The cover of last Friday’s The Economist bears an image of Uncle Sam.
That is not unusual in itself, since he is one of the magazine’s most consistent allegories. In his most current incarnation, however, he departs significantly from Uncle Sam Wilson of Troy and from the Uncle Sam imagined by J.M. Flagg for his 1917 war recruitment poster. In keeping with a more contemporary sartorial standard, the updated version has lost his familiar coat. He is now shirtless and buffer than any economist you are likely to encounter. As wide as his guns, the title above him reads “comeback kid,” implying a rebounding recovery.
Is the Economy on the Rebound? Or is it Reinvention?
The suggestion that we may be on the cusp of a new growth spurt seems ill timed. June’s employment report seemed confirmation enough that something is wrong. As it turns out, a contrarian assessment is not what the venerable journalists of St. James’s Street intend to convey. They agree that the economy is “in a tender state,” but also posit that things are better than they appear. The private sector is positioned for growth. Pointing to politics and the public sector as curbs on our potential, their advice to the next president beckons to the Hippocratic Oath: do no harm.
Rather than rebounding, the economy may be reinventing itself. We should expect no less. After all, decline and reemergence from recession are necessary processes of creative destruction. In the current cycle, the destructive forces have razed the unsustainable positions of the housing market and financial system. It is plain to see that these forces are still at work. What requires substantiation is the notion that a new, stronger order is emerging quickly or to a degree that negates the increasingly profound structural impediments to long-term prosperity in the United States.
Minutes from the June Federal Reserve Board and Federal Open Market Committee meeting, released last week, show a constrained assessment of the economy’s health. In its necessarily tempered language, the Fed observed that economic and labor market activity has slowed since the first quarter. That is rather euphemistic when considering that January’s private sector net job gain was the strongest in almost six years.
Commenting on the current policy juncture, Dennis Lockhart on Friday offered that “with each apparent change of the pace of activity, policymakers as well as business planners, government planners and forward-looking consumers had to ask whether the new trend is likely to be transitory or persistent.”
Our inability to establish a sustained trend has had a dampening effect on behavior, even during those brief periods when the data have improved. At the year’s halfway point, we remain constrained. Absent momentum in the labor market, income growth and spending by households have softened and consumer confidence has retreated from earlier highs. Small business optimism has seen a full reversal of the year’s earlier gains.
Apart from the immediate European threat, U.S. fiscal policy is expected to weigh more heavily on the outlook in the approach to the election. No matter who wins the election, budget politics will maintain a high profile in 2013, even if the reality of our spending imbalance does not come to roost. Reflecting the possibility that domestic indecision or external shocks will reverberate through the global economy, Fed officials have restated their commitment to accommodative policies. The unfortunate reality is that monetary policy has largely exhausted its known potential; it might even be argued that recent moves by the Fed have been ineffectual if not counterproductive inasmuch as they distort incentives for risk-taking.
Opting to forgo a clear and regular message regarding monetary policy’s limits, the Fed risks feeding volatility as it is thrust into the political arena and as markets grow ever more dependent on central bankers’ attempts to offset failures in the fiscal realm. For the time being, that means the interest rate environment will remain exceptionally accommodative. Impairments to the transmission mechanisms of monetary policy mean that commercial real estate investors must remain on alert. The flow of capital is supporting property prices; it is not fomenting a commensurate improvement in the economic underpinnings of value.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.