Why hasn’t the recovery kicked in yet?

at 04:22 PM ET, 06/08/2012

Last winter, Karl Smith, an economist at the University of Carolina, was predicting that the United States was headed for a strong recovery in 2012. His logic was seductively simple — there was lots of pent-up demand for things like cars and housing, and that demand was bound to kick in eventually.


What gives? (Laura Rauch - AP)
Obviously, that never quite happened. Or at least the U.S. economy hasn’t received this big, self-sustaining kick quite yet. After a strong January and February (possibly bolstered by a freakishly warm winter), the recovery seems to have stalled out in recent months. So what went wrong? Smith has a long post over at Modeled Behavior trying to explain why his prediction went awry. It’s very much worth a read.

In short, Smith’s earlier prediction was based on four trends that he expected to take root in 2012: 1) Auto sales would rise because people had gone so long without buying cars that eventually they would have to replace their aging vehicles. 2) The construction industry would finally have to start building new multifamily homes again in response to soaring rents. 3) Local governments would stop cutting back on positions and services — eventually, voters would say “enough’s enough!” And 4) natural-gas fracking in Texas’s Eagle Ford would accelerate and turbocharge the energy industry.

But, Smith notes, of those four factors, only auto sales have so far seen a kick. “[T]hree of the four major push factors did not materialize on time,” he notes. “The good news is that the fundamental dynamics are still there. The bad news is that there is a synergistic effect to all of these things happening at once.”

In other words, eventually new homes will get built to supply demand and governments will stop laying off workers and natural-gas prices will recover. But it would’ve been far better if all of these trends had popped at once. That might have produced a self-sustaining recovery. Instead, the labor market is now growing at a soft pace (as economist Dean Baker notes, that’s true even after accounting for the warm winter), and the fragile U.S. economy is quite vulnerable to shocks from Europe and China.

So can anything break the economy out of its current doldrums? If natural forces aren’t going to produce a fast recovery, Smith argues, then the Federal Reserve has to step in: “The Fed has to say that it will tolerate more inflation or will be more heavily focused on unemployment. This way folks engaging in long term projects will know that even if the economy picks up they can still expect to experience low financing costs.”

 
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