the second half of the year," according to Fed documents released Wednesday. Still, economic growth for the yar as a whole is likely to be feeble.

Even if that second-half rebound happens, businesses are likely to remain cautious in hiring, waiting for signs that any recovery has real staying power. The unemployment rate, now at 5 percent, could rise to 6 percent or higher next year, some economists said.

So the job market needs to get back to full throttle before the economy is truly back on firm footing. After the last two recessions, the country was still losing jobs as the economy struggled to recover.

Some believe the country will experience a "W" shaped recovery. That's wehre the economy picks up with the help of the stimulus, loses steam as that boost fades and then picks up again in the second half of 2009.

It's hard to say with certainty how it will turn out. Each period of economic stress "has its own kind of biography," Bethune said.

Sometimes, our money illusions are shocking

The following Real World Economics column appeared on page 7D of the Sunday, May 25, 2008 issue of the St. Paul Pioneer Press.

By Ed Lotterman

I don't have a Ph.D., so perhaps that is why I occasionally suffer from "money delusion." But if other average Joes would be shocked by expensive fertilizer, as I recently was, some economic theories are on shaky ground.

"Money illusion" occurs when people make decisions based on nominal prices - the dolar figure printed on the invoice - rather than on "real" prices that are adjusted for inflation.

Money illusion is irrational. Many economists believe people are too samrk to be fooled by inflation in this way. Important theories depend on this belief.

I wasn't rational when I bought fertilizer one day about a week ago. I'm trying to keep alive some spruce planted in soil with a high pH. A forester friend said they might survive better if I acidified the soil around the tree.

One way to do that is with sulfur. The fertilizer-grade sulfer I bought when farming 30 years ago was a dusty powder. So I thought my current applications system - a five-gallon bucket and a tomato can - would work better if I mixed the sulfur with other ordinary fertilizer.

My local co-op mixed 50 pounds of sulfur with 300 pounds of potassium chloride. Now 350 pounds of fertilizer makes a very small pile in a pickup bed, so I was taken aback when the bill was $108.50. It was 27 cents-per-poun potash rather than 55-cent sulfur that tripped me up.

That was irrational. I am an economist. Every year I teach many students to adjust for inflation using price indexes. I make such calculations all the time. Yet I fell into the money illusion trap.

If someone had asked me what I used to pay for potash, I would have said about $90 a ton. How much higher might it be now? Perhaps it tripled, to $270 a ton.

It was exactly twice that, $540 a ton. I might have made a different decision if I had realized the bill would be that high.

Do workers make similar bad decisions about wages they accept? Do consumers ignore inflation when they consider alternate purchases or investments? Many economists, especially the monetarists and rational expectationists who are highly critical of government attempts to manage the economy, think not. Their theoretical models depend on nearly everyone being both well-informed and rational.

Would my naive money illusions change these theorists' minds? Probably not. They could argue that I was confused about a small item in our household spending, a minor hobby. A knitter returning to her craft after a hiatus of a few years similarly might be surprised by the price of yarn. But both of us, they would argue, probably know how our salaries are doing compared to inflation and how the prices of milk, bread and chicken breasts have changed.

Perhaps. Macroeconomic theories based on hyper-rationality were all the craze in the 1980s. More recently, microeconomists examining actual human behavior find that money illusion happens. Psychologist Amos Tversky provided strong evidence of this. If not for his untimely death, he would have shared the 2002 Nobel Prize for Economics with Daniel Kahneman.

This may seem neither here nor there for most people. In the meantime I need to scare up a couple bucks and run to the corner store for a gallon of milk.

Fed researchers say rate cuts risk spurring inflation

The following appeared on page 2C of the Saturday May 24, 2008 issue of the St. Paul Pioneer Press.

The Federal Reserve's interest rate reductions risk "unhinging" long-term market expectations for monetary policy and inflation, according to researchers at the Fed's district bank in Minneapolis.

Expectations for the stability of long-term interest rates are "particularly relevant given the recent conflict at the Fed between fighting rising inflation and stimulating a potentially stagnating economy," Andrew Atkeson, a consultant to the bank, and monetary adviser Patrick Kehoe wrote in a paper that appears on the Minneapolis Fed's Web site.

The economists echoes concerns of Fed district bank presidents, in cluding Richard Fisher of Dallas and Charles Plosser of Philadelphia, who recently said the central bank should avoid fueling inflation while trying to revive bank lending and economic growth following the collapse of the subprime-mortgage market.

Plosser and Fisher dissented from the decision by the central bank last month to pare the target rate for overnight loans between banks by 0.25 percentage point. The Fed has cut the rate by 2.25 percentage points to 2 percent this year in the most aggressive reductions in two decades.

AP: Existing home sales continue slide in April

The following appeared on page 2C of the Saturday May 24, 2008 issue of the St. Paul Pioneer Press.

Existing home sales fell for the eighth time in the past nine months, a string of weakness expected to continue as the housing industry, mired in its worst slump in decades, battles falling home prices, tight lending conditions and a weak economy.

The National Association of Realtors reported Friday that existing home sales dropped by 1 percent to a seasonally adjusted annual rate of 4.89 million units, matching the all time low set in January. These records, which cover single-family homes and condominiums, go back to 1999.

The median price for an existing home dropped 8 percent, compared with a year ago, to $202,300. It was the second largest price decline on record and analysts predicted prices would fall further in the months ahead given the huge backlog of unsold single-family homes.

The number of unsold single-family homes in April rose to a 10.7 months suply at the current sales pace, the highest level since June 1985.

As prices fall, it keeps more people sitting on the fence, analysts said, because prospective buyers don't want to purchase an asset that has the potential to fall further in price if they delay making the purchase.

National Debt Clock