The recession might be over, but how goes the recovery?
Wall Street Journal posed that question to two prominent Wall Street economists with two very different views of 2010. Bruce Kasman, chief economist at J.P. Morgan, sees the U.S. growing at about a 3.5% pace for most of next year. That appears optimistic compared to Jan Hatzius, chief economist at Goldman Sachs, who sees gross domestic product growth of 2% or so at the start of the year tapering off to just 1.5% by year-end.
The following is an edited transcript of their remarks during a recent conference call with The Wall Street Journal.
Looking ahead to 2010, what kind of recovery do you see?
Kasman: We’re going to get more growth than people expect, but a lot less than we need. The power of a business cycle, once policymakers are committed to supporting growth and once activity levels get down so low that even modest changes in behavior start to give us a lift, should not be underestimated. Deep recessions have been followed by strong growth [because] those dynamics start to gather some steam. At the same time, even if we’re talking 3.5% to 4% growth, that’s not going to put us in a position 18 or 36 months from now to feel as if we have a labor market that will look anything like it used to over the last 20 years – I think that would take sustained growth in the 5-6% range for three or four years, which we did deliver coming out of the mid-70s and early-80s recessions, so it has been done.
Hatzius: I think we’re going to lose a lot of short-term stimuli and the headwinds to a stronger pickup in underlying demand are, I think, pretty formidable and much more formidable than what you saw, for example, in the mid-1970s or early ‘80s when you had a lot more pent-up demand. I think it’s just a very different business cycle and extrapolating from the history of the ‘70s and early ‘80s I don’t find that promising on the forecasting front.
Kasman: What is similar, I think, in this cycle that has been consistent across cycles is that we get to a point in which the adjustments in housing, in manufacturing, in the retail sector become very sharp and with a little bit of help from policy and an improvement in financial market conditions that provides an opportunity for a lift – and I think now that’s what we’re starting to see take place.
Hatzius: We do have some improvement [in our forecast] and I do think there will be some healing on the surface but I don’t think it’s enough to offset the loss of the stimulus that’s been behind a large part of the improvement we’ve seen over the last six or nine months.
How does your forecast play out for the labor market? Any chance job creation could be stronger than expected?
Kasman: I think the labor market will improve – we’re looking to see jobs begin to be created [on net] sometime early next year – but even with our upbeat view on growth, at the end of next year we’re still sitting with over a 9% unemployment rate so this lift doesn’t really do a lot to dig us out of the hole of the jobs that have been lost in this recession.
Hatzius: I also think we’ll probably start to see some job growth in the course of 2010, starting in the second quarter, but we’ve got the unemployment rate rising through 2010 and that’s a direct reflection of the fact that GDP growth just isn’t strong enough [to bring the rate down]. In our forecast the unemployment rate grinds higher to about 10.5% by the end of the year.
So even if we get the kind of growth Mr. Kasman is forecasting, it seems like high unemployment and other slack in the economy could keep the Federal Reserve from raising interest rates next year.
Hatzius: I don’t have any [rate] hikes in my forecast and if my view on the economy is right then I think the probability of rate hikes is extremely low. I think I’d have to be wrong by a reasonably sizeable margin to get hikes from the Fed next year.
Kasman: We also don’t have the Fed tightening next year although I do think they will be using some levers on the balance-sheet side, particularly with the “reverse repo” plan which we very well think could happen before the middle of next year. The Fed will be seeing growth but will still be watching very high unemployment and core inflation, which could slip below 1% next year. The Fed’s job here is to reflate the economy and I think when they see success on that front they’ll start to act potentially aggressively, but we don’t have the Fed tightening until sometime in early 2011.
Hatzius: I think the risks are tilted towards deflation. We have core inflation falling through next year to close to zero, and if we were to get another downturn in the economy over the next few years then I think the risk of deflation – a painful deflation – is something you cannot dismiss. The Fed has essentially an unlimited ability to tighten policy in response to upside surprises on inflation and output but their ability to provide more stimulus to avoid deflation is much, much more limited.
It sounds like despite your diverging views of growth next year, you both think more needs to be done to stimulate the U.S. economy. Even the “optimistic” outlook here isn’t really expecting a strong recovery.
Hatzius: There’s a good chance that [more stimulus] is going to be the conclusion, at least on the fiscal side, in 2010 and I think it’s appropriate to think about that because you’ve got an economy that is very, very badly underutilized. On the monetary side, I think there’s a case for doing more as well.
Kasman: Where I think we differ is that we [at J.P. Morgan] have some more confidence that in a world of very depressed levels of activity, in which you get more lift from modest changes on the part of businesses and households, I do think we have a business cycle that’s got some power behind it and we should respect what that’s likely to deliver at least for the next three to four quarters. But I would agree with Jan that if his forecast is tracking there’s a need and I think an important need for more stimulus.
Hatzius: The one thing that would be desirable ultimately would be a weaker currency. The boost that the U.S. is getting via the export side at current exchange rates is still pretty limited, and helping that case along through the currency side would certainly be welcome. I wouldn’t say dollar depreciation is at all worrisome – I think it would actually be quite welcome. What we’ve seen over the past few months [with the dollar’s decline] to me looks like a good thing rather than a bad thing.
Kasman: I agree with the importance of helping trade from our demand markets globally. We basically lifted emerging Asia out of its crisis in the 1990s – at least, we smoothed the pain there – and I think there’s an opportunity for the reverse to happen now. Domestically, I think it would be quite dangerous to remove stimulus too early, so I think the idea that there should be early adjustments on the part of the Fed in a world of low inflation and high unemployment is a mistake here – we just have to stay the course and let the private economy make its adjustments, and provide support for those adjustments to take place.
(from Real Time Economics, October 29, 2009)