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Debating the Economy's Comfort Level

Christine Benz

Christine Benz: Hi, I am Christine Benz for I recently attended the Morningstar Ibbotson Conference and had the opportunity to sit down with Kevin Kliesen. He is a research officer and business economist with the Federal Reserve Bank of St. Louis, and he discussed his outlook for the economy.

Kevin, thank you so much for being here.

Kliesen: Thanks, Christine.

Benz: Before we get into this interview, we first want to clarify that any views that you will express in the course of this interview will be your own views and not those of the St. Louis Federal Reserve Bank.

Kliesen: Yes.

Benz: In your presentation this morning, Kevin, you were cautiously optimistic about the U.S. economy for the rest of 2013. Let's talk about your views on that topic, and specifically, let's start with business spending. You think that there is a reason for some optimism there.

Kliesen: Yeah, I think you can build a case for stronger growth this year than what we saw last year. I think the economy naturally wants to sort of go back to where it's comfortable with. And with the economy, we can debate on where that comfort level is, but as some of the uncertainties that we have seen in the past few years kind of abate and ebb away, then obviously businesses will become a little bit more confident. They have a lot of cash on their balance sheets to put to work. As these uncertainties wear away, then I think [companies] will become more comfortable investing in machines and equipment and hiring more workers, as well.

Benz: Another area that you discussed in the presentation was the area of consumer spending. It had until recently been a relatively strong part of the economic recovery. More recently, though, we've seen some signs of consumer weakness. Let's talk about your thoughts on that sector.

Kliesen: Yes, consumer spending is the largest part of gross domestic product; as consumer spending goes, generally the economy is going to follow. So it finished 2012 on a reasonably sound note. Some of the signs this year are a little bit weak. You have the payroll tax, obviously; you have higher gasoline prices. So there is some cause for a concern, but at the same time some of the fundamentals of consumer spending are improving. The labor market seems to be improving, stock prices are going up, and housing prices are going up. You have some of these tensions at work, but I think on balance, economists expect consumers to continue to spend at a reasonable rate.

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Benz: Let's drill into the housing piece a little bit. Obviously, it was one of the big flash points of the recent financial crisis. You think that there is some cause for optimism in housing in the fact that housing prices seem to have bottomed.

Kliesen: Yes, housing prices last year, depending on how you measure it, were up on average 8% which was pretty strong. Now, obviously, they are coming from a low level. If you compare housing prices now versus where they were in 2006, they are still well below where they were then, and obviously you have these geographic disparities, as well. Some areas of the country were hammered like Florida obviously, and some areas of the country were not. So, I think with a lot of the excess inventories that we saw built up prior to the recession, as that's worked off, then obviously builders have to start building more houses. And that's kind of what we're starting to see right now, and in fact, housing has made a positive contribution to real GDP growth now for about a year and a half, so that's good. You got to start somewhere.

Benz: One thing you noted in the presentation was that there tend to be additional beneficial effects that are associated with rising housing prices. Let's talk about some of those.

Kliesen: Yes, so traditional business cycle dynamics and that's just fancy way of saying that as the economy comes out of recession, typically what we see is that housing tends to kind of lead the economy out of the recession. And as people start to build houses and move into houses, obviously they have to fill them with something like appliances and furniture and carpeting, and that has sort of spill-over effects to other parts of the economy. As the demand for furniture picks up, firms produce more furniture, and retailers sell more furniture. So you have these knock-on effects which are beneficial as well.

Benz: Another reason for some optimism you think is that you expect inflation to remain relatively benign.

Kliesen: Yeah. We pay a lot of attention to forecasts of inflation, and inflation expectations built into markets. And right now, at least over the near term, over the next year or two, it doesn't appear that financial markets are all that worried about inflation. Some of that maybe just a reflection that markets are convinced that the Fed, if something bad would happen, would take steps necessary to nip inflation in the bud. So, as of now, it doesn't appear that inflation is at the top of the list [of concerns for] people in the financial markets and consumers, as well.

Benz: You generally sound quite positive or reasonably positive about the economy, but you did in your presentation discuss some potential headwinds, some things that could get in the way of an even better recovery. Let's discuss some of those worrying areas.

Kliesen: Yes. As I said, some of the key risks in the outlook--how we phrase it often--generally reside on the fiscal policy side. We've raised taxes this year as one way to try to deal with the deficit, but again that has effects on the economy. We've raised payroll taxes on everybody virtually and raised tax rates on upper-income individuals and did some other things, as well. So, those naturally impart a drag on the economy.

I think one of the things that worry me maybe more than some other economists is that if you look at the growth of income, it really hasn't been that great. And then you layer on a tax increase for many people, low- to middle-income, and I think that can have tremendous effects on consumption spending, and maybe that might explain some of the weakness in retail sales in January.

If that continues, then obviously consumption as the largest part of the economy, you might see people start revising down their forecast. But again, it's too early to sort of say definitively if that's going to play out because there are other things on the other side that are helping to bolster the consumer.

Benz: Well, Kevin, thank you so much for being here to share your insights.

Kliesen: I am happy to be here. Thank you.

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