The U.S. economy is in for “a long, slow climb out of a deep hole,” said former Federal Reserve Vice Chairman Dr. Donald Kohn, who had the last words wrapping up the 2010 ULI Fall Meeting in Washington, D.C.
Kohn, who stepped down from the Fed only five weeks ago after a 40-year career, identified a variety of factors that will make this the slowest economic recovery since The Great Depression, rather than a “garden-variety” recession that can be addressed by monetary policy. First, the recession was primarily a debt and banking crisis — the kind that historically recovers slowly. Household debt is still high relative to income, despite low interest rates. Savings rates are up from 1% to 6% annually – which is necessary, but cuts into consumer demand. Over-leveraged financial institutions need time to repair their balance sheets.
In addition, Kohn continued, there is an “overhang” of houses and consumer durables. Before the excess supply of housing can be absorbed, owners and lenders need to modify mortgages, and many former homeowners will need to become renters. The only good news in this situation is that housing has become more affordable.
Yet another important factor is tax and regulatory uncertainty, creating a lack of consumer and business confidence that is holding back spending and hiring. Congress still hasn’t decided what the tax rates will be on January 1, 2011, let alone initiated development of a long-term policy – as the United Kingdom and other countries are attempting — to address the ballooning national debt. Health care reform has affected business hiring, with companies uncertain of what new hires will ultimately cost.
Despite all the gloom – compounded by the global nature of this recession – Kohn is optimistic that growth will pick up next year and even more the following year, with inflation remaining very low. Households are rebuilding net worth while stabilizing their savings rates; the financial sector is rebuilding capital; problem loans are being addressed; productivity growth, which inhibits hiring, is likely to slow down; pent-up demand is driving an increase in business spending on equipment and software; and consumer durables are wearing out, so they will need to be replaced.
The recovery could be enhanced by fiscal policy in the form of more government stimulus, Kohn noted – but the problem with that strategy is that it adds to the national debt and there is widespread skepticism regarding its efficacy. Regulatory policy must undergo rigorous cost-benefit analysis, he said. However, he concluded, “we are in uncharted waters” and “public confidence is critical to economic recovery.”