Brookings: Experts - George L. Perry

In the Longer Run, the Short Run Matters

George L. Perry — Tue, 30 Apr 2013 14:28:00 -0400

The worst of the deadlock between the House and the White House has passed, and there are even signs that a compromise may now be reached addressing long-run budget issues. We are in a better place politically than we were late last year, but still in no position to get complacent about near term economic prospects. Chances of renewed recession are low, but so are prospects for vigorous expansion.

For the past two years, the need for fiscal and monetary stimulus has been debated both in Washington and Wall Street. One thing that has been missing from these debates is the potential for longer run damage if the sluggish economy persists. When a recession is brief and the economy returns promptly to high rates of employment, the long-run costs are minimal. But when recovery is weak and joblessness persists for many workers, the long-run costs become meaningful. And they include worsening the long-run fiscal problems that concern everyone.

The economy’s economic potential depends on the size and skill of the work force, the size and quality of the capital stock it works with, and the technical innovations that accompany the new capital. Although future investment can provide the needed capital and innovation, losses on the labor side are likely to be more lasting. In a prolonged slump, unemployment spells become long, discouraged workers stop looking for jobs, and job skills erode or become obsolete. Older workers retire earlier than they had intended. Young workers find few career path job openings and miss the on the job training that is part of the transition from school to the workplace.

Problems remain

All these problems are present today. The job market has improved greatly since the depths of the recession, but there are still 5 million more unemployed than before the recession started. Over this period, the number of people unemployed more than half a year has risen by 3.5 million. Furthermore, the labor force participation rate is 2.3 percentage points lower than it was in 2007. If the overall participation rate had not changed, the labor force would be nearly 6 million larger today. However, this difference reflects both natural changes in participation for various demographic groups and a large number of discouraged workers who have stopped looking for work because of economic conditions. A return to a strong job market would bring back some of these discouraged workers. But the longer the slack labor market continues, the more permanent these effects are likely to be.

The Congressional Budget Office continually updates its projections of potential GDP, and those projections are heavily influenced by its estimates of these labor force developments. Comparing its most recent estimates of potential for 2012 with the projections for 2012 that it made in 2007, we can infer that the recession and slow recovery have reduced potential GDP by $800 billion. Because tax revenues are correspondingly lower and transfer payments somewhat higher, the structural budget deficit, which measures what the deficit would be if cyclical factors were removed, is higher by about $160 billion this year and by perhaps $1.75 trillion over the next ten years. A rapid recovery would improve these prospects and sustained high unemployment could worsen them.

Toward a solution?

All this raises the question of what to do about it.

The Federal Reserve can be expected to continue its monetary easing for as long as necessary. Its example is winning over some foreign central bankers even if not its critics at home. The recent decline in commodity prices, and the persistent low yield on long bonds, provide continuing market evidence that Bernanke and his colleagues are on the right track.

But they need help from the fiscal side. After the initial stimulus package that was passed in 2009, resistance to budget deficits has led to some fiscal tightening in each subsequent year. Last winter’s budget deal that avoided the extreme tightening of the fiscal cliff itself imposed a considerably tighter budget this year.

That’s not good.

Near term fiscal policy should be guided by the doctors’ oath: first, do no harm. While pursuing measures to reign in deficits in the fairly distant future, immediate budgets should be as expansive as politics allows.

Authors

George L. Perry

Publication: Yahoo! Finance

The Fed's Trying To Get the Party Started, So Why All the Criticism?

George L. Perry — Mon, 18 Mar 2013 15:02:00 -0400

Fed bashing has a long history. The Fed has a dual mandate of achieving both high employment and low inflation, and pursues those aims by raising short term interest rates when aggregate demand threatens to become excessive and lowering rates when aggregate demand needs a boost. But while the mandate is symmetric, the popularity of raising and lowering rates is not. Politicians and Wall Street pundits have often criticized the Fed when it tightened policy because higher interest rates were seen as bad for jobs, profits and the stock market, and disliked by borrowers. As Bill Martin, Fed chairman in the ‘50s and 60s, observed, the Fed is unpopular because its job is to take away the punch bowl just when the party is getting good.

So why are some politicians and financial observers criticizing the Fed today when it is just trying to get the party started? In the typical postwar business cycle, high interest rates brought on recessions and then low short term interest rates helped start expansions that restored high levels of employment. This time the recession was brought on by a financial crisis that made it deep and stubborn, and conventional monetary easing-reducing short term rates by buying short term Treasury securities-was not sufficient. Short term rates have been zero for an extended period, yet the expansion has been slower than everyone wanted.

To its great credit, the Fed has innovated its policy by buying sizable amounts of long term treasury securities and government backed mortgage securities in order to reduce long term borrowing costs more directly. And it has committed to continue this policy of quantitative easing until specific targets for the expansion are met. But precisely because these steps are unprecedented, the consequences are less predictable than they would be with conventional policies, and critics can speculate more freely.

Are today's critics on to something? One of their complaints is that the great liquidity the policy has produced will lead to inflation. Someday, inflation could become an issue, but not soon. Along with the rest of the advanced economies, the U.S. problem today is how to boost aggregate demand to expand employment, not how to contain it to resist inflation. Wage costs—a key element of any sustained inflation—are rising so slowly that they are impeding the growth of consumption, a key element of demand growth in the economy. This situation will change only very gradually, giving the Fed plenty of time to respond if it needs to.

Other skeptics suggest the Fed will have trouble unwinding its positions in government and agency bonds in an orderly way. Bond prices may well fall sharply once market participants believe the Fed is starting to reverse course. And that could cause stock prices to drop, too. But markets often adjust abruptly, and these changes would be consistent with the Fed's changed policy aims. If market movements achieve the desired change in rates without much selling by the Fed, the Fed is under no compulsion to continue selling.

Finally, some critics believe the Fed's easy monetary policy-both quantitative easing and ultra low short term borrowing rates-is creating bubbles in stocks and possibly other assets. Stocks have had a long rise since the market bottom in 2009, and a sharp rise over just the past several weeks. But profits have risen sharply over the long period and price to earnings ratios are generally near the middle of their historical range, not the top.

