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.
Harlan Levy: What do you see ahead for the U.S. economy in 2012?
Ethan Harris: We end 2011 on a strong note. Fourth-quarter Gross Domestic Product is ranging about 3.5 percent. Unfortunately, 2012 will be much weaker. We’re facing three shocks in the year ahead.
First, Europe, which is one of our major trading partners is slowly sliding into recession. That will hurt the US economy in terms of trade and confidence.
The second shock is a gradual tightening of U.S. fiscal policy. A variety of spending programs are expiring in the year ahead. And under recent budget agreements, some modest further cuts in spending kick in.
The third negative factor for the economy in the year ahead is the uncertainty surrounding the election and policy going forward. Under current law, at the end of 2012 there will be a major $150 billion spending cut, and all of the – quote -- Bush tax cuts – end quote -- will expire. We expect businesses planning for the year ahead to pull back as they wait to see what happens to these two major fiscal actions.
In other words, policy uncertainty will also be a negative factor in growth next year. So you put it all together, and we’re looking at just under 2 percent growth in 2012.
H.L.: How significant is the move by the European Central Bank to lend banks money at 1 percent, and what do you see happening in Europe in 2012?
E.H.: The big lending program by the European Central Bank is very helpful to Europe. It will slow down the deleveraging by European banks -- that is, slow down the sped at which they try to reduce their loans and other investments. So it will help soften the crisis in Europe, but it doesn’t solve the crisis.
We think that there will be continued tightening of credit in Europe, continued cuts in government spending and increased taxes, and continued shocks to confidence in Europe, and all of the factors point to a mild recession in Europe.
At this stage we do not expect a full-blown financial crisis in Europe, but such a dire outcome is possible and could lead to a severe recession in Europe. Unfortunately, the outcome for Europe is a recession and really the only issue is whether it’s a small or big recession.
H.L.: How might that affect the U.S.?
E.H.: A mild recession in Europe would have a mild impact on the U.S. economy. In our baseline forecast we assume weakness in Europe reduces U.S. growth in 2012 by about half a percent, but if the more dire, full blown financial crisis occurs in Europe it could actually trigger a recession in the U.S. and globally. In 2012 the crisis in Europe is the major risk to the U.S. economy.
H.L.: Going back to the U.S. situation, is the housing market finally nearing a revival?
E.H.: While the housing market has shown some small signs of life recently, we continue to believe a real recovery is at least a year and a half away. Our concern is that there will be a renewed pick-up in foreclosures as banks work their way through legal and logistical problems in foreclosing properties. We think that means more pressure on prices and no growth in construction in the single-family market.
Now there are two bright[spots in housing: The multi-family sector should be strong as families look to downsize and look to rent rather than own, and the renovation market, which is an increasingly important part of the construction industry should be strong as well. But at this stage the impact of the construction industry on the economy is relatively small, because the sector has shrunk in size, so whether it grows 10 percent or is flat doesn’t have a big impact on the overall economy.
However, the true housing recovery requires a significant drop in foreclosures, and that is not likely until 2013 or 2014.
The bigger problem in the year ahead is that the problems in housing hurt consumer confidence and consumer spending, because the house is the most important asset for most families. And this is an asset that is still falling in value and has become very illiquid in the sense that it’s very hard to sell on a timely basis.
H.L.: What about jobs? How long can we keep losing jobs at the level we’re seeing?
E.H.: Again, we end 2011 with some signs of a modest revival in the job market, with job growth accelerating to above 100,000 per month. However, with overall growth slowing, we’re likely to see another slowing in job growth next year. We expect job growth of less than 100,000 per month, and that means virtually no improvement in the unemployment rate.
H.L.: What do you see ahead for the stock market?
E.H.: 20012 will likely be similar to 2011 in terms of the stock market. In other words, it will be a year driven by events rather than exhibiting a strong up or down trend. The first half of the year we are cautious, given the evolving crisis in Europe, but we do think that for the year as a whole stocks will be up modestly, as the European crisis moves into the background and the corporate picture moves into the foreground.
There is a tug of war in the stock market between strong corporate news and bad macroeconomic news, and that will continue to mean volatility in the year ahead.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
