Friday, October 10, 2014

NCBJ 2014: Fed Economist Says "I've Got to Admit It's Getting Better, A Little Better All the Time (It Can't Get Much Worse)"

William A. Strauss, an economist with the Chicago Fed, delivered the keynote address for the Commercial Law League of America's luncheon Thursday.   His overall forecast was for slow but steady growth, declining unemployment and low interest rates as the country digs its way out of the Great Recession.    In other words, he predicted a good climate for reorganizing debtors.

His only reference to bankruptcy was in his opening remarks when he stated:
Bankruptcy is good.  Unemployment is good.   They are necessary evils. . . . Unemployment makes workers available to industries that are rising.   Bankruptcy makes resources available to industries that are rising.
He described the economic picture as a good news, bad news story.   He said that the United States has the strongest economy in the world, although its growth is not impressive.   He said that we should see positive growth this year.   However, he tempered his remarks by pointing out that the relevant metric is not zero.   Each year the labor force grows by 1% while productivity can be expected to grow by 1.0-1.25%.   Thus, a growth in GDP of 2.0-2.25% is the expected trend line.

He said that the outlook for the next five years was growth at:

2014 +2.0%
2015 +2.9%
2016 +3.0%
2017 +2.0%

He said that the economy is recovering slowly from the Great Recession.   After the recessions in the 70s and the 80s, the economy improved by about 20% in the five years after the trough.   Here, the recovery is only expected to be about 11%.    During the Great Recession the economy declined 4% over an eighteen month period.  Subtracting the growth which should have occurred during this period, the economy was down 7%.    

However, the American economy looks positively rosy compared to the rest of the world.   Japan is expected to increase by 1.2-1.3%, Europe by 1.0-1.5% and Russia by 0-1%.    Strauss said that the U.S. needs for the rest of the world to do well in order for our economy to do well.

The housing market illustrates the double nature of the recovery.   On the one hand, housing starts are up 40% and prices are growing by double digits.   On the other hand, 15-20% of homes are still under water financially and prices are back to their levels of ten years ago in real terms.   

The stock market appears to be at record highs, but is not when adjusted for inflation.

Employment is another weak area.   8.7 million jobs were lost during the Great Recession.   We are currently adding about 1 million jobs per year which means that it will take 6 1/2 more years to recover.   He said that the natural unemployment rate is 5.25% and that we are about half a point above that level.   Labor force participation fell by 3% during the Great Recession and is back to 1978 levels.   1.5-2% of this is due to demographics, that is, older workers dropping out of the work force, while 1.0 - 1.5% is cyclical.    What is even more concerning is that participation levels for those aged 25-64 are constant, while the 16-19 and 20-24 year old demographics are down dramatically.   

3.5 million workers have given up looking for jobs and are not counted in the unemployment rate.   He said that the true level of unemployment beyond the natural level is about 4.5 million to which is added a percentage of those working part time who would prefer full time work.   (He gave the statistic.  I just didn't get it in my notes).   

He said that we are "far removed from a labor force that is in balance."

Mr. Strauss said that the demand side of the economy is growing but not by much.  He said that producing too much of anything results in reduced prices rather than inflation.  He predicted that inflation would only be 2.2% in 2014 and 2.1% in 2015.   The Fed's target inflation rate is 2%.   Strauss said that there is nothing wrong with going above the target rate if it will help the labor market. 

He described manufacturing as a stellar sector in the economy.  However, it has only brought back 31% of workers laid off.   The remaining gains have been due to productivity.   The companies that survived are more "lean and mean."  He also said that we have "world class manufacturing in the U.S."  We have 5% of the world's population and 24% of the output in the world.   One growth area is for vehicle manufacturing.   The average car on the road is eleven years old, something that would have been unthinkable a decade ago.  However, it also means that a lot of people will be replacing their vehicles.

Strauss spent a fair amount of time talking about monetary policy.   (He is from Chicago after all).   He said that in 2008, the Fed lowered the overnight lending rate to nearly zero.   He said that he wished they could have lowered it to -4% so that people would have been forced to take money out of the bank and spend it.   However, he said that would have been too disruptive.  Apparently Cyprus did just this by taxing bank deposits and the result was bad.   

He said that he expected the overnight rate to reach its natural rate of 3.0-3.25% by 2017.  He described this as a neutral rate, "not putting the foot on the brake, just taking the foot off the accelerator."

He quoted Milton Friedman as saying that inflation everywhere is a monetary phenomenon and that it results from monetary policy, not the monetary base.

Strauss said that he never had the occasion to study with Friedman.   However, he did have occasion to attend his 90th birthday party where a newly minted Fed Governor named Ben Bernanke was the keynote speaker.   Speaking of the Great Depression, he told Friedman, "We're sorry.   We're not going to let it happen again."   During the Great Depression, the Fed added to the monetary base but not as much as was being lost from bank failures.  As a result, the money supply declined which contributed to the depression.

During the Great Recession, the Bernanke Fed grew the monetary base by 20% but only grew the money supply by 6%.    However, he was true to his word and did not let the country slip into a full blown depression.

In conclusion, he said that we will continue to grow the economy at a decent rate for the next several years and that employment will continue to rise at a moderate level.

In response to a question that I don't remember, he quoted Warren Buffett as saying "You don't know who's swimming naked until the tide goes out."   I don't remember the context, but I like the quote.

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