A correction in stocks can happen with no apparent reason and the Fed's aggressive easing will not be responsible when the next one comes. The present easing will benefit the stock market in the longer run by continuing to promote economic expansion. Just compare stocks in Europe, where economic expansions have faltered, with stocks in the U.S.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: © Mike Stone / Reuters

In Discussing the Economy, Keep It Positive

George L. Perry — Thu, 07 Feb 2013 00:00:00 -0500

There are two things I would urge the president to avoid in discussing the economy. The common thread is to keep it positive.

First, do not focus on the fact that the recovery in employment is too slow. It is, and unemployment is still much too high. During President Obama’s first term, the argument for fiscal stimulus rested on the very distressed business environment and weak job market. But today it might be more helpful for the president to stop repeating this old litany of bad news and instead contribute some optimism about how we are doing.

Let me elaborate. There is no assurance that a relatively upbeat presidential assessment would do any good. But it might. We believe leadership matters in other spheres. And economists generally believe in the importance of expectations in shaping current behavior. Since the Great Recession, business has been cautious about expanding and consumers have been restrained in their spending. Though not yet reflected in most forecasts, there are now signs of revival on both fronts. What is more, the recent revisions to the employment data indicate the job market has already been strengthening more than we had thought. So the president has good grounds for offering a brighter vision of economic prospects.

The second thing I would urge on the president is to keep class distinctions out of economic policy. For decades, the wealthy have gotten much richer while middle class incomes have stagnated. This is an important feature of our recent economic history, and it strongly suggests that any search for new revenues should, in fairness, look first to higher income groups. But the president’s agenda, which needs compromise across the political aisles, is not served if the facts of income distribution morph into class warfare in political rhetoric.

Authors

George L. Perry

Image Source: © Jim Young / Reuters

The World Is Not Flat, Despite the GDP Report

George L. Perry — Wed, 30 Jan 2013 11:00:00 -0500

Ignore the bottom line of the GDP report. Key U.S. private sector demands were strong in the fourth quarter. Construction and business spending on capital goods surprised on the upside. And consumer spending rose at a 2.2 percent rate. Overall GDP gains were held back because government spending fell sharply, business inventory growth slowed, and weakness abroad held back exports.

Such headwinds will continue in 2013. Many European economies are in recession. The budget battles of last year ended up raising payroll taxes starting this month, and some further tax hikes are coming for higher income groups. But don’t interpret the preliminary fourth quarter GDP report as a signal that the economy is going into the new year on an already flat trajectory. Indeed, the employment report that came out alongside the GDP this morning shows reasonable job growth continues. That’s a more robust indicator of health than the bottom line of the preliminary GDP data.

Authors

George L. Perry

Image Source: © Sean Gardner / Reuters

How Safe is the Economy Now?

George L. Perry — Wed, 26 Dec 2012 08:32:00 -0500

Let’s assume we can put away the bungee cord. The president and the Congress reach an agreement that will avoid the massive fiscal tightening scheduled in present law. The deal will impose some immediate revenue increases and spending cuts together with changes that further reduce deficits in future years. For the long run, more will probably need to be done to contain medical costs. But we are past the acute risk that we might impose a severe fiscal tightening on an already slow expansion.

So where does this leave economic prospects for 2013 and how should it change households plans for investing in retirement accounts?

The risk of renewed recession is greatly reduced. Still fiscal policy will tighten next year, and with measures such as higher payroll taxes taking immediate effect, consumer demand will get off to a slow start. But there are also bright spots. Recent increases in housing and autos, where a backlog of demand accumulated during the extended slump, should continue. And business investment, which was probably held back recently by recession risk, should soon improve. Adding it all up, the most likely outcome is a moderate expansion of GDP and employment as the year goes on.

As for retirement accounts, the record over the 5 years since stocks peaked in the US is instructive. The economy in this period has gone through the deepest recession and the most uncertain recovery in 80 years. It is understandable that many households were wary of being invested in stocks during this period.

A dedicated long term investor who put a part of each pay check in a broad US equity mutual fund would be way ahead today. The holdings from the end of 2007 would be back to even and the investments made in the intervening months would show a substantial profit. Those made in the first year of the crash would be up about 50 percent.

The economy is still very far from full employment and monetary policy is dedicated to promoting expansion to restore it. If a too restrictive fiscal policy – falling off the cliff comes to mind – does not get in the way, it should succeed. And that would be a good long term environment for equities.

Authors

George L. Perry

Image Source: © Andrew Burton / Reuters

Is the U.S. Economic Expansion in Jeopardy?

George L. Perry — Tue, 11 Dec 2012 12:02:00 -0500

The advanced economies of the world all turned down in the Great Recession and have experienced only weak recoveries since. Now much of Europe is stumbling, with the weakest economies back in recession and others on the verge. One reason is austerity in fiscal policies. In the UK, the Chancellor of the Exchequer has imposed a more deflationary budget despite marking down his forecast for the economy. Within the eurozone, fiscal austerity is keeping high deficit countries in recession and adding to the recession risk in others. Even Germany is now forecasting virtual stagnation in coming quarters.

The U.S. interacts with Europe through many channels and its markets and economic cycles are usually highly correlated. With Europe in trouble and the fiscal cliff threatening fiscal austerity, how likely is a new U.S. recession in 2013?

U.S. in Expansion Mode

Unlike the situation in most European economies, the U.S. recovery, which has been disappointingly weak, shows signs of getting stronger. Employment gains have quickened in the second half of the year. Consumer attitudes are improving. And some important cyclical sectors of the economy have been looking up.

Housing starts declined by 70 percent from their peak levels and remained depressed for years. Helped by the Federal Reserve's easing policy, homebuilding finally started to recover during 2012. Mortgage rates are low and house prices have risen modestly in most areas of the country. So conditions are right for extended strong construction gains from here.

Automobile sales, another highly cyclical sector, will also contribute to faster growth. In the years before the downturn, annual sales of cars and light trucks averaged around 16 million units. In 2009 unit sales fell to around 9 million, and they will average near 14 million this year. But the potential sales rate is substantially higher. The average age of the car fleet rose during the past four years so replacement demand will be exceptionally high for an extended period.

