Much has been made about Ben Bernanke’s “green shoots” but not much is heard about when they might turn into trees.
Are there any signs that the economy is recovering?
The short answer is, thankfully, yes. But like a gardener needs to meticulously tend to green shoots, especially in the early stages of growth, the economy’s “gardeners” need to do the same.
Over the last few months, much of the optimism for the economic recovery has centered on key macroeconomic variables that show they are slowing down in their rate of decline. Normally we wouldn’t be all that happy over continued job loss or negative industrial demand, but right now we need to take baby steps.
In recent surveys of economists and business leaders, most respondents seem to be a little more optimistic about a recovery than just a couple of months ago. Slightly more than half feel that the economy has hit bottom while some still feel that the recession will extend into 2010. Either way, the forecast has improved. I, too, am optimistic that the worst is over and here are a couple of reasons why.
Better Balance Sheets: Both households and businesses have been putting a lot of emphasis on improving their balance sheets. Consumer credit outstanding has declined steadily since its high in July 2008. Some of this could be the result of defaults and write-offs and as long as unemployment remains high, continued write-offs are expected. But lower consumer debt is also coupled with a steady increase in savings deposits over the same period. In addition, consumers’ financial obligations ratio, a ratio of household financial obligations as a percentage of disposable income, has also declined to 18.5% and is back to a level not seen since 2004. Given the economic uncertainty, many businesses and consumers have put off major purchases. Like consumers, many businesses have been aggressive at lowering costs to maintain margins. Many firms are holding historically high levels of cash just waiting for opportunities to invest.
An Inevitable Durable Goods Cycle: As consumers feel more at ease with their household finances and as unemployment stabilizes, as many believe it will, consumers will begin to replace durable goods. Businesses will also take the opportunity to use their cash to prepare for the next expansionary cycle by upgrading factories, redesigning stores, and preparing new product displays. These events precede an economic recovery so look for firms to increase spending on infrastructure and marketing.
Cheap Money: The Federal Reserve has continued a policy of maintaining low interest rates and high bank reserves. These policies have already helped the financial sector recover and will be a catalyst for growth once consumer confidence improves.
Low Inflation: Nothing helps a recession end like the recession itself. As consumer and industrial demand declines during a recession, commodity prices, producer prices, and consumer prices fall. This helps firms manage the bottom line and helps them make strategic investments in preparation for the next cycle. Consumers welcome the relief of lower prices as they struggle to manage household finances.
Now, I wouldn’t be an economist worth my weight in salt if I didn’t stop here and say, “but on the other hand” (that’s why Truman asked for only one-armed economists). There is one key variable in this discussion that will make all of this more difficult to achieve in the short term and that’s unemployment. Nothing will improve consumer confidence more than a decline in unemployment. Not only does lower unemployment indicate that we are putting people back to work, it helps those who were afraid of losing their job feel a little more confident about the immediate future. This will have a tremendous effect on the speed of the recovery.
Of course there are many other variables that I haven’t discussed that may play a role in this recovery like the effectiveness of fiscal stimulus, large federal deficits, inappropriate government intervention, and the global economic recovery. But that’s why I love teaching economics, always new things to talk about.
