Local Growth Slows, Fed Official Says

Jeffrey M. Lacker told the D.C. Chamber of Commerce that a housing market collapse is unlikely. (By Robert A. Reeder -- The Washington Post)

The Washington regional economy is slowing, but the damage is likely to be limited and the housing market should bottom out "sooner rather than later," the region's top Federal Reserve banker said yesterday.

Jeffrey M. Lacker, president of the Fed district that covers an area from Maryland to the Carolinas, said federal spending in the Washington region should support continued economic expansion. But the growth of that spending is likely to moderate over the next couple of years, he said.

Lacker said several factors should limit the risk of a "catastrophic" collapse in home prices and prevent the housing market from causing too much damage to the rest of the regional economy.

Population is expanding, incomes are growing and, on average, people are having little problem paying their mortgages, he said. Rising investment in commercial real estate is providing jobs for construction workers even as residential construction drops. And relatively few lots are available on which houses can be built, he said, limiting the supply of new homes coming to the market.

The housing downturn "naturally involves a fair amount of uncertainty for market participants," Lacker said. "Both buyers and sellers are probably more unsure than usual right now about where prices need to settle in order to clear markets."

Lacker, speaking at a D.C. Chamber of Commerce luncheon, said the regional economy faces risks, including worse-than-expected damage from the housing slowdown. And he reiterated his opinion that the country as a whole faces a significant inflation risk.

Lacker has drawn national attention as the sole dissenter in two recent Federal Reserve votes to not raise interest rates to combat inflation, which is running well above many economists' comfort level.

"Should inflation persist around the current elevated level, firmer monetary policy would be required to restore price stability," Lacker said.

Lacker said he is comfortable when "core inflation," which excludes food and energy prices, stays at 1 to 2 percent, a view held by many economists and Federal Reserve policymakers. But lately, core inflation has run above 2 percent. The Fed has paused in a campaign of raising interest rates to slow the economy, but it could resume the increases if inflation does not moderate soon.

Lacker is president of the Federal Reserve Bank of Richmond, one of 12 regional branches of the Federal Reserve system. The Richmond Fed covers Maryland, Virginia, most of West Virginia, the Carolinas and the District and keeps tabs on economic developments in that area.

The Washington area economy has historically been protected somewhat during national economic downturns, with the federal government acting as an "economic stabilizer," Lacker said.

Since 2001, the federal government's spending on defense and security contracts has fueled stronger job growth in the region than anywhere else in the country. In the year ended in August, the number of jobs rose 2.5 percent, twice the national average.

The region has shifted from three years of heady economic growth toward a pattern more in line with the rest of the nation, Lacker said.

Federal procurement spending increased 2.5 percent in 2005, compared with increases of 19 percent in 2004 and 16.9 percent in 2003, according to a study by the George Mason University Center for Regional Analysis. The moderating growth means "total metro-area employment should continue to expand at a healthy pace, but at a rate that gradually declines over the next couple of years," Lacker said.

Local economists share Lacker's view that the softening housing market is the biggest risk to the local economy.

Steven Cochrane, chief regional economist for Moody's Economy.com, said residential construction and jobs associated with the housing market -- real estate brokers, home inspectors, mortgage brokers -- added significantly to the region's economic output over the past few years.

"If you take those away, you will shave a lot off growth," Cochrane said.

Anirban Basu, chief executive of an economic consulting company in Baltimore, Sage Policy Group, said Northern Virginia is most vulnerable to the deceleration of government contracting and the housing downturn. Fairfax County businesses enjoyed rapid growth from government contracting, and counties such as Prince William experienced breakneck residential housing growth.

"You didn't see the supply growth in Montgomery and Prince George's counties that you saw in Loudoun and Prince William," Basu said. "So this is not going to be evenly felt around the region."