Don't Fear the Cliff

So we confront the dangers of the fiscal cliff with an economy that appears distinctly healthier than it was a year ago. If fiscal policy was not changing, this underlying strength would point to faster GDP growth in 2013. If we got a worst case outcome from the budget talks, with all the deflationary measures now scheduled having full effect, it would bring on a new recession. But that is not going to happen. And if we get a modest fiscal tightening out of this crisis, it would not disrupt the expansion.

And with a very high probability, that is what we will get.

Unfortunately, it is not likely that a rational process to address long run budget problems will emerge. That will require some difficult choices that include how best to contain the rise in future medical costs. The present crisis is not the environment for such serious matters. But if the imminent debt ceiling confrontation were also resolved now, it might signal a willingness to address the long run problems early in the next Congress.

Authors

George L. Perry

Publication: Yahoo! Finance

Image Source: © Jason Reed / Reuters

How Worried Should You Be about the Stock Market?

George L. Perry — Tue, 16 Oct 2012 00:00:00 -0400

How worried should people be about the stock market? Every day's news reminds us of unusual risks on the economic horizon. The fiscal cliff, which CBO projects as a $600 billion depressant on 2013 GDP, is looming. The European economies are sagging once again, and there is no lasting resolution yet in sight for the euro currency problem. China's spectacular growth has slowed. And the upcoming presidential election adds to uncertainty about what lies ahead. Should one be in stocks in this environment?

Let's start with the election. Taking a really long view, Wharton's Jeremy Siegel calculated the annual return on equities averaged 9.6 percent between 1888 and 2006. The return averaged 10.9 percent under Democrats and 8.6 percent under Republicans. Such a difference gave rise to the slogan "If you want to live like a Republican, vote like a Democrat." But the main message is that stocks have been a good long-term investment regardless of which party occupied the White House.

In the short run, down stock markets often accompany bad economic shocks. How damaging are today's global developments likely to be to the U.S.? The Chinese slowdown has been apparent for several quarters. It has come mainly from the end of its construction boom and weaker exports to the slumping advanced economies. The slowdown has cut into China's imports of raw materials but otherwise had only a modest impact on the U.S. economy.

Europe is a major market for U.S. exports so a deep recession there would have a bigger impact on the U.S. economy through trade. However many in Europe, along with the IMF, have concluded that fiscal austerity is having a large depressing effect , pressuring governments to back off. So the deep recession risk should lessen. The U.S. financial sector is more insulated from Europe's than it was a few years ago, so spillovers from banking problems there should be manageable. And a messy breakup of the eurocurrency zone is not likely any time soon. In short, while the situations could turn worse, it now seems that problems in Europe and China will not derail the U.S. recovery.

As for impacting the U.S. stock market, the European situation has been evolving for years and has roiled markets as the crisis risk alternately worsened and subsided. Short-term traders have reacted repeatedly to these changing prospects, and those who are still solvent should have more opportunities in the coming weeks and months.

For the U.S., the bigger potential risks come from the fiscal cliff, which is the large swing to higher taxes and lower spending that occurs next year if current laws are not changed. To review how it came to this, here are three main elements: The Bush tax cuts were originally set to expire in 2010 to avoid exceeding the ten year budget limits that Congress had imposed on itself. They were extended through 2012 because of the recession. The alternative minimum tax has been temporarily amended for decades to avoid its affecting too many taxpayers. And the sequestration of $800 billion of defense and nondefense spending effective next January was created by the present Congress as a kind of doomsday machine to exert pressure for long run deficit reduction.

Nobody can have confidence about how this strange situation will play out. Right after the election the changes scheduled for January 1 might be pushed to mid-year to give time for a new Congress and the president to act. Or the changes might be allowed to kick in, inviting the risk of renewed recession in order to pressure both sides to find a compromise on long run budget issues. One reason this might be helpful is that discussions with the new Congress would start with substantially higher tax revenues which could then be reduced as part of any compromise. Or--and this seems less likely--they might be as unwilling to compromise as ever and allow the worst to happen.

So how worried should people be about the stock market? Nothing now on the horizon suggests that money invested in stocks today will look like a bad investment five years from now. But it would not be too surprising if stocks fell in this environment. Anyone who cannot afford a decline because they have a near term need for their capital should realize they are risking losses in stocks. They always are.

But now seems as good a time as any to be in the market for long term investors, like those who are saving for college or for retirement. Even such long term investors will be tempted, at times, to get out of the market temporarily. That is understandable but it risks reducing long term performance. As Warren Buffet has observed, nobody is likely to invest well based on what he reads in the paper each morning. And the economic risks discussed here have been, and will be, in the papers daily.

And what is most important: in order to time markets well once, you have to be right twice. First, knowing when to get out, and then knowing when to get back in.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: © Brendan McDermid / Reuters

Weak Economy, Yes, But Not a Death Knell for Obama

George L. Perry — Tue, 31 Jul 2012 12:38:00 -0400

Presidents running for reelection are hard to beat. Since World War II, a period over which Democrats and Republicans have each occupied the White House about half the time, incumbents have won reelection 70 percent of the time. Other things equal, a clear advantage for Obama this year.

On the other hand, it is accepted political wisdom that the state of the economy is what matters most for voters. Fairly or unfairly, the president gets the credit for good times and the blame for bad. Obama initially got high marks for moving aggressively to stop the economic freefall he inherited. His approval ratings were high. But by the summer of 2010, the overhang of the credit and real estate bubbles got in the way of normal recovery and the resulting weak expansion had become a political liability for the president.

So how compelling is the idea that the state of the economy determines the election winner? And is there evidence of a separate incumbency effect? Five of the 7 incumbents who won did so in years with both good job markets and no serious inflation worries. The other two had good job growth but inflationary problems. Harry Truman won in 1948 despite serious labor unrest and inflationary wage increases. And Richard Nixon won in 1972 despite clumsy wage and price controls that suppressed inflation.

