So says Richard DeKaser, senior vice president and chief economist for National City Corp.
“A lot of people are hoping we may get back to where we were in the latter 1990s. I do not at all see that happening,” DeKaser said in a recent telephone seminar on the changing economy and its impact on small business. “This will really be a return to a moderate pace of growth and not a return to boomtown.”
Although the downside of the economic forecast has come to dominate and recession worries are on the rise, he doesn’t anticipate a recession ahead. In fact, the current economic environment almost mirrors that of one year ago when most people foresaw growth continuing uninterrupted into the future, he said.
“I believe the U.S. economy has been through a number of adverse developments, most of which are very much in retreat,” DeKaser remarked.
The Federal Reserve progressively raised interest rates in small increments from mid-1999 to mid-2000 in an effort to slow down the economy and keep inflation from getting out of control. The Fed’s concerns were not at all misplaced, he added.
The Fed is already reversing the interest rate increases of that earlier period. When the board cut the interest rate a full percentage point this January, it represented the most aggressive use of monetary policy ever displayed in the Greenspan era, DeKaser noted, adding that the Fed “is not asleep at the wheel.”
Consumer price inflation has increased from a rate of about 1.5 percent in 1998 to its present 3.6 percent year-over-year rate.
DeKaser noted that energy prices contributed to both the economic weakening in 1998 and the subsequent rebound in inflation. But even when energy is taken out of the mix, core inflation was up from a rate of about 2 percent at the end of 1999 to 2.6 percent at the end of last year.
Inflation hasn’t taken off in a big way, but the trend of all consumer price inflation indicators has been up between 1 and 2 percentage points in the past year, he said
DeKaser observed that cyclical sectors of the economy have historically contributed to U.S. economic recessions, and it was weakness in cyclical sectors that led to the current slowdown. Those sectors include big-ticket consumer items such as autos, home furnishings and appliances, business expenditures on capital goods, and residential and non-residential construction.
GDP growth in the first half of 2000 increased at a 5 percent rate and in the second half increased at a 1.8 percent rate.
But more notable than the slowdown in GDP was the slowdown in consumer spending, DeKaser said. For the past few years, consumer spending — one of the leading factors in the economic expansion — has been increasing at about a 4 percent to 6 percent rate. That tumbled to about a 1 percent rate of growth in the final months of 2000.
The decline in consumer spending is due to a combination of poor stock market performance and its impact on confidence levels and consumer wealth holdings, DeKaser said.
Consumer confidence has dropped from extremely lofty levels. One year ago confidence levels were literally unprecedented in U.S. economic history, he said. In the East Northcentral region, which includes Michigan, there’s been a 31 percent drop — the steepest decline of any region. The rest of the country has seen confidence levels decline 17 to 21 percent.
There’s been a tremendous increase in household net worth since 1995 and a corresponding drop in the savings rate. DeKaser said that’s perfectly sensible and consistent with rising net worth because if consumers, in general, feel they’re meeting their investment objectives through capital appreciation and rising values of real property, they have less reason to meet the same objectives for savings.
“The concern is that if there is a confluence of falling confidence and falling equity valuations, people could attempt to restore past savings levels in a hurry,” he said. “That would undoubtedly put the economy into a recession since consumer spending is almost 70 percent of GDP.”
DeKaser doesn’t think that scenario will play out because of the accumulated “wealth effect” of the past few years and people’s tendency not to respond to extremely short-term economic developments.
In this neck of the woods, weather played a role in the weakening of the economy as well. As DeKaser pointed out, the switch from benign to exceptionally harsh weather in November and December explains part of the consumer retrenchment; consumers simply stayed at home and postponed purchases to another time. As weather conditions returned to normal earlier this year, consumers got back into stores.
Additionally, rising fuel prices absorbed some of consumers’ discretionary income. Although the worst of this winter is past, people could still be experiencing some “residual pain” associated with high energy outlays over those months and might forego consumption elsewhere.
The business community didn’t accurately predict the economic slowdown, DeKaser said, so inventories rose dramatically during 2000. The outgrowth of the slowdown is an inventory “overhang” that’s placing added weight on certain sectors of the economy — particularly manufacturing, which represents about 24 percent of Midwestern economic activity.
Thus, the Midwest region is at a greater disadvantage given its industrial orientation. Since the beginning of 2000, layoffs in the Midwest have increased at about twice the national rate, which is closer to 14 percent.
In December and January inventory levels began to top out and DeKaser said that’s a positive development. Manufacturing activity is still prevalent, but it’s been less intense in recent months.
“In a nutshell, I believe we’ve already taken sufficient steps by way of reduced manufacturing activity to try to get inventories back down to desired levels,” he remarked.
Retail activity picked up sharply earlier this year, energy prices have dropped precipitously in recent weeks, and the inventory correction is substantially on the way to completion, he noted.
For the balance of the year, DeKaser expects to see GDP numbers around 1 percent to 1.5 percent. As the country moves through the remaining quarters of the year, improvements will bring it up to 2 percent in the second quarter and to the range of 3 to 3.5 percent by the second half of next year, he predicted.