State of the Economy

Joel Naroff
Chief Economist, Commerce Bank and President, Naroff Economic Advisors
Thursday, January 17, 2008; 1:00 PM

A wide range of data from the government, private corporations and independent analysts paint a picture of a nation that is already in recession in some states and industries, while much of the nation and big parts of the economy have suffered little.

Joel Naroff, chief economist for Commerce Bank and president of Naroff Economic Advisors, will be online Thursday, Jan. 17, at 1 p.m. ET to discuss the state of the economy.

"We don't have a full-blown nationwide recession now, or even a full-blown slowdown," said Joel Naroff, in an interview with The Washington Post. "But that doesn't mean it doesn't ultimately turn into one. What the Fed and Congress need to do is try to make sure this is a soft period rather than a recession."

This divide, reflected in a report released yesterday by the Federal Reserve, shows a nation struggling to fight off the housing and credit crisis. The challenge facing policymakers is to prevent the problems from spreading without unnecessarily increasing the budget deficit or stoking inflation.

A transcript follows.


Joel Naroff: Hi, this is Joel Naroff. I am glad to answer any of your questions. They can be on the economy, recession, fiscal policy, Fed policy. Anything is fair game. Thanks. --Joel


Harrisburg, Pa.: What is the official definition of a "recession," and might it be time to change that definition or perhaps create a new word that describes a slow growth economy with several sectors in trouble while others are doing well?

Joel Naroff: Most people believe that a recession is two consecutive quarters of negative economic growth. While that is usually what happens, it is not how it is defined. Basically, the National Bureau of Economic Research's Business Cycle Dating Committee looks at several economic indicators, including real GDP, real income, employment, industrial production, and wholesale-retail sales. The members then make a judgment whether activity has sufficiently declined. This is monthly data and the cycle is dated using monthly data.


Boston, Mass.: Dear Joel,

I'm a college freshman. I took AP Micro and Macro in high school, so I do have a basic understanding of what's going on in the U.S. economy right now (possible slowdown or recession), what's being done about it (rate cuts, possible stimulus packages) and what the side effects of such measures could be (inflation, larger deficit, etc). Despite all that, what exactly is meant, in layman's terms, when someone refers to the "subprime mortgage crisis?" Could you clear that up for those of us who don't yet have our degree in econ?

Joel Naroff: The subprime mortgage crisis stemmed from the actions of lenders who gave mortgages to people who were high credit risks. These people normally couldn't qualify for a regular mortgage. They were typically given relatively low initial mortgage rates with the expectation that they would either pay the higher reset rate or refinance. Unfortunately, the housing makret collapsed and declining prices made it impossible for many to refinance and the higher mortgage resets led to defaults. That led to financial firms losing money and becoming more conservative with credit and the credit crunch. It also spread to those industries that serviced the industry as construction activity fell. This spreading into the general economy is the problem we face now.


Washington, D.C.: New figures released earlier this week showed that inflation was up in 2007. If the Fed continues to expand the money supply (as they are sure to do), do you think we'll see a period of inflation combined with an economic downturn?

Joel Naroff: If there is anything good that comes out of a major economic slowdown it is that inflationary pressures tend to be eased. Thus, while inflation is somewhat higher than desired, especially for food and energy, I don't expect any significant increase in inflation even if the Fed eases sharply. The Fed will likely quickly raise rates once the slowdown is over to limit the impact on inflation.


Atlanta, Ga.: I would like to know, how long can we keep borrowing from China, Japan, and Arab countries to pay for this war and president Bush's tax cuts? Down the line, do think Congress or the next president will no choice but to raise taxes to pay for these expenses?

Joel Naroff: Americans like to buy goods from other parts of the world. Those firms get dollars and give us vehicles and toys and clothing and food. They have to do something with the money. Now, they are using that money to buy U.S. companies. Ultimately, we do need to correct the trade and budget imbalances if we are going to have a long term strong economy. With Medicare and Social Security costs rising, we need to expand the economy, grow faster and control our spending. This is a major challenge facing Congress and action needed to be taken before today.


Odenton, Md.: What are the chances that Bernanke will lower interest rates again? And if so, how low can they go?

Joel Naroff: It is very likely that the Fed will lower the funds rate by 50 basis points, 1/2 percent on January 30th and possible at least that much more over the following few months. I wouldn't be surprised if the funds rate hits 3% or even lower.


