Jeffrey M. Lacker, President of the Federal Reserve Bank of Richmond and a voting member of the FOMC, told a University of Delaware audience that, while the economy is improving and inflation is low, the growth is proceeding at a much slower pace than the country has seen in recessions of the past. This lag, he said, is largely because this time housing is not driving the recovery.
The recessions of 1973-1975 and 1981-82 ended with residential investment rising at an average of 40 percent in the each following year. This time the economy is dealing with what the housing boom that preceded the recession left in its wake; a housing stock that is too large in both numbers and size than what households want in light of their current income prospects and credit market conditions.
Not only is investment in housing itself lagging, Lacker said, but other household outlays have grown relatively slowly in this recovery as well. Consumer expenditures increased at an annual rate just below 2 percent in the first five quarters of this recovery. In contrast, in the two other severe post-war U.S. recessions, household spending grew by an average of 6-½ percent in the first year of expansion, thereby adding considerably to GDP growth.
Other than housing, many factors in the economy are encouraging; consumer spending has recently picked up speed, initial unemployment claims have been on a downward trend since last summer and the unemployment rate has fallen by half a percent over the last two months and by more than a percentage point since the fall of 2009, albeit because of a shrinking labor force. In addition manufacturers have added to payrolls over the last three months and average hourly earnings continue to advance. The recent decline in the personal saving rate also suggests that many households have made substantial progress toward repairing their balance sheets. On the business front there are encouraging signs that investment in equipment and software and in new structures is improving and prospects for export growth are also positive.
The Fed chief said that despite all that the economy has going for it, there are still substantial challenges ahead. Housing activity continues to be depressed, residential investment has fallen nearly 60 percent from its peak at the end of 2005 and with the large inventory of vacant homes and continuing foreclosures any advance in residential investment is likely to be slow and uneven. "Having said that, residential investment is only 2-1/4 percent of GDP so the damage this sector is capable of inflicting is in some sense limited."
Those are the near-term prospects, but longer term the government's fiscal policies could have a significant impact on growth. "We have a serious, long-term mismatch between the trajectories of federal spending and taxes" and the Congressional Budget Office's most recent projections show deficits shrinking as a percentage of GDP only until 2015 when they will begin to rise steadily. "The ratio of debt to GDP rises from the current level of around 60 percent to 150 percent in 2030," Lacker said.
One area that could present serious fiscal risk is the still open question of the federal government's role in housing finance. Washington is preparing to consider the fate of the government sponsored enterprises (GSEs) Freddie Mac and Fannie Mae and many proposals would make government guarantees explicit and priced rather than implicit as was the case before the crash. But Lacker believes "perpetuating guarantees for housing-related debt will continue to artificially stimulate the risky leverage that critically fueled the disastrous housing boom." The resulting consequences suggest that government backstops are not "worth the price of over-built, over-leveraged and at times overheated housing markets, on top of the fiscal burden of large contingent liabilities." He believes we should phase out government guarantees for home mortgage debt; home-ownership may be a laudable goal, he said, "but if that is our objective, we should subsidize housing equity, not housing debt.
He pointed out that the Federal Reserve's decision last fall to purchase $600 billion in long-term Treasury securities was done with an eye to its risk and a commitment to regularly review the pace and size of the effort. The improvement in the economic outlook since the program was initiated, he said, suggests that such a re-evaluation should be taken seriously.