"Kee" Points with Jim Kee, Ph.D.


The Wall Street Journal’s monthly Economic Forecasting Survey of 50 plus panelists was released last week, and I think it gives a pretty good consensus view of what professionals expect over the next 12 months. In a nutshell, economists see continued slow growth, muted inflation (and interest rates), and no real job creation (La Jolla Economics; Wall Street Journal). Most feel that the “fiscal cliff” will be avoided with some sort of compromise deal being struck, which accounts for the lack of recession forecasts.

This is consistent with other research that I see. A good ballpark summary of the fiscal cliff likely outcomes and impacts are: High probability of a compromise resulting in smaller tax increases and spending cuts than would otherwise be the case (Citi Research). That is estimated to result in 2013 GDP growth of around 1.9 percent. Remember, the long-term (150 year) average annual GDP growth for the U.S. is around 3 percent and the average for expansions is around 4 percent. A low probability scenario – going off of the fiscal cliff (all tax hikes and spending cuts occur) – would result in GDP growth of around -1.2 percent, or a recession. Another  low probability is a third scenario, that of a grand bargain (full tax, spending, and entitlement reform) resulting in 3.2 percent GDP growth for 2013. We’ll see what happens this week as Congress returns from Thanksgiving vacation.

Is economic growth really that important? Absolutely! Growth of 2 percent means that GDP – total output of goods and services – doubles every 36 years, whereas growth of 4 percent means GDP doubles every 18 years. Higher growth makes the future economy much larger, expanding everyone’s wish list options from government activities to tax and debt reduction to solvency of entitlement programs to defense (as frequently stated by economist Robert Mundell).

Also worth mentioning from last week is the fact that Europe is officially in a recession with overall GDP growth falling 0.1% in the third quarter, the second consecutive quarter of decline. And Moody’s downgraded France’s debt rating from AAA to Aa1 (one notch lower). None of this was a surprise to markets (indeed Standard & Poors had already downgraded France), and, in fact, Germany reported increased business confidence that was higher than expected (Financial Times).

The most interesting thing I saw last week was an article by the Bank Credit Analyst suggesting that Fed policy wasn’t really distorting interest rates that much and that the term “financial repression” was going a bit overboard. Though the piece might have overstated the case somewhat, I have been having similar thoughts. For one thing, financial repression was a term borrowed from true repression in cases like Japan where people were forbidden from investing in certain financial instruments. Just because you can’t earn 5 percent in a risk-free government insured CD doesn’t mean that you’re being financial repressed, if interest rates would be low anywayAnd here’s the point: interest rates are the price that equilibrates the supply of and demand for loanable funds. If interest rates were being artificially lowered because of an increased supply of loanable funds (from the central bank), then you would expect to see a capital spending boom because the quantity of loanable funds demanded would be higher. But you don’t see that, which suggests that interest rates would be low anyway. In other words, low credit demand along with increased savings (supply) as people rebuild their personal balance sheets (“de-lever”) would result in very low rates even without the Fed’s balance sheet expansion (similar to what happened during the Great Depression). So rates might be less distorted by central bank “monetary manipulation” than is commonly believed.