In the three elections that incumbents lost, the economic backgrounds were more mixed. When Gerald Ford lost to Jimmy Carter, the economy was recovering normally from recession, but inflation was stubbornly high in the aftermath of the first OPEC shock to oil prices and the end of the Nixon era price controls. Ford may not have gotten the typical incumbency boost because he had never been elected president. When Carter lost to Ronald Reagan, the economy was a major liability on both the jobs and inflation fronts. The second OPEC shock had spiked inflation even higher and to fight it the Volcker Fed raised borrowing rates to 20 percent and sent the economy into a steep recession. When George H.W. Bush lost to Bill Clinton 12 years later, inflation was not a worry but job growth was, with the economy barely recovering from a mild recession. In the year before the election, employment rose only 1 percent and the unemployment rate was drifting up to 7.5 percent.

Where does this leave election prospects in 2012? Last winter, employment gains quickened and a moderately optimistic forecast was that economic expansion in 2012 would be faster than the disappointing growth of 2011, that unemployment would improve to the 7.5 to 8 percent range this year, and that this pick-up would largely defuse the weak economy as an election issue.

Some of the reasons for this moderate optimism have materialized: housing continued to recover, auto sales were strong, and prices for oil and gasoline declined. But other areas disappointed: exceptional weakness in Europe and China held back U.S. exports, and business investment has been flat. The virtuous circle of growth in jobs, incomes, consumption, and capacity that characterizes strong cyclical recoveries has not taken hold. And the election is near enough that a meaningful change in how voters see the economy is highly unlikely. It is a disappointing expansion, but not bad enough, by historical standards, to unseat an incumbent.

This outlook suggests other things that matter to voters will be important. The Romney camp is making an issue of the new health care law. The Obama camp is pressing for full disclosure of personal finances. And each side is blaming the other for budget problems. It is too soon to tell whether these or any other special issues will resonate with voters. But as of now, incumbency should be enough to see Obama through.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: Tami Chappell / Reuters

A Plan for Euro Bonds Revisited

George L. Perry — Tue, 22 May 2012 13:01:00 -0400

France’s new president François Hollande is expected to push for jointly-issued eurozone bonds this week, a move German Chancellor Angela Merkel is likely to oppose. The political resistance to backing the bonds of other member nation is understandable. But so is the resistance to foreigners dictating a nation's fiscal policies. A well-designed system for euro bonds would provide strong incentives for responsible fiscal actions over the long run and greatly reduce the likelihood of that special assistance if needed in the future. The proposal I offered in 2010, “A New Plan for Euro Bonds,” does this.

Authors

George L. Perry

Image Source: Â© Francois Lenoir / Reuters

Bad Headlines, But a Good Economy

George L. Perry — Tue, 15 May 2012 00:00:00 -0400

If you had thought, as I did, that the U.S. economic expansion was getting healthier, you would have lost a bet on first quarter GDP growth. The preliminary estimate, which we got in late April, showed the economy grew at only a 2.2 percent annual rate, which was a slowdown from the previous quarter and well below the consensus estimate among economists. The GDP news raised the question of whether the expansion is running out of steam.

A week later, the jobs report for April added to that concern. Payroll employment rose only 115,000, after averaging gains of more than 200,000 a month over the previous half year. And the employment estimate from the household survey, which had been rising even more strongly than the payroll data, was even weaker in April. The unemployment rate did not rise, but only because more of those without work were not actively looking for jobs.

So how worried should we be about the health of the expansion? Fortunately, both the GDP and employment reports had better news in the details than in the headline numbers. A drop of 15,000 in government employment contributed to the weak April jobs report. And a decline in government purchases held back first quarter GDP. Spending on national defense fell by 8.1 percent and purchases by state and local governments fell by 1.2 percent (all changes are annual rates). These declines in government spending were an unwanted headwind that subtracted 0.6 percentage points from first quarter GDP growth. But to judge the underlying health of the expansion, the state of private sector demands provides better clues.

Private demand rose by 2.8 percent in the first quarter, and the gains were strongest in some sectors that typically lead cyclical upswings but have only recently come to life this time. Consumer spending on durable goods rose at a 15 percent rate, with auto sales running 8 percent above year earlier levels. Residential construction, the sector that crashed the hardest in the recession and that has been very slow to recover, rose at a 19 percent rate in the quarter.

Private demands were held back by a 12 percent decline in business investment in structures in the first quarter. But this does not portend a general weakness in business investment going forward. The decline came from drillers shutting down rigs in the gas fields in order to move them to fields with oil and gas liquids whose prices are higher than gas prices. Without this temporary decline in drilling activity, private sector demands would have been up 3.2 percent in the first quarter.

Other recent data further support the view that the economy will be growing, not stalling, in the quarters ahead. Income gains have been disappointingly small in recent months, but spending has outpaced disposable income and consumer credit is rising. Both suggest spending optimism by consumers. Permits for new home construction, which presage new homebuilding, are up sharply. And gasoline prices, which had been widely described as heading for $5 a gallon, have instead recently declined.

The risk that higher oil prices would derail the expansion is now slim. Oil inventories are high, the Saudis have expanded production, the risk of disruptions to Middle East supplies has receded, and U.S. production keeps rising. The risk that eurozone troubles could seriously disrupt the U.S. economy is nearer to being tested. But we seem well insulated against financial spillovers. And, if it comes, a shift to less austerity would be better for Europe and its trading partners than the present situation.

Whether, over the next six months, the economy is good enough to be an asset to President Obama or bad enough to be a help to candidate Romney is still unclear. But economic prospects are better than recent headlines would lead you to believe.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: Lucas Jackson / Reuters

The Economy and the U.S. Presidential Election

George L. Perry — Mon, 27 Feb 2012 11:32:00 -0500

"It's the economy, stupid" became the rallying cry for the Clinton campaign of 1992. Now, 20 years later, Republicans are hoping the economy will help unseat another incumbent and bring them the White House. Whether fairly or not, by the time they are seeking reelection, the public holds sitting presidents responsible for the state of the economy. And while other things matter — war and peace, divisive social issues, and the personality of the candidates all come to mind — the economy is arguably the one thing that persistently matters in these elections.

