Just How Strong Is The Economy?

May 14, 2015 at 10:27 am Leave a comment

With apologies to those of you who hate sports analogies, some recent research produced by the Federal Reserve Banks of New York and Chicago demonstrates that we are living in a wedge shot economy:  it looks great from about 150 yards out but as you get closer things aren’t quite as good as they seem.  Suffice it to say that Fed officials have a tough decision to make about when to raise short term interest rates.  If the economy is gaining strength, the time to start raising rates is now or the economy could overheat.  Conversely, imposing interest rates on a feeble economy is the financial equivalent of bloodletting.

Just how sluggish is the economy?  The first bit of analysis comes from the Federal Reserve Bank of New York’s Liberty Street Blog, which, by the way, is a site well worth bookmarking for anyone interested in following economic trends in a digestible format.  It analyzed the most recent Quarterly Report on Household Debt and Credit and its findings go a long way toward explaining why the housing industry has lagged as a stimulus to economic growth even as the worst of the Great Recession fades in the rearview mirror.

Credit card spending is rising for people across the credit score spectrum but even the most credit worthy borrowers are holding back on housing debt.  New mortgage originations are 70% lower than they were in 2013.  In addition, since 2008, the “lions share” of new mortgages have gone to persons with credit scores of at least 720.”  This presumably older and cash heavy demographic isn’t snapping up McMansions at bargain prices either.  Instead “[t]he upsurge in originations by creditworthy borrowers in 2012 and 2013 consisted mostly of refinances and added relatively little to outstanding balances, thanks to record low mortgage rates.”  In other words, the people with the best credit and most money to spend are cutting back on home buying just when the economy needs it most.  Truly patriotic Americans would be taking on debt for the good of the nation.  Just joking.

Then there is the more heated debate about just how good a job the economy is doing creating jobs for people who want them.  Economists will tell you that every economy has a natural rate of unemployment.    Policymakers have to determine what that rate is and raise rates once slack is out of the economy.

Look at the headlines and an economy with an unemployment rate of 5.4% adding more than 200,000 new jobs is enough to make any self-respecting inflation hawk break into a cold sweat.  After all, do we really want a repeat of the late 70’s with its toxic mix of high interest rates, high inflation and disco?

But what if demographics have changed the potential workforce and there is a lot more slack in the economy than the headline numbers suggest?  If this is the case, it is a best premature and at worst counterproductive to raise rates.

The latest researchers to wade into this conundrum are from the Federal Reserve Bank of Chicago.  In a recent report, Changing Labor Force Composition and the Natural Rate of Unemployment, they argue that changing demographics mean that the economy has a naturally lower level of natural unemployment than it did just 15 years ago.  Consequently, policy makers can wait longer before dampening economic growth.  They argue that demographics are destiny and that a growing supply of college educated job applicants and unemployed teens will create an economy better able to accommodate workforce expansion. According to their calculations, the natural rate of unemployment is currently slightly below 5% and will, if present trends continue, decrease to around 4.4% to 4.8% by 2020.

The problem I have with this argument is that it assumes that a college degree will always equal employment and that teens will naturally be absorbed into the workforce as they age. I hope they are right, but, increasingly, I have my doubts.

On that cheerful note, get to work and keep working.

Entry filed under: General.

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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