ABA Banking Journal - February 2008 - (Page 64)

briefing The Economy DANA JOHNSON Chief Economist, Comerica, Inc., Ann Arbor, Mich., and a member of the ABA Economic Advisory Committee Policy choices in event of recession THE U.S. ECONOMY MAY AVOID recession in 2008, but it will be a close call. Growth is slowing in reaction to the credit crunch, falling house prices, and rising energy prices. But time and again, the economy has proved to be resilient; and so far, growth is slowing in a relatively controlled fashion. To be sure, the housing sector is a mess. Recent data confirm that the credit crunch has extended and accelerated the downward trends in building permits, home sales, and house prices. The only realistic hope is that the drag from housing will become less intense over the course of 2008. On the plus side, the economy will continue to get a lift from the trade sector. Export growth should roughly offset the ongoing decline in homebuilding, so the fate of the economy rests largely with the resilience of the U.S. consumer. My bet is that household spending growth will slow but will continue to outpace inflation. Recent data are mildly encouraging. Overall, consumer spending after inflation probably grew at least at a 2% annual rate in the fourth quarter, which if sustained would be strong enough to avoid recession. The ongoing credit crunch, on the other hand, poses a significant threat. A good metric for gauging its intensity is the spread between the 3-month Eurodollar and Treasury bill rates. As the chart shows, that spread fluctuated well above 2 percentage points for most of December, the widest it has been since the 1987 stock market crash. But in the run up to the New Year, the unprecedented efforts by the Fed and the European Central Bank to provide liquidity began to restore order to the bank funding markets, as reflected in the recent narrowing of credit spreads. Private sector writeoffs and recapitalizations also have is unlikely to ease much further. The inflation risks inherent in a weak dollar, soaring energy prices, and sluggish productivity gains will limit Fed easing so long as jobs and spending continue to grow. With headline inflation uncomfortably high, the Fed will tolerate a period of sluggish growth in an effort to avoid a lasting rise in inflation 3-month Eurodollar less Treasury Bill yield 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 1/07 4/07 7/07 10/07 played a role in restoring confidence. The key takeaway is that continued sluggish growth is still somewhat more likely than recession. Under either scenario, though, the unemployment rate will trend higher in the coming year, as job growth slows further or becomes slightly negative. In both outcomes, the popular perception will be that the economy is performing poorly. The monetary policy response to sluggish growth, however, would be quite different from the response to recession. If sluggish growth persists, the Fed and inflation expectations. If the economy lapses into recession, however, the Fed will respond far more aggressively. In the context of sustained weakness in product and labor markets, the dangers to the financial sector will multiply, and wage and price pressures will subside far more quickly. That will motivate the Fed to push down the funds rate far more rapidly in an effort to restore sustainable growth. With underlying inflation likely to fall below 2% in the event of a recession, so too would the funds rate fall in all likelihood. BJ 64 FEBRUARY 2008/ABA BANKING JOURNAL www.ababj.com/subscribe.html http://www.ababj.com/subscribe.html

Table of Contents Feed for the Digital Edition of ABA Banking Journal - February 2008

ABA Banking Journal - February 2008 Contents On ABABJ.COM: Have You Visited Our Brand-New Website? Editor's Column "That's Edutainment" Snapshot: Tier 1 Ratios Stable so Far 100th Anniversary: Then and Now ABA Resources ABA Chairman's Position Don't Despair Pass the Aspirin Cover Story: Socially Responsible Banking Profitably - Incoming America's Community Bankers Council Chairwoman, Dorothy Bridges Demonstrates the Way A True "Rags-to-Banker" Story Retail Banking: On the Money Hunt Community Bank Management: The Ugly Truth About Board Relations Does Core Really Matter? Security 2.0: Not Just a New Kettle of Phish A Personal Case of Mal-Serendipity DOD Credit Regs Demand Attention Mailbox Banker's Mart To Advertise/Index of Advertisers The Economy

ABA Banking Journal - February 2008

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