In the postwar period, incumbent presidents have run for reelection 10 times, winning 7 and losing 3. The winners all had strong job markets going for them. Dwight Eisenhower in 1956, Lyndon Johnson in 1964, Bill Clinton in 1996 and George W. Bush in 2004 all ran with both full employment and low inflation, and all won easily. Unemployment was still around 7.5 percent when Ronald Reagan ran in 1984. But job gains were rapid and unemployment was falling from a recession high of 11 percent. When Harry Truman ran in 1948, the economy was experiencing a postwar boom led by the backlog of demand for housing and autos, but was also buffeted by organized labor unrest and inflation driven by rapid wage increases. Truman won a close election. Richard Nixon in 1972 had a strong recovery and an inflation problem that he suppressed with price controls until after the election. He won in a landslide.

The three losers all confronted economic issues. In 1976, Gerald Ford ran with a stubbornly high rate of inflation inherited from the post-price control Nixon years and the first OPEC oil price shock. The economy was recovering from recession but unemployment was still high. In 1980, Jimmy Carter stood for re-election with even more rapid inflation, fueled by the second OPEC oil price shock, and with a sharply higher unemployment rate, which stemmed from policies to reduce that inflation. He lost in a landslide. George H.W. Bush ran during the first "jobless recovery" of the postwar period. Employment was up by barely one percent in the year leading up to the election, and the unemployment rate stood at 7.5 percent, its worst level of the mild 1991-1992 downturn.

How does today's election year economy compare with these 10 earlier ones involving incumbents? There is no inflation on the horizon. But the excesses that led to the Great Recession also held back the expansion that followed. The overbuilding during the housing boom was so great that the typical cyclical recovery in housing could not take hold. Consumer demand was constrained by the need to unwind credit excesses and by the huge loss of stock market and real estate wealth that took place. And the loss of revenues from the very deep recession forced states and municipalities to cut spending and employment.

But over the past several months, the drag from some of these sources has eased and the expansion is now quickening on several fronts. Despite continuing oversupply in many local markets, housing activity finally began to move up during the second half of last year, with new housing starts in recent months 10 to 15 percent above year ago levels. New car sales have also been rising in recent months, to an annual sales rate around 14 million units. In both these sectors, activity is still far below levels that will return with full prosperity and, judging from the behavior of investors, substantial higher activity levels are expected. Over the first several weeks of the year, when the Dow Jones average rose 6 percent, ETFs for the shares of homebuilders rose 20 percent and Ford and GM shares rose by an average of about 25 percent.

Rising demand will need support from rising jobs and incomes, and recent data show that is coming. Over the past 6 months, employment gains have quickened and total hours worked have risen at a four percent annual rate. Government employment, which had declined steadily last year, stopped falling in January. The unemployment rate, which peaked at 10 percent in late 2009 and was still 9 percent through most of last year, dropped steadily over the past four months, reaching 8.3 percent in January. Barring bad surprises, it is likely to be between 7.5 and 8 percent by election day.

For the past couple of years, the crisis in the Euro zone has been a caveat to any forecast of the U.S. economy. Today that risk is diminished, but uncertainty over the world oil market, with Iran again at the center of the problem, has risen in its place. A disruption of supplies would drive up prices and slow the US recovery both by cutting auto sales, especially sales of larger domestically produced vehicles, and by siphoning off purchasing power more generally.

While some damage to the expansion now seems likely, it may be contained, especially if Saudi Arabia makes up some of the supply loss. And an early resolution of the crisis might even produce a favorable outcome. Prices have already firmed, anticipating reduced supplies from Iran. If the crisis is now resolved without supply disruptions, prices will retreat.

Where does this range of economic prospects place the 2012 election relative to the 10 previous contests involving incumbents? A year ago, the closest comparison was with the Bush election of 1992. But now it's looking different. In the Bush-Clinton election, unemployment was actually drifting up to its peak of 7.5 percent. Barring a sustained rise in oil prices, unemployment will still be high, but falling from its peak of 10 percent. That more nearly resembles Reagan's situation in 1984, though without the very strong employment gains of that year. If the Iran crisis is resolved without disruption -- an outcome the President would get some credit for -- and oil prices fall, a stronger expansion becomes more likely. That economy would clearly favor the incumbent.

Authors

George L. Perry

Publication: Real Clear Markets

Image Source: © Jason Reed / Reuters

The Economy in 2011 and Beyond: Bright Spots Amid Dark Clouds

George L. Perry — Wed, 14 Dec 2011 11:42:00 -0500

In 2011, slow job growth and high unemployment headlined each month’s employment report. Is the economy likely to do better in 2012? There are some economic bright spots that suggest the economy’s internal dynamics are quickening. But there are also serious outside risks that challenge policy makers both here and abroad: The unresolved debt crisis in Europe, the slowdown in China, and as of this writing, the U.S. fiscal tightening that will occur if there is another policy stalemate.

For the past four months, employment measured in the survey of households has averaged around 300,00 a month, well above the trend growth rate of the working age population and enough to reduce unemployment meaningfully. This far exceeded the employment gains measured from the payroll data of business establishments which are the ones headlined each month. Slow employment growth has been holding down incomes and consumer demand, helping perpetuate the weak expansion. If recent months are a guide, that drag on expansion may be over. But demand from other sectors will have grow, and the prospects for that are mixed.

The construction sector spans a broad range of activities from residential improvements to bridge building. Over the past year, declines in public construction, driven by the drop in state and local revenues, about offset the increases in private construction where a big upswing got underway in nonresidential building. Construction rose by between 10 and 20 percent in the commercial, recreational, power, manufacturing and transportation areas. There is reason to expect strong gains again in 2012 since corporate internal funds are plentiful and borrowing conditions remain easy. Furthermore, the pressure on public sector spending should ease because state and local budgets are in better shape than they were a year ago.

