Editor’s note: Harry M. Davis, Ph.D., is the economist for the North Carolina Bankers Association and professor of banking at Appalachian State University. He also writes the North Carolina Bankers Association Business Barometer.
BOONE—At this point in this recovery, the economy faces several questions. First, is the slowdown in housing and the subprime lending debacle about to end? Second, is the economy headed for a recession in the near term? Third, is the Federal Reserve Board (FED) close to cutting interest rates? Fourth, is the state economy improving?
The answer to the first question is "yes." The housing market periodically experiences excesses, so this episode was to be expected. New home and existing home sales have fallen from the all-time-record levels of 2005 and housing prices are no longer rising. Sales and starts are at 2003 levels, which were records at the time. Housing sales and starts have about hit bottom and will not be a negative as we go forward.
Most attention is on the subprime lending debacle, which has caused problems with segments of the housing market, but represents a relatively small percentage of the total. The negative impact of this lending on the economy has already been discounted and is about over. One positive result is that subprime lending will receive greater scrutiny and regulation in the future.
The answer to the second question is "no." The economy is slowing for a soft-landing. After growing nearly 4 percent annually from 2002-2005, the economy slowed to 3 percent last year. Presently, the economy is growing at closer to 2.5 percent, which is slower than its potential and the post-WWII average.
In spite of being pounded from all directions, the economy is not in recession and is not likely to enter one soon. The employment rate remains under 5 percent, which is close to full employment. Wages and salaries are growing in real terms, though still not back to the level of 2000. The Dow Jones and S&P 500 stocks are near five-year highs. Household wealth of Americans is at an all-time record.
The economy is reacting to several factors that lead to slower economic growth. The Federal Reserve Board, under Chairman Ben Bernanke, increased interest rates through the summer of 2006, hoping for lower inflation and to cool down the housing sector and overall economy. Energy prices have bounced back above $60 a barrel. Oil prices continue to follow the vagaries of the Middle East as well as the wars in Afghanistan and Iraq and tensions between the West and Iran. At this level, oil prices are a drag on the economy.
The U.S. economy will grow about 2.75 percent for the rest of the year. The unemployment rate will remain under 5 percent. Corporate profit growth has slowed and will not be a strong engine of growth for the economy this year.
The answer to the third question is "sorta." Bernanke and the Fed feel they have only partially succeeded at their stated goals. Even now, the Fed appears to feel the rate of inflation is still too high and is therefore opposed to cutting interest rate at this time. The Fed’s next move on interest rates will be down by 25 basis points and will likely occur in the second half of the year.
The answer to the fourth question is "yes." North Carolina’s economy has experienced a rebirth. We are adding jobs, and our unemployment rate is at a six-year low of 4.5 percent. The state economy will continue to grow at about 2.5 percent next year, which will keep the unemployment rate under 5 percent.
