Rapaport Magazine

Recession or Not?

Economic forecasts indicate that strength in the stock market is expected to compensate for an ebbing housing market.

By Kate Rice
RAPAPORT... The economic outlook for 2007 is essentially a benign one. For some economists, the fact that the housing market is on a downturn is disturbing; the more pessimistic fear that it could herald a recession that may have already begun.

But others are more optimistic, feeling that the so-called “wealth effect” of a strong stock market, a 5 or 6 percent growth in income and an unemployment rate that is expected to stay low will offset the housing downturn. They see 2007 as the start of a cycle with lower, but more sustainable, growth rates.


Dean Baker, codirector for the Center for Economic and Policy Research in Washington, D.C., sees a recession looming on the horizon of the U.S. economy in 2007. That’s because much of the post-2001 recovery was fueled by a booming housing market. Average housing prices have risen by 50 percent since 1997, after adjusting for inflation, which Baker considers an “unprecedented” run-up. Now, construction and home sales have dropped by almost 20 percent from a year ago. In addition, as Baby Boomers enter their retirement years, he sees a shrinking demand for housing relative to the population. Baker sees the impact as strongest in the Northeast, West Coast, Florida and some parts of the middle of the nation, such as Chicago. Because these regional economies are so big, any downturns they experience will reverberate throughout the nation.

Baker projects a drop in the housing sector of at least 40 percent from its 2005 peak and expects the drop to hit bottom by the end of 2007 or early 2008. He also points out that the weakening housing market has been accompanied by declines in nonresidential construction, durable goods orders and in manufacturing. “I think we’re on the edge of it, if not in the actual downturn itself,” he says.

At the same time, Baker is concerned with what appears to him to be Federal Reserve Board Chairman Ben Bernanke’s preoccupation with inflation. Baker believes that a painful downturn is inevitable, but that a quick turnaround is possible. But conditions have to be right for such a turnaround. He believes the nation should be prepared to run a big deficit — one caused either by government spending or tax cuts — to turn the economy around. However, in terms of monetary policy, an over-valued U.S. dollar is complicating this situation. A declining dollar will inevitably lead to inflation — Bernanke’s primary concern right now.

Baker thinks a falling dollar will boost U.S exports and that’s worth somewhat higher inflation. But he doesn’t know if Bernanke could stomach that. Nor does Baker think the strong stock market can offset the impact of falling housing prices. He thinks the wealth effect is minimal.

But other economic observers are more sanguine.


Greg McBride, senior financial analyst for Bankrate.com., a major online aggregator of financial rate information, expects the Federal Reserve Board (the Fed) to cut rates a few times in 2007, reversing its 17 prior rate hikes. He compares these rate cuts to the subtle steering adjustments drivers make on the interstate in order to stay in their lane.

“They don’t want the economy to slow down too much,” he says of the Fed, adding that forces already slowing down the economy include the housing market and rising oil prices. But McBride also points out other bright spots.

“Unemployment is at 4.4 percent, the economy is consistently adding jobs and the rate of growth in the economy, although not as strong as earlier in the year, is still solidly in positive territory,” McBride says.

McBride believes this means that the nation will get the soft landing the Fed wants, with slower but more sustainable economic growth, receding inflationary pressure and declining interest rates.

“And that really sets the stage for what could be a really good year for a good stock market,” McBride says. “It has a wealth effect of its own on consumers and that is particularly important when the housing market is in transition.” Moreover, he says, a strong stock market also bodes well for industries that deal with luxury consumer products.

Kathleen Camilli, president of Camilli Economics, LLC, also has a positive outlook. She says that while some economists are predicting that weak auto production, the slowing housing market and a slowdown in manufacturing will tip the economy into recession, she does not expect this. Instead, she is predicting that the fourth-quarter gross domestic product (GDP) will show approximately a 3.5 percent increase, which would be an increase over the second and third quarters.

“It’s been a year when growth started rapidly and slowed a lot, but I am optimistic that lower gas prices will boost GDP,” Camilli says.


Camilli also cited the ABC News/Washington Post Consumer Confidence Index, which now stands at zero on its scale from +100 to -100, well up from a recent low of -19 in August. She credits that increase to consumers feeling more confident about their personal finances and ties that to decreasing gas prices.

All but one of Camilli’s indicators are blinking green for go, she says. The single exception is the fact that the yield curve between three-month Treasury bills and ten-year T-bills turned negative in July. Usually, when that happens, it presages a turning point in the economy by about six months. However, she thinks that this is no longer a valid indicator because the Chinese have begun buying long-dated treasuries, changing the dynamic of that indicator.

Camilli also sees strong business spending. That’s why she’s baffled by the pessimism expressed by other forecasters. She doesn’t expect the slowdown in housing to have the negative impact that Baker and other economists are predicting. “Everybody is saying that housing prices will turn negative because we had speculation and housing prices came off their highs in 2006 and when people’s houses don’t go up in value, people sour on the economy,” she says. But she disagrees.

“The real driver is your salary,” Camilli says, pointing out that personal income is expected to grow at 5 or 6 percent. Like McBride, she points to the low unemployment rate. “As long as income and unemployment [rates] are good, people spend money,” she says.

Predictions for 2007
GDP growth -0.7 percent
Job growth -1.2 million
Nominal wage growth 3.4 percent
Inflation (Consumer Price Index) 2.6 percent
Residential construction -12.0 percent
Consumption -1.2 percent
Investment 2.0 percent
Exports 4.0 percent
Imports -2.0 percent
Government expenditures 2.0 percent
Source: Center for Economic and Policy Research

Article from the Rapaport Magazine - January 2007. To subscribe click here.

Comment Comment Email Email Print Print Facebook Facebook Twitter Twitter Share Share
Comments: (0)  Add comment Add Comment
Arrange Comments Last to First