Homebuilding is a different matter. The historic excesses of the housing sector continued to hold back the U.S. expansion in 2011, and they still dominate housing prospects for 2012. In the aggregate, house prices are down nearly a third from their 2006 peaks and the fraction of mortgages that are under water is still at historic levels. If there is a bright spot in this picture it is that housing markets are local. Normally these local markets are highly correlated because they are driven by aggregate developments such as borrowing costs and the rise in wealth and incomes. But at present, local markets are driven by earlier price excesses, and these were far worse in some areas than others.

House prices have stopped falling in most of the country and have started rising in some areas. High end Manhattan real estate bottomed some time ago. Prices in the upper East Side and Upper West side are up 10 percent over the past year and major new construction projects are in the works. In south Florida, the lower end of the market continues to be severely depressed but sales of higher priced condos in the Miami area are recovering, thanks mainly to an influx of buyers from Brazil and other prospering Latin countries.

Lower cost areas will be the slowest to recover, both because they were particularly hard hit by mortgage problems and because they are the most affected by the present job market. But more building of any sort will help employment in construction and in related industries such as building materials and home furnishings. During its period of steep decline, residential construction directly subtracted about a percentage point from GDP growth. It is too early to expect a substantial positive contribution this year. But at least the decline is over and some recovery is underway.

Exports, which are highly responsive to growth rates in other economies, have been a bright spot from the start of the present expansion . Even over the past year, when global growth slowed markedly, they contributed nearly a percentage point to the disappointing U.S. growth rate. But the immediate future for export demand is quite uncertain. Europe's expansion is in jeopardy, and Chinese growth has slowed markedly.

China has become a major market for U.S. exports of raw materials and capital goods, and their growth importantly affects other Pacific rim economies. So how well China manages its current slowdown is key. As in other countries, a construction boom is at the center of the slowdown, but parallels end there. Chinese banks are instruments of state policy. So bad debt problems and overbuilding should not get in the way of restoring economic growth. But for the immediate future, China's demand for our imports will slow.

Europe poses a greater risk. The December summit meeting in Brussels did little to address the problems of the euro system for the long run and provided only ambiguous guidance for the near term. A very hopeful interpretation is that Germany will accept whatever degree of ECB support the Sovereign bond markets need. If that is not forthcoming, the range of bad outcomes for Europe and for its trading partners is very broad.

Authors

George L. Perry

Image Source: Â© Lucy Nicholson / Reuters

European Debt Crisis is Far From Over

George L. Perry — Thu, 08 Dec 2011 10:55:00 -0500

The debt crisis situation in Europe is dire.

European officials, led by German Chancellor Angela Merkel and French President Nicolas Sarkozy, have promised to hammer out new fiscal agreements for this week's summit.

The initial rumor called for tight new budgetary rules for the long run with penalties for violating them, and a new system for enforcing them. The sweetener? Germany would agree to expanded eurozone support for the sovereign debt of all eurozone members.

The odds of tighter new rules have gone down, but the sweetener remains.

The markets have so far reacted positively, if provisionally. Risk premiums on the bonds of Italy, Spain and other fiscally weaker members have fallen abruptly and stock markets are higher.

Mission accomplished? Hardly.

German support for euro-wide backing of members' sovereign debt is certainly a game changer. It is urgently needed in the present acute debt crisis and is probably essential to preserving the euro currency zone in the long run.

And if such support is to be available, a system for assuring prudent fiscal policies by eurozone nations is also needed.

It is not that reckless fiscal policies were the common cause of the present crisis -- they were not. But German and Dutch voters do not want to risk subsidizing reckless fiscal policies indefinitely.

So what should a good system look like?

Read the full article at CNNMoney »

Authors

George L. Perry

Publication: CNNMoney

Image Source: Â© Philippe Wojazer / Reuters

The Turtle Soup Economy: How Real Is America's Economic Expansion?

George L. Perry — Mon, 24 Oct 2011 16:09:00 -0400

Jazz great Cole Porter once sang, "Is it the real turtle soup or merely the mock?" It's a relevant question about the state of the current economic recovery as well. By late summer, a double dip recession had become a familiar forecast of U.S. economic prospects. The financial crisis in Europe remained unresolved and threatened to spread. And most data measuring current economic activity turned weaker. Today Europe's crisis remains unresolved, and the political difficulties that stand in the way of a fix have become even more apparent. But the recent data show a few brighter spots on the economic landscape.

Retail sales, which had stagnated through the spring, rose at a 7 percent annual rate between June and September. New auto sales were part of the story, with domestic brands in September having their best month yet in the recovery. This spurt occurred despite continued declines in surveys of consumer sentiment, showing once again that such measures are not reliable predictors of aggregate consumer spending.

Manufacturing production has been another bright spot. After remaining flat between January and June this year, production rose at a 7 percent rate between June and September. A part of this rise was in production of business capital goods, a category that rises when business grows more optimistic about its own prospects. Business capital goods orders, which presage future production of machinery, equipment and aircraft, surged in July and August. But the surge came in orders for aircraft, many of which are for delivery years in the future. Aside from aircraft, recent orders imply only modest further gains in capital goods production.

Residential construction remains deeply depressed, particularly for single family homes. Housing starts and permits for multi-unit buildings rose this summer from very low levels. And nonresidential construction seems to have bottomed out in the first half of the year.

Slow employment growth has been the most disappointing feature of this recovery. Without faster employment growth, any pickup in consumer demand or in demand for capital goods will not be sustained. And the headline number for employment growth, which is based on firms' payrolls, averaged only 96,000 per month between June and September. However a separate BLS employment estimate, based on the monthly survey of households, shows a distinct pickup, with gains averaging 230,000 per month in this period. Which one to believe?

From month to month, the household data are highly volatile, which is why they get so little attention when the monthly data are released. But over longer intervals they are as useful as the payroll data in assessing how the economy is growing, which suggests averaging the two into a combined measure. After monthly gains averaging 55,000 over the previous twelve months, this combined measure rose by 163,000 a month between June and September.

All in all, there is evidence the expansion has quickened. But the inference from recent data is highly tentative. And if current prospects are a bit brighter than three months ago, they are still far from bright enough. The double dip now seems unlikely, and this should be good enough for the stock market. But until we see growth above trend for an extended period, this will remain a mock expansion.

