National Economic Forecast: The end of 2011 will be strong, but beyond 2012? Depends who you ask

Economists like to talk about the shape of the economic recovery. Ideally, it would have been V-shaped: a rapid, dramatic upswing following the recession. Several months into the recovery, which technically began in June 2009, economists were predicting a still-not-shabby U-shape. All held out hope that it wouldn't be an L-shaped recovery. At the 47th Annual Economic Forecast Luncheon, co-sponsored by the economics department at the W. P. Carey School of Business and JPMorgan Chase, two prominent national economists shared their thoughts about the shape of things to come — in 2011 and beyond.

Economists like to talk about the shape of the economic recovery. Ideally, it would have been V-shaped: a rapid, dramatic upswing following the recession. Several months into the recovery, which technically began in June 2009, economists were predicting a still-not-shabby U-shape.

All held out hope that it wouldn't be an L-shaped recovery. At the 47th Annual Economic Forecast Luncheon, co-sponsored by the economics department at the W. P. Carey School of Business and JPMorgan Chase, two prominent national economists shared their thoughts about the shape of things to come — in 2011 and beyond.

Joel Naroff, president of Naroff Economic Advisors, Inc. said that there is no letter to describe the kind of economic rebound this is shaping up to be. Clearly, he said, it has not developed in the V-shape we would have liked. "The recovery is a race and though we all wanted the hare we wound up with the tortoise." But a V-shaped recovery was "never possible given what caused the recession," Naroff said.

Past V-shaped rebounds were led by the housing and financial markets — two areas that have this time been drags on the economic recovery. "In previous recoveries the first quarter or two we would see increased housing activity. And typically banks emerged from recessions ready to extend credit, which powered growth. Neither of those is happening now."

So instead Naroff sees the recovery as an inverted square root sign. "We're on the plateau now, where growth is somewhere between modest and moderate. That's likely to continue for a while. But the factors that have been holding the economy back are in the process of being eased," Naroff said.

He predicts a big surge in growth next year, before a small downward readjustment to a "new normal" rate of growth. James Glassman, managing director and senior economist at JPMorgan Chase, calls the shape of the current recovery "frustrating — if that is a shape." He explained, "Frankly, most things will look like a 'V' shape on paper in the history books, but that reveals little about the feel."

Like Naroff, Glassman sees the current sluggish recovery as relatively temporary — one that will turn into robust growth in the latter half of next year. "Ironically, despite recent downbeat news, and the possibility that the U.S. economy may grow no faster than 3 percent for the rest of 2010, a number of new developments are pointing to a better economic performance in 2011 than was predicted only three months ago," Glassman said.

Growth in 2011: slower, then stronger

While both Naroff and Glassman see the economic recovery as on relatively firm footing, they said that the trajectory is not yet straight upward. Naroff forecasts GDP growth in the 2 percent to 2.5 percent range until mid-2011, when he predicts growth will spike to between 4 percent and 5 percent.

Glassman forecasts 2 percent GDP growth in the first and second quarters next year, 3.5 percent growth in the third quarter, and 4 percent growth in the fourth quarter. For Naroff, the biggest factor keeping the economy back right now is the job market. But he believes that it is improving.

"It will be another three, four, six months, but that labor market improvement will become clear," he said. Comparing one month to the previous one doesn't show much improvement, Naroff explained, but comparing this year to last makes "massive" improvements quite clear. "Six months from now, we'll see even bigger improvements." Once improvements in the job market become clear, Naroff said, that will be the trigger that ignites growth.

"Once people begin believing their jobs are not in danger, confidence will rise. That will lead to a loosening of the purse strings, generating more spending. The rising demand will require firms to add workers. As hiring increases, job security, consumer confidence, and household spending will improve further," Naroff explained, adding, "That is already starting to happen."

While Naroff sees negative perceptions about the labor market as the biggest reason for still-sluggish growth this year and the first half of next, Glassman said that it will be the unwinding of fiscal stimulus that will slow growth in the first half of 2011 (he predicts growth will slow from an average of about 3 percent this year).

"Particularly in the state and local sectors, the federal stimulus bought some time, but as that stimulus winds down, governments will have to tighten spending." But Glassman, too, sees improvements on the horizon — "developments pointing to a better economic performance in 2011 than was predicted only three months ago."

That is in large part, he said, due to the fact that "markets have finally embraced the idea that the Fed will hold its policy rate down for longer than earlier assumed" and to the Fed's decision to buy Treasury securities, as well as hints that Congress will extend the tax cuts set to expire at the end of this year.

Growth in 2012 and beyond: well above trend, or well below

So both Naroff and Glassman forecast slow growth through the middle of 2011, then fairly rapid growth for the second half of the year. But as they look beyond 2011, their forecasts differ dramatically. Naroff said, "As I look at 2011 and into 2012, the possibility of first strong and then more normal growth seems to be realistic." But the definition of "normal" is key, Naroff said.