Laurel, Md.: No one (other thane a few owners of commodity futures) really likes inflation.

Except for their own house.

Does our nation's political priority of keeping home values high reverberate into other kinds of inflation?

Joel Naroff: The surge in home prices during the housing boom led to a lot of people using their homes as ATM machines and spending a lot of money. To the exptent that it created excess demand, there were some inflationary pressures created by the housing boom. Now we have a major slowdown and inflationary pressures should ease somewhat.


Nashville, Tenn.: While I have heard candidates speak of a stimulus tax cut, so far no one has explained how that could help the current stagflation. Most agree that what has hurt the economy is four years of sustained high oil prices, which are high because of the falling dollar, which fell because the U.S. is printing money to finance the war in Iraq, i.e. the war costs have been put on the deficit. Congress couldn't even find a way to pay for fixing the Alternative Minimum Tax so how can a tax cut which will simply be put on the deficit, cure a problem that is caused by the deficit?

Joel Naroff: The budget deficit is a major constraint when trying to deal with the current economic slowdown. It has limited the government's flexibility in coming up with fiscal policy, since that policy tends to increase the deficit. Congress really has to come up with a fiscal policy that follows the three T principal: It must be timely in that it has to increase spending now; It must be tageted to those who will spend right away and it must be temporary as recessions don't normally last a long time. We shall see if Congress succeeds in coming up with a package that follows those guidelines.


Lafayette Hill, Pa.: The Fed seems to be far more interested in preventing a recession than avoiding an acceleration in inflation, even though there is a serious danger of both occurring in the near future. This goes against the conventional wisdom I learned in college econ, based upon the Fed's actions in the 1970's, that inflation will keep growing until it is choked out of the economy by an economic slowdown and therefore should be dealt with first. Is there a new paradigm now explaining the Fed's actions, is this the result of election year politics invading the Fed, some of each, or is there another explanation?

Joel Naroff: While inflation has risen, it still is not that high. Yes, food and energy costs have skyrocketed but other prices are rising at a more reasonable pace. This gives the Fed some wiggle room to act aggressively to deal with the looming recession. Economic slowdowns usually ease inflation pressures as well. The Fed will likely act aggressively but once it is clear the economy is out of danger, look for the Fed to raise rates fairly quickly. This will be done to limit the potential impact on inflation of the monetary and fiscal stimulus.


Eugene, Ore.: I wonder how long China will countinue buying U.S. federal notes, etc?

Joel Naroff: China ran a trade surplus with the U.S. of about $250 billion in 2007. It has to do something with that money. Treasuries are the safest form of investment in the world. While the Chinese might want to diversify their portfolios, as should everyone, they will still likely buy lots of Treasury securities for the foreseeable future.


Joel Naroff: Fed Chairman Bernanke was in front of Congress today and in his testimony he indicated that the economy had deteriorated and that some fiscal policy would be warranted. This is likely to green light Congress to come up with something. Whether it meets the economist test of being timely, targeted and temporary, we don't know. But with the Fed likely reducing rates at the next meeting on January 30th and possibly additional cuts in the following few months, there looks to be a lot of stimulus coming. That should help ease the problems, though they may come too late to prevent a recession.

Right now, I still think it is possible that we skirt a recession. But the risks are high. With the coming fiscal and monetary stimulus, the slowdown may not be that long lasting or deep.


Fairfax, Va.: Do you think the entire country will be officially, in a matter of time, be in a recession? Is it inevitable, what with the current conditions? And what does recession actually mean as far as my pocketbook and my house?

Joel Naroff: Clearly, the recession risk is high and rising. But we need to see where job growth goes. If it does not turn negative, we could get enough consumer spending that coupled with world growth and exports would keep us out of a recession. Regardless, for many people and businesses the growth will be so slow that it will feel like a recession.

As for your house, the housing market problems are likely to continue well into next year. If you want to get an idea what could happen to the price of your house, ask a realty how many homes are now on the market compared to how many were on the market five years ago. That will give you an idea about the excess inventory and potential price declines you could face.


Washington, D.C.: So will this Bernanke action be the jump start the economy needs?

Joel Naroff: It will help. But monetary policy acts with a lag so it will take time to have an impact on the economy. It may ease any recession rather than prevent one. It also is what we call a blunt instrument. Interest rate cuts are not targeted so it isn't clear when and where the impacts will first be felt.


