The Lingering Economic Malaise

Today, the Commerce Department reported in June personal income increased $6.8 billion or 0.1 percent, and disposable personal income decreased $210.3 billion or 1.8 percent, because the stimulus rebate checks inflated May income figures. Personal consumption expenditures increased $76.5 billion or 0.6 percent but adjusted for inflation, consumer spending was down 0.2 percent.

Consumer spending contributed importantly to the 1.9 percent increase in second quarter GDP; however, this was largely from a boost in May consumer spending spurred by the $168 billion stimulus package checks. Not all this money was spent in May; much was saved and available for spending in June, but consumers slowed down.

Rising unemployment, falling home prices, tougher credit card terms, and high gas prices have consumers hunkering down. Particularly weak has been consumer spending on durable goods, reflecting growing pessimism about the outlook for the economy.

Without an additional government policy jolt, the economy is headed for a very slow second half of 2008. Either the third or fourth quarters should register negative GDP growth.

The economic malaise is significantly caused by the failure of the Wall Street banks to straighten out their business and mortgage lending operations. They can’t adequately access the fixed income market to raise money to finance loan to businesses and home buyers—in the wake of the subprime scandals, insurance companies, pension funds and other fixed income investors don’t trust the banks and won’t buy their loan-backed bonds. The Federal Reserve and Treasury have shored up the banks with emergency lending but done little to address these systemic problems.

Now, widespread credit shortages and huge payments abroad for high priced oil and consumer goods from China are driving down demand for U.S. made goods and services, and destroying jobs. With Federal Reserve, Treasury and the Congress taking little action to address these problems, the economic mess should continue into 2009

The news on inflation is unsettling but should improve.

The price index for personal consumption expenditures, including food and energy, was up 0.8 percent in June and was up 4.1 percent from June 2007. However, this has been largely caused by higher oil and food prices, and the news on oil prices should get better.

The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This core price index was up 0.3 percent in June, after rising 0.1 and 0.2 percent in April and May. In June, the index was up 2.3 percent from June 2007.

As important to the Federal Reserve, the market-based core inflation index, which excludes food, energy and imputed prices like rent on owner occupied homes, was up 0.3 percent in June, after rising 0.2 and 0.1 percent in April and May. That index has increased 2.0 percent since September 2007.

In the second half of 2008, global oil and other commodity price inflation should moderate, and as the effects of slowing demand grip the economy, the feedback effects of higher energy and commodity prices into U.S. core inflation should ease.

In July, gasoline prices were up only 0.2 percent in July and have been falling in recent weeks. Overall, headline inflation should moderate soon.

The Federal Reserve, by constraining U.S. economic activity, can do little to lower global oil and other commodity prices sooner than market forces require. Despite the ruminations of inflation hawks on the Open Market Committee, the federal funds rate is likely to remain unchanged beyond the November election and into 2009.

The Federal Reserve Open Market Committee meets Tuesday but hardly anyone expects an interest rate hike. Most attention will be focused on the Committee’s statement about the risks of inflation and slowing growth. Look for noise about inflation, to placate the hawks, but nothing in this portends action.

As the economy slows down during the second half and job losses mount, the Fed will have few options but to admit the economy suffers from severe structural problems beyond the reach of interest rate policy, or look completely out of touch. The failure of the large money center banks to adequately participate in business and mortgage lending, their inability to securitize loans thanks to flawed and suspicious management practices, and the taxes on growth from large trade deficits on oil and with China will drag on the economy like leg irons on a capsized sailor.

PETER MORICI is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.





PETER MORICI is a professor at the Smith School of Business, University of Maryland School, and the former Chief Economist at the U.S. International Trade Commission.