"The economy over the past two decades has been driven by bubbles. Without the extra demand created by the bubbles, we should not expect to see 'normal' growth anywhere near what we had come to expect over the past twenty years." The "new normal" Naroff predicted, will be growth in the 2.75 to 3 percent range, rather than the 3.5 to 3.75 percent growth pace we enjoyed in the 1990s and 2000s.

Yet Naroff has "no problem" with an average annual rate of growth that is 20 percent below the trend growth rate of the last two decades — because it is "actually sustainable." He predicted, "We won't have the roller coaster ride we've had the last twenty years. Of course there will still be ups and downs, but there won't be surges and collapses."

It's not that the "new normal" will be characterized by an absence of speculative bubbles, Naroff explained, but that "we will have enough confidence to identify the forming bubble and stop it sooner." He said that the prevailing attitude in the 1990s and 2000s — articulated by then-Fed chairman Alan Greenspan — was "we won't know a bubble until it has burst."

But Naroff said that plenty of people did in fact see the tech bubble of the 1990s and the housing bubble of the 2000s as they formed, but that policymakers didn't intervene. "Next time I think policymakers like the Fed chairman will blow the whistle before the bubble is so enormous," Naroff said. "That is probably the best news in this forecast."

Glassman, in contrast, predicts above-trend growth in the 4 percent to 4.5 percent range for the next decade or so. "You have to ask: Where does the economy want to go and what kind of growth will be necessary to get there?" Glassman explained. "The economy tends toward full employment — marked by a 4.5 percent or 5 percent unemployment rate."

Glassman said he figures that GDP needs to grow at 4 percent to reduce the unemployment rate by 0.5 percent a year. The impetus behind a trend toward full employment, Glassman said, is the Federal Reserve Bank's congressionally-mandated aim to maximize employment while balancing inflation at about 2 percent.

"The idea that slower GDP growth is a 'new normal' doesn't square with the aim of the central bank," Glassman said. "The Fed will keep its foot on the gas until the economy is back to full employment." Indeed, Glassman said, the Fed has demonstrated an ability to propel the economy forward.

There is some political pressure for the Fed to "back off" on its economy-stimulating measures, but Glassman said that Fed officials have articulated that they will hold steadfast to their congressional mandate. "They'd only back off if Congress changed the Fed's mandate, and I don't think that's going to happen."

In fact, Glassman said, political pressure for the Fed to take its foot off the gas "ignores evidence." Those who suggest that the Fed "back off" cite concerns about inflation, but "inflation is actually too low now," he said. Which means that the Fed can — and will — "run the economy a little hot" until the unemployment rate comes down.

Both Glassman and Naroff characterize their views of post-2011 growth as "polar opposites." Glassman predicts strong economic growth until the economy returns to "business as usual" — an unemployment rate of 4.5 percent or 5 percent. Naroff's forecast of slower post-2011 growth "means that it will take an extended period for the unemployment rate to decline and the longer term/full employment rate will be higher."

For American businesses and consumers the difference between Glassman and Naroff's post-2011 forecasts is dramatic. One predicts a "classic story of cyclical recovery" — higher-than-trend growth for a decade or so — and everything that goes with it: (relatively) quickly falling unemployment rates and (relatively) high income growth (for businesses and consumers).

The other predicts a "new normal" — lower-than-trend growth — and everything that goes with it: more slowly declining unemployment rates (and relatively higher longer-term unemployment), slower income growth (for businesses and consumers), and slower stock price growth. Yet both economists are equally optimistic — about both their very similar 2011 forecasts and their widely divergent longer-term forecasts.

Bottom Line:

• Joel Naroff, President of Naroff Economic Advisors, Inc. forecasts GDP growth in the 2 percent to 2.5 percent range until mid-2011, when he predicts growth will spike to between 4 percent and 5 percent.
• James Glassman, Managing Director and Senior Economist at JPMorgan Chase, forecasts 2 percent GDP growth in the first half of 2011, 3.5 percent growth in the third quarter, and 4 percent growth in the fourth quarter.
• Beyond 2011, Naroff predicts a "new normal" rate of growth — in the 2.75 to 3 percent range, which is 20 percent below the growth pace we enjoyed in the 1990s and 2000s. He foresees slower growth because, he said, the "new normal" economy won't be driven by bubbles.
• Glassman, in contrast, predicts above-trend growth in the 4 percent to 4.5 percent range for the next decade or so as the Fed "keeps its foot on the gas" to speed the economy's return to a historically average unemployment rate of 4.5 percent to 5 percent.
• Yet both economists are equally optimistic — about both their very similar 2011 forecasts and their widely divergent longer-term forecasts.