Economist and author Ethan Harris is managing director, head of North America economics, and coordinator of global economics at Bank of America Merrill Lynch. Previously he worked at Lehman Brothers, where he was chief U.S. economist since 2003. Before that he worked at the Federal Reserve Bank of New York.
H.L.: What’s your reading of the report of 3.2 percent growth in first-quarter Gross Domestic Product?
E.H.: This is another sign that the U.S. economy is on a good but not great recovery path. We’re seeing solid growth in exports, capital equipment spending, and pretty good growth in consumer spending. But that’s offset by the continued woes in the real estate sector and for local government.
The net effect is a recovery that’s lower than the normal 7 percent growth you would expect coming out of a major recession.
H.L.: With unemployment insurance claims of 450,000 last week, what does that tell you about the job picture?
E.H.: It’s suggesting that layoffs are still higher than normal and that we’re getting net-only slow job gains in April. Normally in a healthy job market unemployment claims would be running at about 350,000 per week, so layoffs are running about 100,000 more than normal.
The job market is one of the last parts of the economy to return. We do expect better job growth in the second half, with payroll gains reaching about 200,000 per month and a slight drop in the unemployment rate.
H.L.: When do you see healthy job growth?
E.H.: A real recovery in the job market probably won’t happen until 2011 or 2012. First we need to see more of the wounds from the financial crisis to heal and for business confidence to fully recover.
H.L.: Is business confidence getting stronger on Main Street or just Wall Street?
E.H.: Wall Street has recovered much faster than Main Street because of the extraordinary actions of the Federal Reserve. However, given the ongoing problems in the housing market, the slow healing in the banking system, and the continued psychological wounds from the crisis, the recovery will lag the recovery on Wall Street.
We’ve already seen some recovery with parts of the economy growing quickly, but we don’t expect a broader recovery that lifts all boats until 2011 or 2012.
H.L.: Are financial reforms healthy for the finance sector and the economy?
E.H.: I think whether financial reform helps the economy depends a lot on the fine print. Certainly financial reform is needed, given the scale of the crisis we’ve come out of. There needs to be a balancing act between regulation and innovation, but I think it’s too early to judge the economic impact of financial regulatory reform.
Certainly uncertainty about the regulatory environment, whether we’re talking about health care or financial regulations, has had at least a small negative impact on the recovery, because in the face of uncertainty people tend to hesitate. But again, financial reform is important, and, if done right, helpful to the economy.
H.L.: Isn’t the housing market just cruising the bottom, and if so, can the recovery in the U.S. economy do more than limp along?
E.H.: The housing market is certainly in a fragile bottoming process. It’s very dependent on ongoing government support. At least some of the strength is due to tax incentives for homebuyers, which expired on Friday. Those tax incentives have made the housing market look better than it really is.
In addition, there are a variety of programs designed to slow down the foreclosure process and attempt to smooth the shock to the economy, and this will mean the shock of foreclosure will be spread out rather than absorbed in one big blow.
Our forecast is that housing remains weak for an extended period of time, and a true recovery only comes as the foreclosure process nears an end. That suggests the real recovery in housing is at least a year away.
H.L.: How much of a threat to the U.S. economy are the debt problems of Greece, Portugal, Spain, Italy, and Ireland?
E.H.: The problems in Europe are a reminder of a couple of risks to the U.S. economy. First, the U.S. is running its own big budget deficits. So while we’re not under the same immediate pressure as Greece, we face a more gradual fiscal consolidation as well.
Greece is also a reminder of the risks to the European economic recovery. If the Greece crisis runs out of control, it could spark a broader crisis in Europe and, in a worst-case scenario, renewed recession in Europe. That would hurt U.S. trade and hurt U.S. markets.
So, while Greece is a very small country, accounting for less than 1 percent of world output, the crisis has the potential to have significant negative impacts.
H.L.: What’s your take on the stock market and whether a correction is coming soon?
E.H.: I think outside of risk factors like the Greek situation, the backdrop for the stock market is positive. The U.S. economic recovery looks well-established. We’re in a low inflation environment, and with that low inflation, we have a very growth-friendly Federal Reserve. So, absent a big external shock, we should get an ongoing recovery in the U.S. stock market.
The two biggest risks stem from policy problems. First would be if the Greek crisis continues to escalate, and the second comes at the end of this year, when all of President Bush’s tax cuts are set to expire. The risk is that the Democrats and Republicans can’t agree on a compromise, and the economy faces a temporary surge in tax rates.
So a key theme of the outlook for both the economy and capital markets is the importance of good policy. The biggest risks come from policy mistakes.
Disclosure: No positions