Consumers are not immune to two recent price increases: fuel and home mortgage rates.
Martin Baily, senior fellow at the Institute of International Economics, predicted GDP growth would slow to 2.5% in the second half of the year and remain at 2.5% in 2007. Two reasons for tepid growth: energy costs are affecting consumer spending, and housing-even though it is not the "bursting bubble" many have feared-no longer is driving spending via the "wealth effect."
Baily said the value of American owner-occupied housing increased $6 trillion from the first quarter of 2003 through the fourth quarter of 2005. He cited Federal Reserve studies that found the propensity to spend from housing wealth is greater compared to other kinds. Stock market wealth, for example, is viewed more cautiously, while housing money is seen as "money in the bank."
"As housing wealth goes up, it encourages people to spend," he said. "Dear to [credit union] interests, there will be a slowdown, but I don't want to overstate. If prices remain flat, Americans have not spent all of [the $6 trillion]."
Baily said he does not expect a sharp decline in housing prices across the country, though he said some individual markets such as New York, Boston and Los Angeles might see drops.
Since the late 1990s, the U.S. has had a huge influx of foreign investments. The result, Baily said, has kept the dollar far above a level consistent with trade balance. He anticipates a decline in the dollar over the next two to five years, accompanied by a rise in long-term interest rates, which will take the pressure off American companies trying to compete and help reduce the current trade deficit.
All of these factors, of course, are being watched closely by the Fed and its new chief, Ben Bernanke. Baily said the U.S. economy has been very strong in terms of overall growth in recent years, and has reached low unemployment: "To the point some think it is near full employment."
"What will determine the next step-recession or growth? The Fed and Bernanke will be a large factor," he declared. "Bernanke has said the Fed will respond as new information becomes available. If what I say is right and the economy is slowing down, it is right for the Fed to pause. They have the Federal Funds Rate up to 5% and will have to resolve the tug of war between controlling inflation and not wanting to kill growth."
Baily said inflation has been "pretty well contained," and the economy has not seen a spillover from recent commodity price inflation to total inflation. The more pressing concern, he stated, is the link between the global economy and U.S. interest rates. As the dollar begins to slide, long-term rates will start to move up.
Although a major oil supply disruption and/or a sharp drop in the dollar and sharp rise in interest rates is a possibility, Baily predicted "a deep recession is not very likely. It certainly is something [credit unions] should plan for in terms of preparing for a disaster scenario, but there are self-correcting factors in the national and global economies."
