Stimulus will leave US even more vulnerable, experts warn
WASHINGTON – EVEN if Federal Reserve chairman Ben Bernanke, United States President George W. Bush and the US Congress win the battle to avert a recession in the US this year, they risk losing the war to strengthen the economy for the long term.
US economic growth will get a boost in the second half of this year, as consumers spend some of the US$107 billion (S$150.6 billion) in tax rebates passed by Congress and signed by Mr Bush this month.
The US may suffer a letdown afterward, as the kick from the stimulus wears off, leaving the economy vulnerable to its underlying weaknesses: a retrenching financial industry, indebted consumers and slowing productivity growth.
‘This is not a one- or two-quarter phenomenon,’ says economist Neal Soss of Credit Suisse. ‘This is not a V-shaped event. It’s a slowgrowth scenario.’
Fed officials see growth picking up to more than 2 per cent next year, as inflation ebbs to 2 per cent or below.
Mr Bernanke is slated to discuss the central bank’s forecast in a testimony to Congress tomorrow and on Thursday.
So far, the Fed’s deepest interest rate cuts since 2001 have not helped the financial markets or the economy. What they have caused is an increase in inflation expectations, with the price of gold soaring to a record US$958.40 an ounce last week.
What is more, say economists Soss and Ethan Harris of Lehman Brothers, policymakers face structural changes in the economy that are not so susceptible to the traditional tools of interest-rate and tax cuts.
As a result, Mr Soss sees the economy expanding just 1.3 per cent this year and about 1.5 per cent next year.
Mr Harris is even more pessimistic. He sees growth easing to 0.9 per cent next year from 1.1 per cent this year and 2.5 per cent last year.
Fed officials acknowledged in the minutes of their last meeting on Jan 29 and 30 that they were having trouble getting ahead of the credit squeeze in financial markets.
The financial industry is curtailing credit and conserving capital after a decade-long boom in profits went bust in the third quarter.
Following mounting losses on past loans, banks have already taken write-offs of US$163 billion since the beginning of last year.
A Fed survey released on Feb 4 found that banks had become stingier in granting credit during the previous three months.
Fed officials say they expect that to continue, making it harder for the central bank to stimulate the economy through lower borrowing costs.
‘The Fed can give liquidity to the markets, but the Fed cannot do much if the markets are afraid of solvency risks,’ said Mr Robert McTeer, a former Dallas Fed president.
Consumers, until now the driving force behind the expansion, are feeling the squeeze. While households will get a short-term boost from the coming tax rebates, their longer-run finances look shakier.
Households reduced their savings rate to virtually nil in December from close to 10 per cent of disposable income 15 years earlier.
That trend may reverse as credit becomes scarcer and home prices fall.
Mr Allen Sinai, chief economist at Decision Economics, calls the pullback by consumers ‘a seismic shift’.
‘For several years, the growth of consumer spending is going to be significantly below its long-run average of 3.5 per cent,’ he said.
Consumers have also been pinched by the rising cost of food, fuel and other necessities.
Inflation, as measured by the personal consumption price index, clocked in at a 3.5 per cent year- over-year rate in December, the highest for that month since 1990.
Behind the heightened inflation concerns: slowing productivity growth, making it harder for companies to recoup higher costs through increased efficiency.
Professor Robert Gordon, of Northwestern University, says the surge in productivity that began around 1995 was a one-time event sparked by the advent of the Internet.
Nobel laureate Edmund Phelps says there is little the Fed can do when faced with such a structural change.
‘We’ve had a series of booms, and it seems to me they are now over,’ says Mr Phelps, an economics professor at Columbia University.
‘As a result, we’re going to see a period of slower growth than in the past.’
BLOOMBERG NEWS (Source: The Straits Times 26 Mar 08)