Thursday, May 1, 2008

Why is the US not in a Recession?

Recently, I had a question from a reader - why is the US in recession?

The first thing to bear in mind is that the US is not technically in a recession; in fact at 2.4% annual growth, the US economy appears to be doing relatively well. It certainly seems a long way off an actual recession.

Why is there a perception that the US is in recession, when in fact it isn't?

  1. Economic Statistics reflect the past. Growth statistics tend to be backward looking. They reflect economic conditions of the past 6 months, rather than what is going to happen. If you look at other statistics, such as, as the level of planned investment in the economy, the outlook appears more negative.
  2. The Worst is Yet to Come. House prices have fallen 12%; but many argue bigger falls are still to come. There is excess supply and demand is still falling. The number of mortgage defaults has been high, but arguably more are still at risk of future mortgage defaults as they remortgage their balloon mortgages.
  3. The Housing Market is in Recession. The housing market is experiencing particular difficulties. The fall in house prices regularly make headline news and people tend to equate problems in the housing market to the wider economy. The housing market is particularly important because people make the link to their own houses. People tend to remember bad news more than good news. So whilst the housing market is in decline, exports are doing quite well (thanks to declining dollar)
  4. Reflationary Monetary and Fiscal Policy. In 2007, the rise in mortgage defaults were mainly caused by rising interest rates. However, since the start of the year, the Fed have aggressively cut rates to 2% from 4.5%, this has largely averted the problem for many with expensive mortgages. The cut in rates tend to boost demand and this has definitely helped shore up the economy. (Although I would doubt future cuts would help any more) The government have also offered a tax rebate in the hope that this will boost consumer spending.
  5. Declining Dollar has helped boost Exports. The dollar has fallen substantially against most major currency's. This gives an impression of economic weakness, that people may equate to 'being in a recession'. But, a devaluation actually helps boost demand
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