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The
national economy is experiencing a slowdown in the very important housing
market, and energy prices continue to hover at relatively high levels. In
addition, the fear of inflation seems to be a preoccupation with the Federal
Reserve and investors. These conditions plus the uncertainty in the
Middle East
are acting as a drag on overall economic performance. Most data seem to
suggest that the national economy is cooling down. Unless some unforeseen
event takes place, a full fledged recession is unlikely. However, if the
Federal Reserve should continue to reduce liquidity and raise interest rates,
the economy could be pushed into recession. Hopefully the Federal Reserve
already appreciates the fact that the economy is slowing and any further
tightening on its behalf could nudge the economy over the economic cliff.
Let's take
a closer look at some key economic variables to see how the economy is
performing. The Bureau of Economic Analysis, the BEA, reports that GDP grew
at a seasonally adjusted rate of 2.9 percent in second quarter. This
contrasts sharply with the approximate 5.8 percent in first quarter 2006.
This is a clear sign that the economy is cooling down. Meanwhile the Bureau
of Labor Statistics, BLS, reports that the consumer price index, CPI, rose by
4.5 percent on an annualized basis in second quarter. Core CPI, which
excludes the volatile energy and food sectors, grew by 3.2 percent during the
same period. Both measures of inflation were higher than what the Federal
Reserve considers to be good for the long run health of the economy.
The Bureau
of the Census indicates that new housing starts on a seasonally adjusted basis
dropped to 1.45 million units in July, down from about 1.60 million units in
June. As a matter of fact, we have to go back to 2004 to see a lower level of
housing starts. The Bureau of the Census also reports that existing single
family home sales fell to 5.51 million units in the second quarter. Early
this year the annualized rate was running at over 6.0 million units. In
addition, newly built single family home sales were running at an annualized
rate of 1.4 million in late 2005 and are now down to 1.07 million units in the
second quarter. It is clear that the national housing market has lost
momentum. Housing is a very important indicator of the overall health of the
economy because so many other activities are tied to the vibrancy of this
sector. Moreover, household consumption has been fueled by rising home
values.
As
mentioned early in this report the Federal Reserve is very concerned with the
inflationary pressures building in the economy. As a result the Federal
Reserve has slowed the growth rate of money. Data from the Federal Reserve
Board indicates that the growth rates in M1 and M2 have slowed dramatically
since 2003. For example, M1, the most basic measure of the money supply, was
growing at about a 9 percent rate in 2003 and by 2006, the growth rate of
money had fallen to close to zero! M2, a broader measure of the money supply,
was growing at around an 8 percent rate in 2003, and is now down to about 4.5
percent in 2006. The data indicates that the Federal Reserve has been slowing
the rate of money supply expansion and level of liquidity in the economy.
In
conclusion, there is no question that the Federal Reserve had to react to the
growing price pressure in the economy. A vicious wage price spiral can be
very destabilizing to the long run growth and prosperity of an economy.
However, let us hope that the Federal Reserve has not miscalculated in its
attempt to bring the economy to a soft landing. Further, that the Federal
Reserve officials recognize that further interest rate hikes and tightening of
money supply growth may jeopardize the economy and push the nation into a
recession. |
