Economist and author Ethan Harris is managing director and head of North America 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.: How bad is the job situation, and what’s your outlook for next year?
E.H.: We’ve had only an average of 40,000 jobs gained in each of the last four months, which is very similar to the slowdown we had last summer. While this is not a sign of a recession, it is a very disappointing outcome. In the early stages of an economic recovery, you should be seeing 200,000 to 300,000 monthly job gains, and this is far short of that performance.
Job growth also isn’t enough to prevent some increase in the unemployment rate.
As some of the shocks that have hit the economy fade we expect a slight improvement in the job market. Earlier in the year, rising oil prices hurt the economy. More recently, the dysfunctional debate in Washington has hurt confidence in growth. While we do not expect everything to be great in Washington in the year ahead, we also don’t expect threats to either default on the debt or shut down the government. So the negative vibes from Washington should ease, and that should be good for business confidence and hiring. We do expect by next year payroll growth will move back above 100,000 per month.
H.L.: What do you see happening with the sovereign debt problems in Portugal, Italy, Ireland, Greece, Spain, and now Belgium and how much will they affect the U.S. economy?
E.H.: Europe is facing an even bigger crisis than the U.S. Policy-makers seem unable to make tough decisions unless the markets force them. Hence we expect more of the same in Europe, with periodic financial market pressures, followed by policy actions that help stabilize the markets.
I think this is going to have an ongoing negative effect on the stock markets and confidence, but the shock is unlikely to trigger a recession in either the U.S. or Europe.
H.L.: Given Europe’s troubles, a lousy job market, intractable housing woes, and weak consumer sentiment, is the economy heading for long-term doldrums?
E.H.: The weak recovery is a natural outcome of the crisis that preceded it. When you have a major collapse in real estate and banking, economic recoveries tend to be slow and painful. We are likely to be in this slow recovery for at least the next year and a half or two years. Further on we could expect better growth, but only once we get through our real estate problems.
H.L.: Will the Federal Reserve give the economy another dose of stimulus, and can the Fed do much at all?
E.H.: The Fed still has some ammunition, but it’s the low-caliber quality. The Fed’s big asset buying program last year had only a small positive impact on growth. Any new program would also be likely to have a small impact on growth. We expect the Fed to continue to offer small measures to support the markets as a way of showing that they’re still in the game. This will be good for market confidence, but the Fed has no magic bullets here.
H.L.: Is a major correction ahead for the U.S. stock market?
E.H.: I think that most of the weakness has already happened, although I’m not sure we’re quite out of the woods yet. It’s important to recognize that while the economy looks very fragile and the political news is very disturbing, the corporations in the U.S. are in good health. So the key to the outlook for stocks is that stocks will tend to move higher if the macroeconomic news and political news is OK. When things start to get very ugly either in the economy or in Washington that tends to dominate over corporate fundamentals. If, as we expect, the economy improves modestly, and if Washington avoids the extreme dysfunction of this summer, there should be room for some improvement in the stock market.
H.L.: Are there sectors of the market that deserve investment now?
E.H.: we have a longstanding view favoring companies with large exposure to emerging markets, so we continue to believe that these multinational trade-oriented companies should outperform.
H.L.: What should Congress do about the budget deficit?
E.H.: I think any realistic approach to the budget deficit requires that everything is on the table. That means controlling and cutting discretionary spending, slowing down the growth in entitlements, and doing some kind of revenue enhancements. Ideally, the revenue enhancements would come through tax reform that closes loopholes but doesn’t raise tax rates. Such a three-pronged approach would be credible in that it would involve shared pain, and it could be big enough to make a major dent in the deficit.
So far Congress’s exclusive focus on discretionary spending has not produced a credible deficit reduction plan.
It’s also important to recognize that the timing of the fiscal tightening should match the ability of the economy to handle the tightening. Big budget cuts today would torpedo a very fragile recovery. A sensible plan should start slowly but have a credible long-run path