An economic forecast from Mark Zandi

The first part of this week I am attending the annual State Fiscal Policy Conference organized by the Center on Budget and Policy Priorities. While most of the conference sessions focus on the fiscal challenges facing state governments – and the need to pursue balanced and fiscally responsible approaches to preserving core public services in these difficult times – the opening plenary featured an informative and convincingly-argued talk on the prospects for the national economy by Mark Zandi, the chief economist for Moody’s Analytics and one of the nation’s most perceptive and widely-respected economic policy analysts. In recent years. Zandi has gained particular prominence both as an adviser to the McCain campaign during the 2008 Presidential election and as co-author, along with former Federal Reserve Vice Chairman Alan Binder, of an important report this past summer that found that federal stimulus measures had a huge and positive impact in turning around the economony and averting a full-scale Depression.

Zandi’s talk, which he titled “Struggling to Hit Escape Velocity,” made three major points about  the economy. The first was that the economic recovery, which had been gathering steam in late 2009 as a result of the spending and tax cut provisions of the stimulus bill passed by Congress in February 2009, has lost momentum over the past six months. Real GDP, which grew 3.3 percent in the second half of 2009, slowed to 2.7 percent in the first half of 2010 and is on pace to grow just 2.0 percent in the second half of this year. This is “painfully slow growth” which will not be enough to forestall further increases in the unemployment rate, which he expects to creep back above double digits in 2011. Zandi identifies two main culprits for the slackening economy: the declining economic impact of the stimulus package and the European debt crisis of earlier this year, which battered stock prices,  reversed growing business and consumer confidence, and slowed private sector hiring.  Although the European crisis now seems to be over, Zandi believes it set back the American recovery by a good six to 12 months.

Zandi’s second argument is that the next six to 12 months are likely to be very uncomfortable. Although he estimates the odds of slipping into another recession to be only about one in three, he identifies three main issues that will serve as a drag on economic growth. The first is that businesses are still reluctant to hire. Monthly hires, which were running over 5 million before the recession, fell to about 4 million with the recession and have remained at that level, far below what is needed to lower the unemployment rate. Business growth is constrained by a continued credit squeeze on small businesses and an ongoing drop in confidence in the wake of recent economic turmoil and epic policy changes. Secondly, the foreclosure crisis has not abated, with record levels of homes in foreclosure proceedings or more than 90 days past due on their loans and home values continuing to fall. This also impacts consumer confidence and keeps businesses from borrowing. Finally, Zandi pointed to the dire budget situations of state and local governments as a major cause for concern. State and local governments, which are the largest single employer in the country, have seen a loss of 400,000 jobs in two years and are laying off 20,000 – 30,000 people a month. In the absence of additional federal assistance, states face budget shortfalls approaching $100 billion in the next year, which will lead to additional job losses and cuts to services.

Zandi’s third major point is that looking beyond next year, the economic picture looks much brighter. After another year of sluggish growth in 2011, he is forecasting strong GDP growth of 4 to 5 percent in 2012 and 2013; he expects a five-year trajectory to return to full employment, which is significantly more rapid than the ten years predicted by many economists. He laid out several grounds for optimism. On the policy front, he believes the aggressive policies being pursued by the Federal Reserve Board will succeed in boosting the stock market and keeping mortgage rates and the U.S. dollar low. At the same time, the huge profit margins and earnings growth that U.S. corporations are now enjoying should, he believes, translate into renewed hiring over the coming quarters. More fundamentally, he sees real improvement in addressing the key problems that triggered the Great Recession, namely unsustainable levels of household debt. Household debt liabilities have fallen by over $1 trillion over the past two years; with lower debt obligations and continued low interest rates, Zandi is expecting to see strong and sustainable growth in consumer spending.

Zandi concluded by saying that his reasonably optimistic economic forecasts are premised on a pair of core assumptions about the nation’s future course. The first is that the U.S. economy must transition from one where growth is powered by consumer spending to one fueled by business investment and exports of manufactured products and services in which American can enjoy a competitive advantage. This will require a highly skilled and educated workforce, which in turn will require major and effective investments in the education and training of our people. At the same time, the nation will have to address its long-terms fiscal problems through fiscal restraint, entitlement reform, and revenue options focused on curtailing tax deductions.

“The problems we face are serious but they are manageable, they are not overwhelming,” he said, ending on an upbeat note. “Whenever we’re put to the test as a nation, we come through. We always have for 250-odd years.” In these times of widespread anxiety and shaken confidence, this is a timely and hopeful reminder