Authors

George L. Perry

Publication: Huffington Post

Image Source: Â© Brendan McDermid / Reuters

A New Plan for Euro Bonds

George L. Perry — Wed, 29 Dec 2010 17:45:00 -0500

The sovereign debt crisis in the euro zone has shaken bond markets everywhere. At their latest meeting in Brussels, euro zone governments strengthened their commitment to central bank support for the bonds of member states that come under siege. This monetary solidarity is useful, but some degree of fiscal unity is also needed. The core point of disagreement among governments is how far to go toward making euro bonds a sovereign responsibility of the currency union itself and how to enforce fiscal discipline on individual nations if bonds become a joint responsibility.

The following plan pushes individual nations toward fiscal prudence and reduces the risk that shocks destabilize euro bond markets in the future. It does so by strengthening the impact of market forces in non-crisis times rather than relying on rigid rules and penalties, which are likely to be clumsy at best and onerous across sovereign states. The plan also aids the transition from the present crisis and moves gradually toward a limited form of fiscal unity for the euro zone.

The proposal creates a two tier framework for sovereign borrowing. The first tier consists of bonds issued to cover annual deficits up to some specified size limit—say 2 percent of a nation’s GDP (and to roll over maturing bonds of this tier). Such a percentage is sustainable in the long run and consistent with steady or declining ratios of debt to GDP. Call these Eurobonds. Any borrowing above this limit must be done by issuing second tier bonds. Call them national bonds. The euro bonds are the responsibility of the borrowing nation but backed by the currency union and issued by its bond authority. The national bonds are conventional, backed and issued by individual nations.

Some analysts and politicians have suggested a different kind of two tier system based on ratios of bonds outstanding to GDP. When the ratio is above a specified limit, bonds carry a risk premium. However at present this ratio ranges widely, from over 130 percent to under 30 percent. There is no reasonable starting point and little guidance on what level is optimal. For any chosen target, there is little if any incentive for countries so far above it that attainment is many years away, and no incentive for countries already below it.

The large incentive effects of the plan presented here are present in each annual budget cycle. With euro bonds senior to national bonds in the conventional sense, a lending nation under duress would suspend payments on national bonds and renegotiate them if necessary before suspending payments on euro bonds which, in any case, would have the backing of the euro authority. With some debt consisting of euro bonds, any prospective risk of nonpayment would now be born entirely by the smaller number of national bonds outstanding, so the loss to each national bond would be greater. The interest differential between euro and national bonds is correspondingly widened, increasing the incentive to reduce deficits.

These economic incentives will be buttressed by political effects that may be even more potent. With only conventional national bonds, there is little evidence of how much is being charged for incremental borrowing. In the new framework, the marginal cost of incremental borrowing will be clear and conspicuous for each nation.
The 2 percent limit on national borrowing is in the useful range for the longer run once economic conditions are more normal. Deficits of that size would be sustainable and would gradually reduce debt to GDP ratios in most countries. In the mid-2000s, most small euro nations were near budget balance, with Greece and Cyprus conspicuous exceptions. Germany, France and Italy had deficits in the 3 to 4 percent range and Spain, Belgium, the Netherlands and Ireland were all near balanced budgets. Today deficits across the euro area average 6.5 percent.

Because of present economic and bond market conditions in the euro zone, incentives to reduce deficits are already compelling. So the size limit could start higher, say at 4 or 5 percent, and decline over several years to the eventual 2 percent. Countries now confront high borrowing costs because markets question their ability to meet interest payments. By financing part of any new debt with euro bonds the proposed system would immediately reduce interest costs and lower the risk of nonpayment. Though euro bonds are initially a very small part of the total, the effects would be considerable, reflecting all future benefits of the dual tier framework.

The introduction of the new framework need not favor troubled economies over more stable ones. Member nations whose deficits would not otherwise reach their limit on euro bond issuance could do so by using euro bonds to retire outstanding national bonds. And since Eurobonds only gradually become a feature of the currency union, the benefits of this modest degree of fiscal union are achieved without politically divisive fiscal cost.

Authors

George L. Perry

Economy Looking Brighter; Most Forecasts Still Too Dark

George L. Perry — Thu, 29 Apr 2010 10:22:00 -0400

Ever since positive GDP growth resumed in the summer quarter of last year, the consensus outlook for the economy has underestimated the strength of the expansion. It’s easy to see why. Once the global financial system seized up in September 2008, economic activity throughout much of the industrial world started a steep decline. It was a good bet that the U.S. was in the worst downturn since the 1930s, and it was possible that the downward spiral would go unchecked for an extended time.

History will applaud the policy responses that helped stop the decline by mid-2009. But doubts remained about virtually every sector of the economy and doubts dominated the aggregate business outlook. The Philadelphia Federal Reserve’s average of GDP forecasts made in the second quarter of 2009 anticipated an annual growth rate of 1.2 percent over the last two quarters of the year. But GDP actually grew at a 3.9 percent rate over that period.

The job market has badly lagged the gains in output. The unemployment rate continues near its post-Depression peak. The widely followed change in payroll employment declined at over a 2 percent rate during the last half of 2009 even as output growth resumed, and only leveled off in the first quarter of this year. Output typically grows faster than employment, all the more so in a period of cyclical recovery. But the difference of 6 percentage points in their growth rates during the last half of 2009 is unusually large and not sustainable.

There is reason to believe employment growth is already beginning to strengthen. In a research paper a few years ago (Gauging Employment: Is the Professional Wisdom Wrong? Brookings Papers on Economic Activity: 2005), I showed that the employment change available from the survey of households is as useful as the change in the payroll data. When the two diverge for a time, they tend to come back together in future quarters. As a rule of thumb, the best measure of what is actually happening to employment is a simple average of the change in the payroll and household data. In the first quarter of this year, the household data rose at a 1.4 percent rate. The weak job market is finally improving, even though the payroll data has not yet shown it. Payroll employment for April, which will be reported next week, should reflect the improvement.

