Looking Back, Looking Forward

Kicking off the new year, the latest edition of the Atlanta Fed’s EconSouth magazinecontains our annual review of the year past and our bravest guess about the one to come (articles in this issue include outlooks for the national, international and Southeast economies and features on small business and other topics). If we are looking for enduring lessons about the national economy from the previous year, I nominate the time-tested but oft-ignored advice to be wary of reading too much into short-term economic ups and downs:

“Better-than-expected increases in several economic indicators in the spring led many economists to revise up their growth estimates. A quick snap-back in the economy, as has been typical in most other deep recessions in the post–World War II era, seemed a distinct possibility.

“However, such a snap-back was not to be. It is now clear that some of the rebound in growth stemmed from a rebuilding of depleted inventories in the first quarter and the waning influence of various government spending programs. By summer, the incoming economic data had weakened considerably, and the pace of expansion in the major expenditure categories raised the specter of a step backward into contraction…

“Bumpy growth for an economy transitioning out of a recession is not unusual. For example, GDP [gross domestic product] jumped by 3.5 percent in the quarter immediately following the end of the 2001 recession, but it then slowed to just 0.1 percent three quarters later. To date, that pattern of growth proceeding in fits and starts has certainly been representative of this recovery.”

In fact, it now appears that the U.S. economy grew in 2010 by somewhere in the range of 2.5 percent to 3 percent, just where the Blue Chip consensus was at the beginning of the year (and, incidentally, somewhat better than what we at the Atlanta Fed were expecting). Still…

“Despite these improvements, economic performance has been somewhat disappointing. The recovery has not been strong enough to meaningfully reduce the unemployment rate. Throughout the year, the unemployment rate has remained well above 9 percent. Income growth (excluding transfer payments made by the government) has been weak—up less than 1 percent for the year on an inflation-adjusted basis. The housing market is struggling in the face of continuing foreclosures despite a variety of tax incentives and historically low mortgage rates, and the commercial real estate sector likewise has not recovered. This theme of improvement in some areas and ongoing weakness in others illustrates the unevenness of the recovery and more uncertainty than normal about future economic prospects.”

Will 2011 be a different story? Quantitatively, probably yes—growth should take another step up this year. But the story, we think, remains essentially the same:

“The incoming data as well as reports from the Atlanta Fed’s business contacts are broadly consistent with a relatively restrained growth trajectory. There are, in fact, several factors that will plausibly inhibit the pace of the expansion. Weakness in residential and commercial real estate is ongoing. Business and consumer attitudes are still extremely cautious, and slow spending growth by businesses and households is continuing to hold back inflation. Over the near term, additional business spending appears likely to be geared primarily toward activities such as targeted mergers and acquisition and further increases in efficiency rather than toward pure expansion. Slow and uneven sales, opportunities to reduce costs through increased productivity, structural adjustments in labor markets, and uncertainty over government policy—including changes in labor and environmental rules, tax policy, and financial regulations—are restraining job creation. Slow job growth, naturally, implies that unemployment could remain elevated for some time.”

But…

“Of course, risks lurk on both the upside and downside for the outlook, but there are reasons for optimism. Financial firms and households have made significant headway in repairing their severely compromised balance sheets, and most are in a much better financial position than they were a year-ago. Businesses in particular have substantially more liquidity and significant capacity to deploy capital to new projects. Some of the uncertainties that have vexed private decision makers, such as the course of near-term tax policy, may finally be abating…

“Recent surprises in the economic indicators have been predominantly to the upside, which is a very good sign. If such positive surprises persist, and confidence in the economic environment grows, it could be that current estimates for only slight improvement in 2011 have been too modest.”

Here’s hoping.

Note: For more perspective on the 2010 economic outlook and monetary policy, stay tuned for Atlanta Fed President Dennis Lockhart’s speech to the Rotary Club of Atlanta, scheduled for Monday, January 10. The text will be posted on the Bank’s website.

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