Mark Zandi’s “Reasons for Optimism and Caution” On The Economy

Moody’s Analytics Chief Economist Mark Zandi offered four reasons for optimism on the economy and three for “nervousness” at lunch today before the National Economists Club. He expects 3% real GDP growth this year, like last year, and 4% next year. “There won’t be a lot of progress on the unemployment rate this year [currently 9.0%] because of labor force growth from people returning to the job market.”

Four reasons for optimism:

1. U.S. business is in very good shape. Profits and balance sheets are strong. Earnings have driven the stock market higher.
2. Households are de-leveraging rapidly, righting the wrongs that got us into this downturn. At the peak in July, 2008, Americans held 425 million credit cards. As of March, 2011, they held 320 million credit cards. Household liabilities have fallen over $1 trillion since the peak two and a half years ago. Two-thirds of that were liabilities written off by creditors and one-third was from repayments.
3. Credit conditions are improving, a precondition for stronger growth. Underwriting standards are easing. Commercial and industrial lending to small business is starting to rise, a sure sign of economic strength.
4. Monetary and fiscal policy remains very supportive of the economy. “On net, QE2 has been a plus for the economy…although it has contributed to commodity price increases.” Stimulus will wear off this year, and the Fed will begin raising rates back to normal levels starting in 2012. Zandi expects 0.2% to 0.3% of GDP of federal government fiscal tightening this year and about 1% a year going forward.

Three reasons for caution:

1. Oil price increases have exceed everyone’s forecast. We’ve essentially “taken this year’s 2% point payroll tax cut in put it in our gas tanks.” “There’s very little margin for error [in oil markets]. The gap between demand and potential production is only 3 million barrels per day [in a market of approximately 88 million barrels a day].”
2. “The [home] foreclosure crisis is not over.” Zandi estimates housing prices will decline between 3% and 5% this year before they bottom.
3. The fiscal crisis must be dealt with. The FY11 deficit will be around $1.4 trillion or 9.0% of GDP. The structural deficit is about 5% of GDP, and policymakers need to reduce that to 2% of GDP to escape punishment by bondholders demanding higher interest rates.

In the Q&A, Zandi estimated state and local fiscal travails would put a 0.4% drag on the economy this year. Normally, it adds 0.25% to the economy. This year, state and local governments will cut about 500,000 jobs, and they are expected to cut another 250,000 jobs going forward.

Before the recession, the non-accelerating inflation rate of unemployment (NAIRU) was about 5%. It is somewhere between 5.5% and 6% now with increased numbers of long-term unemployed.

Treasury borrowing rates in his forecast assume a gradual return to a 4.5% 10-year note.

On the debt limit, “There is no way around raising the debt limit.”

On muni debt, “There is zero probability of a muni bond default.”

What would happen if Washington fails to reduce its deficits? “Global investors would revolt. Interest rates would spike, and we’d enter a vicious [downward] cycle.”

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