October 19, 2009
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Alan Levenson, Chief Economist of T. Rowe Price shares his insights on the economy and expectations for a recovery. |
Most observers agree that the economy is now on a path to recovery after having endured its steepest downturn in decades. Several factors are encouraging:
- Demand for goods and services is increasing. Most notably, housing construction is on the rise, and businesses are beginning to invest in new machinery and other types of capital equipment.
- Factories are getting busier. Gauges of industrial production are rising, a trend that should continue now that manufacturers have aggressively cleared shelves of inventory.
- Fewer jobs are being eliminated, and paychecks are increasing moderately before taking account of inflation.
How strong the recovery will be—and whether it will prove durable—depends on whether the economy can surmount several profound challenges:
- Banks remain wary about lending following last year’s credit crisis.
- Consumers are beginning to save more. While a higher savings rate is good for the economy in the long run, its rise will slow the pace of consumer spending recovery relative to income growth.
- The nation still has an “overhang” of unsold homes, which will continue to weigh on housing prices.
- The nation’s factories still have plenty of spare capacity, which will make manufacturers less likely to invest in new plants and equipment.
- Cash-strapped state and local governments are likely to spend less.
Because of these challenges, we expect the economy to grow only modestly next year. Our “base case” expectation is that gross domestic product will expand by roughly 2.0% over the four quarters of 2010—a much better showing than the 0.8% contraction we expect in 2009 but still below the economy’s long-term growth trend.
In our economic forecasts, we always examine a range of potential outcomes in an effort to assist our portfolio managers' thinking. At all times, we acknowledge that the economy might be either weaker or stronger than we expect, so we develop "base case," "weaker growth," and "stronger growth" scenarios. Outlining a range of plausible outcomes can help guide managers' thinking about how to reduce the risk to their portfolios should conditions take a turn for the worse, while allowing for gains if conditions improve.
That noted, the chances for a stronger recovery appear to have increased recently. In particular, we think the possibility has increased somewhat that the economy may enjoy a more robust expansion as automakers and other producers rapidly ramp up output following severe cuts in production last year.
In this positive scenario, the economy would enjoy a bounce off the bottom of the kind it experienced following steep slowdowns in the 1970s and 1980s. We should stress, however, that this hopeful scenario must be balanced against an equally likely unfavorable outcome. The fragile banking system and the possibility of drastic efforts to reduce debt on the part of businesses and consumers merit especially careful attention in coming months.
We are continuing to closely monitor the balance of forces at work in the economy, and we will adjust our forecasts as more data become available.
For more economic insights, watch "Economic Update," with Alan Levenson.
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