Washington, D.C.: Perhaps a dumb question, but I get confused when I read that part of our economic problems are that the American savings rate is extremely low and then read that part of problem is that people aren't spending. They seem to contradict each other. Can you shed some light on the subject?

Joel Naroff: Over time, we need to save more so we can invest more. The savings goes toward investing in business capital and public infrastructure. A low savings rate means we have to pay up for capital from the rest of the world and it could put pressure on interest rates. In the short term, such as the current situation, while we are spending all we have, the problems being created by the housing mess have slowed demand in so many parts of the economy that growth has deteriorated. But income growth, which is the key, is in part determined by job gains and the easing of job growth has put less into workers' hands. Thus, we have slower income growth, slower spending, housing problems and the resultant economic softening.


Seattle, Wash.: Wouldn't it be smarter to just tax all CEO and exec pay, benefits, and stock options/loans beyond $1 million at a 90 percent rate for those firms which fire employees?

Or cancel all the contractors in Iraq -- and use that money to repair and replace our collapsing bridges and roads in America?

Joel Naroff: Ther is a lot of anger at the executives who helped create a lot of the mess but got big payouts. Still, this is the responsibility of the boards of Directors and investors. It is the political process that determines how we spend the public's money. The electorate will ultimately determine how much we spend on wars, bridges, education and welfare.


Jacksonville, Ala.: Where are they going to get the money for the stimulus? Do you think this so-called stimulus will work? I think most people will just save the money or spend it on their debt.

Joel Naroff: The problem with most stimulus packages is that they create little stimulus. If you give people money, nothing stops them from paying down debt or simply saving it. If you give business tax credits, it doesn't mean they will run out and buy capital equipment they don't need or want. That is why fiscal stimulus to ease an economic slowdown is so difficult to effectively construct. I like to say that politicians want to help in the worst way, which unfortunately is the way they usually wind up helping. Hopefully, that will not be the case this time.


Prescott, Ariz.: Do tax cuts lead to revenue growth for the federal government? I keep hearing people claim this as a reasonable position (i.e. presidential candidates), but I would think it is fantasy (especially at current tax rates). If it is fantasy like I suspect, it should be by definition, not a sincere/serious position. And following on this, why do people get to keep saying it without getting called on being completely insincere and/or unserious?

Joel Naroff: The issue for tax cuts is not that they don't create revenue but is the revenue they create enough to offset the tax losses and keep the deficit from rising? I don't know of any study that showed that tax cuts completely pay for themselves. Some have larger offsets than others. The tax cuts that create more long term growth are the best. The ones that simply add to short term spending or subsidize activity that would have taken place anyway create the least amount of growth and therefore tax offsets.


Palo Alto, Calif.: What's the difference between the various Democratic candidates stimulus/economic proposals?

Which one do you think is the best, and why?

Finally, what effect do you expect the run-up to the election to have on the economy?

Joel Naroff: Everyone has a proposal. The Democrats seem to be targeting individuals in distress and smaller businesses. Some proposals will work well, others may not. That is true with all the Republican proposals. But until we see what the package actually looks like, it is hard to know how effective it will be.


Palo Alto, Calif.: How immune are places like Silicon Valley from the housing crisis?

The theory is that the combination of low supply and high demand will keep prices up.

What do you think?

Joel Naroff: The local economy will determine the extent of the price decline. A rapidly growing area will be able to deal more easily with any excess supply of homes and if there is low supply, then prices could rise. It is hard to generalize about an area as large as Silicon Valley, but to the extend that technology firms do well and hire, then the housing problems will be limited.


Seattle, Wash.: Why is this the responsibility of investors? I own direct shares in about 40 different corporations, and I'm not permitted to vote on the pay, bonus, and benefits of my direct employees in the CEO/exec suites.

In fact, when they sell a company, both sets of execs reward themselves with massive pay packages that I only get an up/down vote on whether the deal should occur, not a separate vote on ...

Joel Naroff: One investor, even a large one, can rarely affect a corporation's policies. But it is the sum of all investment decisions that determines stock prices. If investors sell, prices will fall and that should have an impact on boards and governances. Yes it is indirect and sometimes futile, but the alternative is the government or regulators running businesses and that is even worse.


Joel Naroff: Thanks everyone for asking questions. Let's hope the Fed acts aggressively and Congress comes up with a stimulus package that actually works so we can get past the current slow period with minimal disruptions. --Joel Naroff


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