Sustained job growth will require a strong economic expansion and the prospects for GDP growth are good. The health of the financial sector is no longer a risk for the overall economy. The big banks that needed government intervention a year ago are prospering and their balance sheets are improved. Bank lending is still down, probably reflecting both cyclically reduced demand and more conservative lending standards. But unlike a year ago, when the excessive reluctance to lend threatened the economy somewhat higher standards are now desirable and unsurprising. Bad commercial real estate loans continue to burden regional banks, but the crash in residential construction is behind us.

Some new central banking issues have emerged. In Europe, the sovereign debt crisis poses new risks for policymakers and the banking system. The U.S. has been affected mainly through the appreciation of the dollar, and that would have to go considerably further before it posed a dilemma for policymakers here. The Federal Reserve still must get rid of the mortgage assets it purchased to support the banking system during the crisis. But it can be trusted to do so at a pace consistent with its continuing commitment to economic expansion.

In this supportive financial environment, consumers seem to be feeling better and are spending more. Capital goods orders are rising, helped by orders from growing economies abroad. The expansion in 2010 should easily exceed the current 2.9 percent consensus forecast, starting with the GDP report for the first quarter that will arrive this Friday.

Authors

George L. Perry

Brookings Papers on Economic Activity 1:2007

George L. Perry and William C. Brainard, eds. — Sat, 01 Sep 2007 00:00:00 -0400

Brookings Institution Press 2007 329pp.

Brookings Papers on Economic Activity (BPEA) provides academic and business economists, government officials, and members of the financial and business communities with timely research on current economic issues.

Learn more about the BPEA conference series.

Contents:

Editors' Summary (Full Text - PDF)

Articles:

International Reserves in Emerging Market Countries: Too Much of a Good Thing? (Abstract - PDF)
Olivier Jeanne

Explaining a Productive Decade (Abstract - PDF)
Stephen D. Oliner, Daniel E. Sichel, and Kevin J. Stiroh

Foreign Capital and Economic Growth (Abstract - PDF)
Eswar S. Prasad, Raghuram G. Rajan, and Arvind Subramanian

The Effect of Dividends on Consumption (Abstract - PDF)
Malcolm Baker, Stefan Nagel, and Jeffrey Wurgler

Report:

Cracking the Conundrum (Abstract - PDF)
David K. Backus and Jonathan H. Wright

ISSN: 0007-2303

ABOUT THE EDITORS

George L. Perry

William C. Brainard

William C. Brainard is professor of economics at Yale University.

Ordering Information:

{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 978-0-8157-1355-5, $36 Order

Brookings Papers on Economic Activity 2:2006

George L. Perry and William C. Brainard, eds. — Thu, 01 Feb 2007 00:00:00 -0500

Brookings Institution Press 2007 162pp.

Contents:

Editors' Summary (Full Text)

The Sources and Sustainability of China's Economic Growth (Abstract)
Gary H. Jefferson (Brandeis University), Albert G. Z. Hu (National University of Singapore), and Jian Su (Peking University)

The Return to Capital in China (Abstract)
Chong-En Bai (Tsinghua University), Chang-Tai Hsieh (University of California, Berkeley), and Yingyi Qian (University of California, Berkeley)

The Contradiction in China's Gradualist Banking Reforms (Abstract)
Wendy Dobson (University of Toronto) and Anil K Kashyap (University of Chicago)

ABOUT THE EDITORS

George L. Perry

William C. Brainard

William C. Brainard is professor of economics at Yale University.

Ordering Information:

{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 978-0-8157-1354-8, $36 Order

Brookings Papers on Economic Activity 1:2006

George L. Perry and William C. Brainard, eds. — Fri, 01 Sep 2006 00:00:00 -0400

Brookings Institution Press 2006 304pp.

Brookings Papers on Economic Activity (BPEA) provides academic and business economists, government officials, and members of the financial and business communities with timely research on current economic issues.

Learn more about the BPEA conference series.

Contents:

Editors' Summary (Full Text)

Bubble, Bubble, Where's the Housing Bubble? (Abstract)
Margaret Hwang Smith and Gary Smith (Pomona College)

The Recent Decline in the Labor Force Participation Rate and Its Implications for Potential Labor Supply (Abstract)
Stephanie Aaronson, Bruce Fallick, Andrew Figura, Jonathan Pingle, and William Wascher (Board of Governors of the Federal Reserve)

Are Successive Generations Getting Wealthier, and If So, Why? Evidence from the 1990s (Abstract)
William G. Gale (Brookings Institution) and Karen M. Pence (Board of Governors of the Federal Reserve)

Reforming the Defined-Benefit Pension System (Abstract)
David W. Wilcox (Board of Governors of the Federal Reserve)

ABOUT THE EDITORS

George L. Perry

William C. Brainard

William C. Brainard is professor of economics at Yale University.

Ordering Information:

{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 0-8157-1352-5, 32 Order

Brookings Papers on Economic Activity 2: 2005

George L. Perry and William C. Brainard, eds. — Wed, 01 Feb 2006 00:00:00 -0500

Brookings Institution Press 2006 321pp.

Contents include:

Editors' Summary (Full Text)

Articles

Central Bank Transparency and the Signal Value of Prices (Abstract)
by Stephen Morris (Princeton University) and Hyun Song Shin (Princeton University)

Where Did Productivity Growth Go? Inflation Dynamics and the Distribution of Income (Abstract)
by Ian Dew-Becker (Northwestern University) and Robert J. Gordon (Northwestern University)

Are Empowerment and Education Enough? Underdiversification in 401(k) Plans (Abstract)
by James J. Choi (Yale University), David Laibson (Harvard Univeristy), and Brigitte C. Madrian (The Wharton School, University of Pennsylvania)

A Robust Strategy for Sustainable Energy (Abstract)
by Klaus S. Lackner (Columbia University) and Jeffrey D. Sachs(Columbia University)

Report

Gauging Employment: Is the Professional Wisdom Wrong? (Abstract)
by George C. Perry (Brookings Institution)

ABOUT THE EDITORS

George L. Perry

William C. Brainard

William C. Brainard is professor of economics at Yale University.

Ordering Information:

{9ABF977A-E4A6-41C8-B030-0FD655E07DBF}, 978-0-8157-1351-7, $36 Order