Perspectives

Also see our Economic Commentary which supplements the Laufenberg Economic Quarterly and primarily focuses on more recent economic developments.

This page is designed to offer you my perspective on economic fundamentals, ranging from business cycles to yield curves. It will provide more detailed economic analysis than is generally available in the Quarterly. For the most part, the essays provided here will attempt to discuss timely fundamental issues related to the forecast but are expected to have a longer shelf life than the content on either the Quarterly or Commentary pages. I hope that over time you will consider the information on this page as a source of reference when debating economic issues in the future.

Daniel E. Laufenberg, Ph.D.
LaufenbergQuarterly.com

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Recession fear, not fact
(September 4, 2011)

Recent concern that the U.S. economy is slipping back into a recession, or is still in recession according to a few, has been exaggerated in my view. Part of the problem is that a few highly regarded economists have gone so far as to suggest that the chance of another recession this year has climbed to 50 percent.1 Admittedly the risk of a recession has increased somewhat in recent months due in large part to the political shenanigans in Washington, DC. But most of these shenanigans are self-inflicted and can be corrected rather easily with some cooperation from both sides of the political spectrum.

The economy did hit a sizable speed bump in the first half of this year, but the fundamentals still seem to favor a reacceleration of growth in the second half. That being said, many forecasters, even some who were very optimistic earlier in the year, have downgraded their forecast for growth along with Standard & Poor’s downgrade of long-term U.S. Treasury obligations. I have not been totally immune to this situation either. I too have taken some of the optimism out of my forecast for the second half, but it still is far from a recession scenario.

That being said, it may be helpful to review who determines if the U.S. economy is in a recession and the criteria used to make that call. The National Bureau of Economic Research (NBER) has a committee of economists—called the Business Cycle Dating Committee (Committee)—that maintains a chronology of peaks and troughs in economic activity. A recession is a period between a peak and a trough, and an expansion is a period between a trough and a peak. During a recession, a significant decline in economic activity spreads across the economy and can last from a few months to more than a year. Similarly, during an expansion, economic activity rises, often substantially, spreads across the economy, and usually lasts for several years. However, it is important to note that “in both recessions and expansions, brief reversals in economic activity may occur—a recession may include a short period of expansion followed by further decline; an expansion may include a short period of contraction followed by further growth.”

According to the NBER, the “Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real gross domestic product (GDP) measured on the product and income sides, economy-wide employment, and real income.” The Committee also may consider indicators that do not cover the entire economy, such as the Federal Reserve's index of industrial production. For the purpose of this discussion, I will examine the various measures of economic activity that the Committee may consider in its determination of whether the economy is expanding or contracting.

The first of the indicators used by the NBER is real GDP growth as measured on the product side of the national income and product accounts. This measure continues to rise, albeit at a much slower pace more recently than it did earlier in the recovery (see Chart 1). However, as noted by the NBER on its website, it is not unusual for real GDP growth to experience a short-period of very slow growth, even contraction, followed by further growth during the expansion phase of a business cycle. Indeed, every indication from more recent data suggests that real GDP growth in the third quarter will be at least twice as fast as it was in the first half and possibly three times as fast.2

Of course, the pace of the recovery so far has been disappointing. In particular, the recovery has been in place for two years and real GDP still is below its previous peak of the fourth quarter of 2007. This was not the case prior to the latest round of benchmark revisions to real GDP published by the Bureau of Economic Analysis in July. The primary reason for the downgrade of the recovery was because the recession was estimated to be even more severe than measured earlier. Indeed, the pace of real GDP growth over the four quarters of 2010 was actually revised upward to 3.1 percent from 2.9 percent. However, this was due in large part to much stronger real growth in the second quarter of 2010 rather than later in the year.

chart 1

The trend seems to be the problem. That is, real GDP grew 3.3 percent in the first year of the recovery but only 1.6 percent in the second year. Obviously, this downward trend in the growth rate is a source of concern for many. However, the NBER understands that expansions can be very uneven. I suspect that 2011 will be no different in this regard and that the economy will deliver a much better performance in the second half than it did in the first. The arguments supporting this more positive outlook are outlined in the August 2011 issue of the Laufenberg Economic Quarterly.

Second, another economic indicator that seems to get considerable weight in the NBER’s decision to time the start of recessions is nonfarm payroll employment. As shown in Chart 2, private nonfarm payroll employment continues to drift higher, albeit at a slower pace more recently. For example, in August, private payroll jobs increased a scant 17 thousand, following a gain of 156 thousand in July. The headline statistic of total payroll employment in August was unchanged due to a decline of 17 thousand government jobs. Recall that the August payroll employment data, both private jobs and total jobs, were distorted by a strike in the communications industry, which temporarily subtracted 45 thousand jobs. In September, payroll jobs will be up 45 thousand due to the end of the strike. Anecdotal evidence suggests that businesses need more employees but are reluctant to do anything because of the uncertainty of new regulations being written and the impact of the expanded government health-care program scheduled to go into effect in 2013.

chart2

Despite expectations of more jobs in the near future, the level of private employment most likely will remain well below its previous peak in late 2007 for quite some time. Indeed, it is possible that we will experience another recession before employment hits a new high, which would prolong the perception of a weak labor market even longer. I just think it is still too early, although not impossible, for the next recession to begin given the excess capacity still in the U.S. economy. Financial imbalances still persist but are no way near levels that would trigger another financial crisis and inflation, although higher in the first half due to energy prices, will not persist long enough to be a threat to the expansion for now.

