Quarterly outlook

Dr. Paulo Guimarães is Clinical Associate Professor in the Division of Research at the Moore School of Business, University of South Carolina. He teaches a course on forecasting and is responsible for the South Carolina Economic Outlook, which provides quarterly and annual projections of the South Carolina economy.

There is a general consensus among economic forecasters that the chances of recession now are much higher than they were a few months ago. Some economists go even further and claim that the U.S. economy is already in recession.

To be sure, the U.S. economy has been struggling since last summer following the turmoil in the financial markets, triggered by investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates. Since then, the flow of bad economic news has been unabated.

The housing market remains depressed and is showing no signs of improvement. New residential construction is still decreasing, and the same is true for sales of new single-family homes. This, despite a substantial decline in housing prices—the median sales price of new houses was $216,000 in January 2008 compared with $239,800 in January 2007, a drop of 10 percent. The decline in home prices is corroborated by the S&P/ Case-Schiller national home price index—the gold standard for measuring value changes in overall U.S. housing—showing a drop of 8.9 percent in the last quarter of 2007, the largest drop in 20 years of data.

The lower home prices have had an impact on consumer spending.

Consumers feel less wealthy, and, thus, less willing to spend. At the same time, the ability to borrow against the value of their homes is curtailed, leading to additional cuts in personal spending. In fact, advance estimates of U.S. retail and food services sales for January 2008, adjusted for seasonal variation and holiday and trading-day differences, show an increase of 3.9 percent compared to January 2007. Given that the inflation rate for this period was 4.3 percent, this means that in real terms, retail sales have declined. Not surprisingly, the category with the largest increase in retail sales was Gasoline Station Sales—up 23.0 percent since January of last year. This is mostly a reflection of the increase in oil prices, which have recently broken through the symbolic mark of $100 per barrel.

If we take into consideration that personal consumption expenditures are the largest contributor to Gross Domestic Product (GDP), it comes as no surprise that many analysts are predicting an actual decline in real GDP for the first quarter of 2008. The advance estimates for the last quarter of 2007 already show a significant deceleration of GDP. In the final quarter of 2007, the annualized growth rate of GDP was down to 0.6 percent. Does that mean that a recession has started or is about to start?

Recession or Not?

A common rule of thumb is to look for two consecutive periods of negative growth of GDP. However, recessions are defined as broad-based declines in economic activity and are determined by a group of academic economists at the national Bureau of Economic Analysis (BEA). To reach their conclusion, these economists look at several measures of economic activity, including real GDP, real income, employment, industrial production, and wholesale/retail sales.

There is no single formula to determine whether or not the economy is in recession, and the BEA decision contains an element of subjectivity. The fact is that some of the indicators of economic activity, such as personal income and employment, are not clearly in the red zone. U.S. disposable personal income is growing at above 5 percent, and employment is still increasing, even though it slowed considerably in recent months. Anyway, in the case of employment, the numbers are preliminary and the figures for the last 12 months will be revised with the publication of employment figures in March. If the revised numbers show an actual decline in employment, then the case for declaring a recession will be very strong.

In his recent testimony before Congress on February 27, Ben Bernanke, chairman of the Federal Reserve, reiterated the downside risks to the economy and noted that the economic situation has become less favorable. The Fed has had a very aggressive intervention policy and in January made an emergency cut of 75 basis points, followed by another cut of 50 points on the federal funds rate target.

Despite the large cut of 125 points in January, more cuts are likely to follow when the Fed meets again in March (after this issue goes to press). This aggressive policy of rate cuts, along with the fiscal stimulus plan recently approved by Congress, should provide the needed incentive for the economy to avoid recession. But with these low interest rates we will have to trust that the Fed will be able to contain inflation despite the high energy prices and weak dollar.

South Carolina Slowdown, Too

Just like the rest of the nation, the South Carolina economy has also experienced a significant slowdown in recent months. The most visible change was the increase in the unemployment rate.

As of December 2007, the unemployment rate was back to 6.6 percent, eroding the gains obtained in 2007. But the December up-tick in the unemployment rate—it jumped from 5.9 percent in November to 6.6 in December—does not find support in the other unemployment-related figures. For example, we know that a sustained upward trend in jobless claims is an excellent predictor of either a severe slowdown or a recession. But the number of unemployment claims for South Carolina does not show a pattern indicative of a recession. The same is true for the number of layoff events. On the other hand, at 1 percent, the growth rate of total employment for 2007 was quite low, although the numbers are likely to be revised upward.

In sum, the current outlook is for a period of very slow growth in 2008. There are still no clear indications that we are in a recession. o