Fed Watch: Yes, I am Optimistic
Yes, I am Optimistic, by Tim Duy: I stood relieved when Federal Reserve policymakers recognized the tendency toward pessimism during this recovery when no such pessimism was warranted:
Finally, a couple of members suggested including language in the statement indicating that recent foreign economic developments had increased uncertainty or had boosted downside risks to the U.S. economic outlook, but participants generally judged that such wording would suggest greater pessimism about the economic outlook than they thought appropriate.
This stands in contrast to fairly consistent efforts to find the dark cloud in every silver lining. This, from the Wall Street Journal:
Economic prospects are flagging across Europe, Japan and big emerging markets such as India, a turn that presents fresh challenges to the relatively robust U.S. economy at a time when the world needs a dependable growth engine.
At least they mentioned the "robust" part. And the perennial activity of agonizing over holiday sales is in full swing, despite the reality that holiday sales tell you little if anything about the overall economy.
The lesson no one wants to draw from this recovery is that the US economy is both stronger and more resilient than commonly believed. Everyone, it would seem, is in the pessimism business - and such pessimism seems endemic throughout the US public. Perhaps only pessimism scores political points. Or perhaps that is only human nature. As Deirdre McCloskey recently remarked in her review of Piketty:
…pessimism sells. For reasons I have never understood, people like to hear that the world is going to hell, and become huffy and scornful when some idiotic optimist intrudes on their pleasure. Yet pessimism has consistently been a poor guide to the modern economic world. We are gigantically richer in body and spirit than we were two centuries ago…
Overall, I find the pessimism (from the right and the left) inconsistent with the fact that despite the ups and downs of the quarterly data, throughout the recovery, GDP has grown at a fairly consistent rate:
And even that might hide the strength of the recovery this year. GDP growth has exceeded 3% in four of the last five quarters. In two of those quarters, growth was in excess of 4%. It is simply reasonable to believe that the first quarter GDP report was largely an aberration. Do not dismiss the real improvement in the economy since 2009. It is not unimportant that 2014 is likely to be the biggest year for private sector employment since 1999 and that auto sales will reach a level not seen since 2001. It is not unimportant, in contrast to the conventional wisdom, that "in the post-Great Recession era, the growth in full-employment is, without a doubt, way out ahead." These are just three of many genuine signals of economic strength. It seems to me that in the effort to find what is wrong with the economy, everyone misses what is right.
The US economy is far more resilient than it is given credit for. None of the downside risks of recent years have been sufficient to derail the recovery, nor will the supposed downside risks of next year. They are mostly external, while the primary engine of US growth is internal and flexible. The decline in energy prices (another purported reason to fear the new year) will prove to be no exception. I believe we are witnessing a supply driven dynamic, not collapsing global demand. The US economy will adjust as the balance shifts from energy producers to energy consumers. While this will have some concentrated, negative implications for a handful of sectors and geographies (I would hope but find it unlikely that state and municipal leaders in North Dakota recognized the boom-bust nature of the commodity cycle well in advance of the bust part), I expect that the net impact will be modestly positive.
Indeed, the resiliency of the economy was almost certainly on display in the years preceding the Great Recession. Brad DeLong likes to note that the economy was adjusting to the housing collapse (a much deeper and widespread sector of the economy than energy production) fairly well until the financial crisis:
…you also have a strong argument that it was the financial crisis and not the collapse of the housing bubble that was the lead violin in this catastrophe. Construction reached its housing-bubble peak in the third quarter of 2005. From then until the third quarter of 2008, through the business cycle peak and out the other side, the market economy adjusted as smoothly to the recognition of a sectoral disequilibrium as the most optimistic of macroeconomists could have hoped: interest rates fell as demand for loans to finance construction eased off, and exports and business investment took up the slack resources released by the shrinking construction sector. The NBER's Business-Cycle Dating Committee did not conclude that the U.S. economy was in a full-blown recession until more than halfway through the fourth quarter of 2008.
As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying (and under-appreciated) impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy. This ultimately is the reason that despite the seemingly persistent belief that the recessionary bogeyman is just around the corner, recessions are remarkably rare events.
Since 1983, the US economy has been in expansion for 350 months. Recessions account for just 34 months, less than 10% of the time. In any given month, the probability of recession is certainly less than 10%. Recessions are concentrated in a handful of periods. If you are not in a recession this month, it is almost certain that you will not be in a recession next month. Consider that only three times since 1983 has a recession occurred in a month preceded by an expansion.
But this makes it seem as if recessions simply spring out of thin air, which they do not. Even if you thought the conditions for a recession were currently brewing, it is highly unlikely that the momentum of the US economy will turn in twelve months or less. Even if you thought, for example that the financial sector could not absorb any losses that stem from a decline in energy prices and thus be faced once again with crisis (unlikely, in my opinion, especially in the wake of regulatory enhancements since the last crisis), it would still take months for that shock to propagate throughout the economy.
Moreover, this ignores the other relevant feature of US recessions – they are preceded by long periods of sustained monetary tightening. And the Fed has not yet initiated even its first rate hike. Even if you accept that tapering is tightening, we are still on the front end of the cycle rather than the back end.
Hence my probability of recession in the next twelve months: 0%. I would place similar odds on the following twelve months as well.
To be sure, improvements were not as quick as many had hoped, but the shortfalls can largely be traced to two sectors – housing, in which the financing mechanism was damaged, and the failure of the fiscal authorities to adequately plug the hole. But the resilient economy continued to march higher nonetheless. And now fiscal policy is no longer a drag; the bottom in government jobs has likely been reached. Moreover, there is one silver lining in the relatively low pace of new housing activity – such activity has room to run. I expect that over the next two years housing will become an increasingly strong force in the US economy. Nor will the economy likely be impeded by monetary policy, which even if tighter than expected is likely to remain more accommodative than traditional metrics of appropriate monetary conditions would suggest.
Bottom Line: Perhaps, just perhaps, the US economic expansion has been consistently undersold, and continues to be undersold. It is worth considering that maybe it is time to just accept the good news without the desperate search for every dark cloud.
Posted by Mark Thoma on Monday, December 1, 2014 at 12:15 AM in Economics, Fed Watch, Monetary Policy |
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