Conditions appear to be in place for a good year for the U.S. economy, which is likely to be marked by moderate, sustainable growth and lower inflation, Federal Reserve Board Vice Chairman Donald Kohn recently told the Atlanta Rotary Club.
Deceleration of economic activity in the second half of 2006 was concentrated in the housing and motor vehicle sectors. As of November, single-family housing starts were down 30 percent from the peak in January 2006, but there were tentative signs that the housing market may be stabilizing, he noted. House sales appear to have flattened out since mid-2006, mortgage applications have been increasing, and consumers’ perceptions of home-buying conditions have improved.
It’s hard to predict when the housing market will rebound because this downturn is different from those in the past, he explained. “It was not triggered by a restrictive monetary policy and high interest rates; indeed, relatively low intermediate and long-term interest rates are helping to support the stabilization of this sector.” Instead, the current contraction follows an unusually large run-up in sales and construction as well as prices relative to the return on other assets.
“Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed,” he said.
In the automotive sector, car and light truck production producers slashed output last year in an effort to reduce elevated inventories, Kohn pointed out. October production of light vehicles was the slowest in more than eight years but build rates increased in the final two months of 2006 and available data indicates that manufacturers will maintain that pace through first quarter.
“Thus, with sales reasonably well maintained through December, the drag for this sector’s inventory correction should be ending,” he said.
Recent softening in other manufacturing sectors “is not the leading edge of general economic weakness but instead an adjustment to a sustained pace of expansion that, necessarily, is less rapid than that from mid-2003 to mid-2006,” he said.
On the whole, business seems to be reasonably upbeat and it appears that consumer demand for non-housing goods and services has continued at a good pace. However, Kohn cautioned that some of the recent strength in consumer demand may be due to lower fuel prices “in which case part of the strong gain in spending in recent months may be transitory.” Another concern is that last year’s strong consumer spending was due in part to an earlier rise in household wealth. “In the wake of the current slowdown in house price gains, I expect that, over time, households will find it necessary to build their net worth by holding back on consumption,” he said.
Despite recent favorable price data, Kohn warned that it’s still too early to relax inflation concerns – a key factor in Fed decisions regarding interest rates. Some of the recent disinflation may represent one-time influences such as energy costs, which moved down in recent months but are expected to increase gradually. Despite slowdowns in manufacturing and home building, labor markets seem to have stayed fairly tight and growth of labor costs could pose a serious threat to price stability.
“A very gradual decline in the trend rate of inflation continues to be the most likely outcome, but that path is still by no means assured,” he said. “In my judgment such a decline remains critically important to the sustained prosperity of the U.S. economy.
Deceleration of economic activity in the second half of 2006 was concentrated in the housing and motor vehicle sectors. As of November, single-family housing starts were down 30 percent from the peak in January 2006, but there were tentative signs that the housing market may be stabilizing, he noted. House sales appear to have flattened out since mid-2006, mortgage applications have been increasing, and consumers’ perceptions of home-buying conditions have improved.
It’s hard to predict when the housing market will rebound because this downturn is different from those in the past, he explained. “It was not triggered by a restrictive monetary policy and high interest rates; indeed, relatively low intermediate and long-term interest rates are helping to support the stabilization of this sector.” Instead, the current contraction follows an unusually large run-up in sales and construction as well as prices relative to the return on other assets.
“Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed,” he said.
In the automotive sector, car and light truck production producers slashed output last year in an effort to reduce elevated inventories, Kohn pointed out. October production of light vehicles was the slowest in more than eight years but build rates increased in the final two months of 2006 and available data indicates that manufacturers will maintain that pace through first quarter.
“Thus, with sales reasonably well maintained through December, the drag for this sector’s inventory correction should be ending,” he said.
Recent softening in other manufacturing sectors “is not the leading edge of general economic weakness but instead an adjustment to a sustained pace of expansion that, necessarily, is less rapid than that from mid-2003 to mid-2006,” he said.
On the whole, business seems to be reasonably upbeat and it appears that consumer demand for non-housing goods and services has continued at a good pace. However, Kohn cautioned that some of the recent strength in consumer demand may be due to lower fuel prices “in which case part of the strong gain in spending in recent months may be transitory.” Another concern is that last year’s strong consumer spending was due in part to an earlier rise in household wealth. “In the wake of the current slowdown in house price gains, I expect that, over time, households will find it necessary to build their net worth by holding back on consumption,” he said.
Despite recent favorable price data, Kohn warned that it’s still too early to relax inflation concerns – a key factor in Fed decisions regarding interest rates. Some of the recent disinflation may represent one-time influences such as energy costs, which moved down in recent months but are expected to increase gradually. Despite slowdowns in manufacturing and home building, labor markets seem to have stayed fairly tight and growth of labor costs could pose a serious threat to price stability.
“A very gradual decline in the trend rate of inflation continues to be the most likely outcome, but that path is still by no means assured,” he said. “In my judgment such a decline remains critically important to the sustained prosperity of the U.S. economy.
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