Research

Podcast: Lee McPheters checks the vital signs of the economy

Consumers are worried, and that's a bad sign for the economy. Consumer spending accounts for 70 percent of the economy; these days people appear reluctant to buy big-ticket items like cars and major appliances. Months ago, former Fed Chairman Alan Greenspan kicked off a flood of speculation that the economy was headed into recession, talk that has created bad psychology about economic conditions. Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business, talks about the state of the economy nationally and in Arizona — a state that has consistently led the nation for job growth but which now ranks at number 18. For more of McPheters' analysis, see JPMorgan Chase Arizona Blue Chip Economic Forecast, which was released today.

2008-01-30

Consumers are worried, and that's a bad sign for the economy. Consumer spending accounts for 70 percent of the economy; these days they are reluctant to buy big-ticket items like cars and major appliances. Months ago, former Fed Chairman Alan Greenspan kicked off a flood of speculation that the economy was headed into recession.

Lee McPheters, director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business, talks about the state of the economy nationally and in Arizona — a state that has consistently led the nation for job growth but which now ranks at number 18. For more of McPheters' analysis, see JPMorgan Chase Arizona Blue Chip Economic Forecast, which was released today.

Transcript:

Knowledge: There's no getting around it. The economy, locally and nationally, is in poor shape. But just how bad is it? And, perhaps more importantly, how bad will it get? Here with an assessment of the state of the economy is Lee McPheters, professor of Economics and director of the JPMorgan Chase Economic Outlook Center at the W. P. Carey School of Business. The big question is: are we in a recession or not?

Lee McPheters: To really date a recession, the data have to be all put together, assembled, and usually the official process that dates a recession doesn't take place until perhaps as much as a year — even a year and a half — after the recession has started, and probably is over. So to say that we're in a recession now, really all you have to work with is various signals of recession rather than the actual hard data, which would either be looking at our measure of output, gross domestic product.

But in addition, typically the National Bureau of Economic Research — that is the agency, the group, the organization that does this — they also look at employment, they look at personal income, they look at industrial production, and none of those figures are really going to be available for several months. So, short answer is: it looks like we're in a recession, but we really won't know for months.

Knowledge: That's really the nature of recessions. Sometimes you don't know until they're over.

McPheters: That is correct. And I think that the potential for data revisions is probably pretty good. And what I mean by that is, when we look back on this period and look at the Arizona employment data — after it is finally revised, benchmarked, and finalized — we will probably see that the fourth quarter of 2007 was a whole lot weaker than we thought it was. And no one thinks it's very strong anyway, so I think that it's very likely that we're going to see either zero or negative growth in the fourth quarter of 2007 by the time the data are finally fully analyzed and revised.

Knowledge: So, until that data comes out, you mentioned the signs of a recession. On the national level, what are some of those signs?

McPheters: Well, one of the things that you would look at, of course, is the Index of Leading Indicators, and that index has been moving downward for a couple of years now. And that signal is just about so strong that it's very, very difficult to ignore it. Typically, people would want to look at the unemployment rate, but unemployment is a lagging indicator. And particularly in an economy like ours that has not had a lot of super-strong job growth but sort of a moderate job growth anyway, it may well be that as the economy slows, businesses do not actually lay people off, because it's costly to rehire, it's costly to train.

And so there's a period that could go perhaps as long as a couple of quarters before layoffs really begin in earnest and unemployment goes up. So, we have some signals in the economy. We have the Index of Leading Indicators. Of course, we've had a period of a much more volatile stock market, and the lows have been alarmingly low.

And even though there's been some recovery in recent days, nonetheless, the stock market is certainly not sending any signals of strong growth. When you look at the general level of consumer spending, when you look at consumer sentiment, all of these things tend to suggest that the economy is just much, much weaker than it was even three to four months ago.

Knowledge: How much of this, especially with consumer sentiment, is more of a psychological thing?

McPheters: I think that there is a very strong psychological component to it. There is a lot of chatter about recession. And this really began several months ago when Alan Greenspan, in a speech — among a number of other points he was making — mentioned that he thought that this particular expansion had been on for quite a while, that there were some earnings signals from businesses that their earnings were not as strong as they had been, as vibrant as they had been, and he thought that the possibility of recession was perhaps growing more probable.

So, what we have had is a great deal of commentary from people that follow the economy, that the economy is on the brink of recession. We've seen action by the Federal Reserve. We've heard about foreclosures. I think all these things, combined with the reality of high gasoline prices, no prospect in sight for reduced prices of oil or gasoline, concerns about the credit crunch, just all of this put together gives, I think, a flood of bad news that has really had an effect on the consumer, in spite of the fact that unemployment rates are around 5 percent. We used to think that was full employment.

Knowledge: So, who's the culprit in this? Is it the sub-prime collapse, or was that just a symptom of a fundamental problem in the economy?

McPheters: I think that, first of all, we need to really emphasize how important the consumer is. The consumer accounts for about 70 percent of the economy. So if the consumer has a sudden change of heart about spending, a reluctance to perhaps buy automobiles or other big-ticket items like appliances, when consumers see the value of their house beginning to fall relative to what they thought it was — at least on paper — these sorts of things can affect consumer spending.