My forecast is that businesses will remain cautious about expanding payrolls in the face of this uncertainty. This does not preclude them from hiring, just not aggressively. They will add to their payrolls but only the minimum required. Jobs are expected to increase about 150 thousand a month on average over the next year or more. Based on demographics, an average net increase in payroll jobs of less than 100 thousand a month is enough to keep the unemployment rate unchanged. In other words, not as many new jobs will be needed because of the “Boomers” going into retirement. According to my very crude calculation, about 50-60 thousand more people are retiring each month now than in 2000, suggesting that more vacant jobs must be filled before new jobs are added. An interesting aspect of this is that gross new hires in recent months are tracking at a pace just shy of 4 million a month. More would be better but 4 million a month is not bad.

Another measure of broad economic activity used by the NBER to time business cycles is personal income less transfer payments after adjusting for inflation. As shown in Chart 3, this measure too has been trending higher but it too is still well below its previous peak in early 2008. Once again, this measure of activity does not suggest that a recession is underway. Nevertheless, neither does it preclude one from showing up in the near future. My forecast is that real personal income less transfer payments continues to drift upward over the next year or two before it risks rolling over. This is just another way of saying that the current expansion is expected to continue but not for ever. Indeed, the current expanion is unlikely to be as long as the previous expansion, which was a stellar 73 months long but still was the shortest of the last three. The average length of the eleven expansions since World War II has been 59 months.

chart 3

Finally, one of the indicators considered by the NBER that does not cover the entire economy is industrial production. I have narrowed this indicator to only include manufacturing because it represents the bulk of the industrial production measure and because it is the more stable component of industrial output. As shown in Chart 4, manufacturing output has increased from its trough in mid-2009 at a very solid pace until decelerating in the second quarter of this year. More recently, it has reaccelerated. For this economic indicator more than any other, the supply disruptions from Japan following the earthquake in March, especially in the auto industry, probably explained much of the second-quarter deceleration.

chart 4

The outlook for real output growth in manufacturing remains positive, but not as stellar as it was earlier in the recovery. I expect that manufacturing output will trend higher along a line not too dissimilar to the trajectory in this line during the last expansion, which was less steep than the trajectory during the expansion of the 1990s.

The bottom line is that none of the measures of broad economic activity or the even the narrower measure of industrial production suggest that the U.S. economy has slipped back into a recession just yet. In fact, the data continue to indicate, despite some disturbing revisions recently, that the expansion is underway and has been for two years. That being said, just because the data have been trending higher over the last two years does not guarantee that they will continue to do so going forward. Could the U.S. economy be at the brink of entering another recession? The answer is yes, but the probably of such an outcome in my view is still quite low. The business cycle has not been repealed, which works in both directions. Before we have another recession, it seems reasonable to expect that the economy experience an expansion. For the most part, I do not feel that the current expansion has created the imbalances needed to jeopardize its survival. That will take more time—at least two more years in my opinion.

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1. For example, Martin Feldstein, Harvard University economics professor and President Emeritus of the National Bureau of Economic Research, said the U.S. recovery that began two years ago has been losing steam and there are even odds the economy will slip into a recession. “This economy is really balanced on the edge,” Feldstein said in an interview on Bloomberg Television “Surveillance Midday” with Tom Keene. “I think there’s now a 50 percent chance that we could slide into a new recession.” August, 2, 2011.

2. See Daniel E. Laufenberg, “Downgrading the U.S. political economy,” Laufenberg Economic Quarterly, August 2011, pp. 5-12.

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For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

Dlaufenberg@stonebridgecap.com

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The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.


Current Perspective

2011 Economic Perspectives

Recession fear, not fact
-- September 4, 2011

Core inflation: a policy guide more than a policy target
-- May, 2011

Help not wanted?
-- Feb, 2011

Special Report: Health Care Legislation
Essay No.1 - Costs
Essay No.2 - Revenue
Essay No.3 - Budget Deficits

2010 Economic Perspectives

Causes of the financial crisis revisited
--November, 2010

A less robust U.S. Economy longer term
--August, 2010

Greece: A test of Europe's resolve to remain united
--May, 2010

The U.S. jobs machine restarting at a slower pace
--February, 2010

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