Economy limping back to strength
Fed: Return to normal may take 5 or 6 years

By Neil Irwin and Renae Merle
Washington Post Staff Writer
Wednesday, November 25, 2009

The unemployment rate will remain elevated for years to come, according to a forecast released Tuesday by the Federal Reserve that addresses for the first time economic conditions at the time of the next presidential election.

It paints a grim picture. Top Fed officials expect the unemployment rate to remain in the 6.8 to 7.5 percent range at the end of 2012 and said it could take "about five or six years" from now for economic activity to return to normal. The jobless rate was 10.2 percent in October.

That sober forecast came on top of a revised government estimate also released Tuesday of economic output in the third quarter showing that the recovery got off to a slower start over the summer than previously thought.

Government efforts to prop up the economy -- including the $787 billion stimulus package passed in February, the "Cash for Clunkers" program to support auto sales this summer, and a zero interest rate policy by the Federal Reserve -- are helping. The contribution of government spending to gross domestic product in the third quarter was actually higher than originally reported, the Commerce Department said.

But so far, the impact of these efforts has not been enough to engender a strong rebound.

"It is a slow-motion recovery," said Stuart Hoffman, chief economist at PNC Financial Services Group. "It sure doesn't look like the beginning of a normal, rapid recovery."

The math is simple: The U.S. economy is capable of growing at roughly 2.5 to 3 percent a year, thanks to population growth and technological improvement, and needs to grow faster than that to create large numbers of jobs and significantly improved standards of living.

Following the last recession of comparable depth for example, in 1981-82, gross domestic product growth averaged a 7.8 percent annual rate for four quarters.

In this recession, by contrast, the five current Fed governors and 12 presidents of regional Fed banks expect growth of 2.5 to 3.5 percent in 2010 -- which would be enough to bring the unemployment rate down only slightly.

"Business contacts reported that they would be cautious in their hiring and would continue to aggressively seek cost savings," said minutes of the Fed policymaking meeting earlier this month, which were released alongside the forecast. The officials "expected that businesses would be able to meet any increases in demand in the near term by raising their employees' hours and boosting productivity, thus delaying the need to add to their payrolls."

The minutes even raised the prospect that this could be a jobless recovery, with slow hiring for some time, as was the case during the past two recessions. The Fed leaders "discussed" that possibility. But they were slightly more optimistic than before, upgrading their projections for the economic growth and employment in 2010 and 2011 from the levels envisioned in June.

The officials also discussed -- and apparently dismissed -- the risk that their ultra-low interest rate policy is stoking bubbles in the markets, artificially inflating the value of stocks, gold and other assets. "While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks," the minutes said.

The Fed minutes weren't the only report Tuesday to serve as a reminder of the softness of the recovery so far. GDP, a broad measure of economic output, rose at a 2.8 percent annual rate in the July-to-September period, the Commerce Department said, compared with the 3.5 percent growth rate first reported. The agency re-calculates the data as more complete information becomes available.

"It's hard for me to get excited over 2.8 percent growth at this stage of a recovery," said Sung Won Sohn, an economist at California State University Channel Islands. "Historically at an early stage of a recovery, we should be growing at 4 to 5 percent, just to pick up the slack. We should be experiencing a rubber-band effect, snapping back, but we're not."

Economists say they think the economy has continued growing in the fourth quarter, though still at a measured pace -- an annual rate in the 3 percent range. Employment frequently lags overall output at the end of a recession, as skittish employers ramp up production using existing workers rather than hiring, unsure whether rising demand will last.

The Commerce report showed that personal consumption expenditures rose at a 2.9 percent rate in the third quarter, not the 3.4 percent growth originally reported, with a particularly steep reduction in the growth in purchases of durable goods, such as automobiles.

Activity in both commercial and residential real estate was worse than previously thought, and imports were higher. In one positive revision, government spending and investment rose at a 3.1 percent annual rate, not the 2.5 percent originally estimated.

Meanwhile, the housing sector continues a bumpy recovery, according to recent data. Housing starts stumbled more than expected last month, but existing-home sales surged more than 10 percent, according to data released Monday. It was buoyed by first-time buyers rushing to cash in on an $8,000 tax credit initially set to expire this month. Congress has since extended and expanded the tax credit to more buyers.

But many economists doubt whether the sales gains in October are sustainable, particularly if unemployment continues to rise and government policies, such as Fed purchases of mortgage related debt and homebuyer tax breaks, are curtailed.

Also, U.S. home prices rose are continuing to improve, according to the Standard & Poor's/Case-Shiller home price index data released Tuesday, but still lumber around 2003 levels.

In 20 major metropolitan areas measured by the index, home prices rose 0.3 percent in September from the previous month, its fifth consecutive monthly increase. Prices were down 9.4 percent compared with the same month last year. Prices rose for the sixth consecutive month in the Washington region. They were up 0.8 percent on a seasonally adjusted basis, according to the index.

The increase was modest and fewer cities saw an improvement. "While clearly September was a positive month . . . it didn't feel quite as a robust as some of the summer months did," said David Blitzer, chairman of the S&P's index committee.

© 2009 The Washington Post Company