And since the consumer is so important, this affects the whole economy. So, one of the things that bad psychology can do is sort of be a self-fulfilling kind of prophecy. If consumers, in fact, slow down their spending, the whole economy is going to slow down. So we're really just on the edge, I think, rather than really seeing that. The indicators are telling us there's a recession underway, but I think consumers just have a lot of uncertainty, and that's affecting the overall economy.

Knowledge: Now, what we're seeing on the national level, is that being reflected in Arizona?

McPheters: We work with a number of economists in the state that try to develop a consensus forecast, a consensus outlook for the Arizona economy, and we were surprised by our most recent survey of Arizona economists. Over a third of them reported that they felt that the Arizona economy had entered a recession in the fourth quarter of 2007. And they were basing that primarily on consumer spending, as reported by the Arizona Department of Revenue.

In the process of collecting sales taxes the Arizona Department of Revenue collects data on all types of sales, retail sales, restaurants, automobile sales and so forth. And those numbers are just extremely weak. They are looking very much like they did in the recession of 2001. We are expecting 1 percent growth in retail sales for all of 2007. Those are recession level numbers and a number of economists have really said that's enough.

There is our indicator our economy is a whole lot weaker than anybody thought it was. The main information that we have is retail sales. We also see employment is getting weaker and weaker. Those are the things I think that, in Arizona, seem to be even more pronounced than at the national level. In fact, let me add to the employment picture. Up until October of 2007, Arizona was one of the top 10 job growth states. So compared to all other states, Arizona was growing faster than most of them.

And in October all of a sudden, Arizona slipped to 13th, and then in November slipped to 15th, and then in December, the most recent data we have available, Arizona is now 18th among all states. And so it appears, when you consider Arizona's position as a growth leader, that we have really slipped out of the leading job growth state kind of category, if you would call it that. And we probably are going to see unemployment going up and job growth heading towards zero here over the next three months probably, three to six months.

Knowledge: Again, was the culprit here the sub-prime fallout?

McPheters: No. I would say that the main driver for Arizona is much less — Arizona is a state that depends on construction. And the growth of population, the growth of construction, both residential and nonresidential, public sector construction, all those put together, account for a sizable part of our state output and state income every year. With the slowdown in residential construction, that has not only affected employment in construction.

It has also affected such things as retail at the home improvement stores. It has affected people who perhaps would be taking home equity loans. As home prices begin to weaken, we have a situation where people are less inclined to think to take money out of their house and use it either for consumer spending or for improvement or education. So all of this, this side of things, has had an effect.

The other side of it would be higher gas prices, inflation, and uncertainty about the future. All of those things seem to have hit the Arizona consumer particularly hard and although this is certainly not unique to Arizona, it seems to have happened a little sooner here than I think anyone expected.

Knowledge: So we have been hearing about plans from Congress to stimulate the economy, regardless of whether $1,200 or $600 or $300 per kid. Will it come soon enough or will it be one of those things where the economy has kind of righted itself by the time people start getting these checks into the summer, if the projections of the timetable are correct?

McPheters: Economic policy has really two separate approaches. One would be monetary policy: interest rate, money supply changes, that sort of thing. The other would be fiscal policy: tax cuts, tax rebates as are being discussed in the stimulus packages. And both of those work with a lag. In the monetary policy, even if you have a very strong reduction in interest rates as we have seen from the Federal Reserve, it takes several months to work through the economy. Fiscal policy has a couple of lags.

One of them is just the political lag where you need to get all the parties together and get them to agree. So even though the House of Representatives has approved this stimulus package, it still has to go through the Senate and then it has to be implemented through a whole series of administrative maneuvers.

So people will probably have this extra money in their pockets — it'll be several months before that happens. And typically in this type of fiscal policy action, the policy itself finally has an effect a little bit after the fact and is not as potent as it would be if somehow you could magically see how the economy is slowing down and get moving in advance.

I'm certainly optimistic though that the effect of the stimulus package will have a short-term effect and we'll probably see one or two quarters where the economy benefits from approximately $150 billion injected in. That doesn't really get out some of the longer term problems that we need to have to be globally competitive. But I think that it will help us in this particular downturn.

Knowledge: Looking at the information that you have on hand now, can you tell whether this is going to be a very bad recession, a mild recession?

McPheters: This appears to be a recession that may well look something like 2001, which was in fact a relatively mild recession. One of the things that is beneficial about the current recession is that, in spite of the fact that there is a lot of discontent with the weak dollar, that makes U.S. exports, U.S. products, much more competitive globally. The economy is a lot more global than it was even in 2001.

So that means that the United States can continue to count on exports as one of the drivers of the economy. So that's a plus. In the recession of 2001, housing was really not hard hit. And in this particular recession, housing has been on the ropes for almost two years now. The hope is that housing will recover within the next six to nine months. And if that happens, that would actually be a really strong stimulus to again make this recession somewhat shorter than some others we have seen.

Economics Faculty