- The Washington Times - Saturday, December 9, 2006

Among the 10 economic expansions that have occurred since the end of World War II, only three have lasted longer than the current one, including its two immediate predecessors, which lasted 92 and 120 months, respectively. With November marking the fifth anniversary of the current economic expansion, now is a good time to assess the present state of the U.S. economy and its likely direction. Such a review is all the more timely because the Federal Reserve’s interest-rate policy-making committee convenes Tuesday amid uncertainty on the inflation front and a pronounced slowdown in economic growth.

Given that the trough of the last recession occurred during the fourth quarter of 2001, we are now in the 20th quarter of the expansion. To understand where the U.S. economy is today, it will be instructive to review how the current expansion has evolved. In terms of the economy’s growth rate, the expansion has proceeded through three distinct phases. Following a relatively shallow eight-month recession that ended in late 2001, the first phase of the expansion lasted five quarters, during which the economy’s average annualized growth rate puttered along at 1.75 percent. In no post-recession quarter did the economy achieve an annualized growth rate above 2.7 percent until April-June of 2003 (3.5 percent). Over the three-year period beginning with the second quarter of 2003 and ending with the first quarter of 2006, the U.S. economy’s growth rate accelerated rapidly, averaging more than 3.75 percent per year. After growing at an annual rate of 5.6 percent during the last quarter of that three-year period, the economy entered its third post-recession phase in April. At 2.4 percent from April through September, the U.S. economic growth rate fell by more than a third. Most analysts believe growth during the current quarter will decelerate further.

The relevant questions are: Is the current slowdown just a breather, after which growth will rebound above 3 percent? Or will the slowdown intensify, with growth falling below 1.5 percent for several quarters and perhaps even becoming negative?

The latest forecasts from the White House, the Fed and the Congressional Budget Office all project that the economy will expand by about 3 percent next year. However, it may be premature to take much comfort from a consensus view that is indisputably optimistic. As CQ Weekly recently reminded us, in December 2000 “the 52 forecasters who participated in the monthly Blue Chip Economic Indicators survey collectively expected the economy to grow by 3.1 percent the following year.” As it happened, the economy entered a recession in March 2001, and the consensus forecast proved to be wildly off the mark.

If the bursting of the stock-market and telecom-investment bubbles proved to be the downfall of the last expansion, the housing market represents today’s economic wild card. Clearly, something major is happening throughout the housing market and industry, both of which proved to be major pillars of the current expansion. Since 2001, soaring housing values enabled households to extract trillions of dollars in equity from their homes through mortgage equity withdrawals. Much of that money was used to finance consumption, which fueled the first phase of the expansion and was indispensable in sustaining growth at its high level throughout the expansion’s second phase. Meanwhile, residential investment (i.e., the construction of new houses) soared as well, increasing at an average annual rate of 8.9 percent during 2003, 2004 and 2005.

This year the housing market and residential construction have entered their own recessions. Residential investment has declined four quarters in a row, plunging at an 11 percent annual rate in the second quarter and by 18 percent in the third. During the past two quarters on average, the collapse of residential investment alone has shaved nearly a full percentage point from the economy’s overall growth rate. Then in October, housing starts plummeted by 15 percent compared to September; they were down more than 27 percent from a year ago. October building permits were down 28 percent from year-ago levels. Meanwhile, new-home sales in October were 25 percent below the level a year ago. Existing-home sales were down 11.5 percent from October 2005; and the median home price was 3.5 percent below its year-ago level, the largest drop on record.

Led by a big drop in auto production, the manufacturing sector, which declined in November, may have joined the housing sector in recession. Fortunately, the much larger service sector continued to expand last month. An increase of 132,000 payroll jobs represented another positive development in November. Compared to initial employment reports revealing that 271,000 payroll jobs were created during the three previous months, subsequent revisions raised the three-month total to 512,000 new jobs. On the other hand, productivity increases have sharply decelerated during the two previous quarters.

Over the past 12 months, consumer prices have risen a very tame 1.3 percent. But so-called “core” consumer prices — which exclude energy and food and to which the Fed pays great attention — have risen 2.7 percent. That’s well above the Fed’s comfort zone. However, with declines in the housing and manufacturing sectors threatening to further adversely affect consumption, the Fed should refrain from raising short-term interest rates on Tuesday.

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