Bernanke's bear saved by fairytale
It is still too early for a full celebration of what some are starting to call the return of the Goldilocks economy writes Gerard Baker
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January 17, 2007
AT the end of the month Ben Bernanke will celebrate his first year as chairman of the US Federal Reserve.
A very quiet celebration is being planned, from what I understand. There will be enough liquidity to keep the level of interest sufficiently high, though Bernanke may take away the punch bowl just as the party gets going.
The main dish on the menu, however, should be bear. With evidence accumulating that the US has again avoided the terrible fate predicted by the doomsayers, the central bank chairman and his colleagues could be forgiven for feasting freely on the entrails of all those bearish prognosticators who have been predicting collapse for the past year.
They won't, of course, being of a cautious, even pessimistic, disposition. But as 2007 gets under way, that soft landing for the US economy everyone said couldn't happen is clearly in sight.
There were two main sets of worriers a year ago. One said recession was imminent. The other said it was merely deferred.
The first group cited the bursting of the housing bubble and a US dollar collapse as the reasons US growth would turn negative.
The second said inflation was spiralling out of control and the Fed would be forced to raise interest rates much more sharply than it had already, and then the economy would drop into recession.
So far, the housing collapse has not materialised. Residential construction spending has fallen sharply in the past year, and Fed officials acknowledge that activity in the housing sector will be a drag on GDP growth for the whole of 2007.
But what has not happened is the consumer spending crunch caused by a fall in house prices.
Since house price increases are assumed to have been a key factor behind strong consumer spending growth over the past five years, a decline in prices was expected to lead to a retrenchment.
But - again, so far - house prices have declined only a little nationwide. More importantly, new research suggests that, when prices were rising, consumers did not spend anything like as much of their housing wealth as was previously believed. As a result, they are unlikely to cut back sharply.
The US dollar's fall has also continued - intermittently - but has not produced the much feared loss of confidence by international investors in US assets. So, except for housing and a sunsetting car industry, the rest of the US economy has done just fine.
On the inflation side, the signs are also encouraging that the worst fears of 2006 will not be realised in 2007. Inflation - however you measure it - eased in the second half of last year, thanks partly to the decline in oil prices.
The big worry for the inflation pessimists was what they believed to be a sharp slowdown in the US economy's potential growth rate.
Between 1995 and 2000 the US enjoyed a productivity-fuelled surge in its trend rate of growth - the rate at which the economy can grow without igniting inflation - to somewhere above 3.5 per cent per year. Between 2000 and 2005 that trend rate accelerated even more. But last year new data suggested that productivity gains had ebbed and the trend could be back down to its more boring rate of about 2.5 per cent or even lower.
That is worrying for inflation, because it means that even at a relatively sluggish actual growth rate of about 2.6 per cent, which the economy is expected to post in 2007, inflation could accelerate.
But there is reason to doubt the new pessimism on productivity and trend growth. It is quite possible that the recent slowing in productivity could just be the undershooting counterpart of an overshoot between 2000 and 2005, and that the correct trend rate is still around 3 per cent.
What is more, as David Hale, of Hale Economic Advisers, points out in a new paper, Are Profits Driving the US Business Cycle?, the fabulous rate of US corporate profitability growth in the past few years, even as real wages are increasing, may suggest that the official productivity numbers are being understated.
It is still too early for a full celebration of what some are starting to call the return of the Goldilocks economy. But if they do have that anniversary party at the Fed this month, they should surely serve porridge not too hot, not too cold; just the right temperature.
The Times
