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Double-dip very unlikely, but fiscal policy is a disaster: Interview with Mickey Levy

Mickey D. Levy is Bank of America’s chief economist and an adviser to several Federal Reserve banks.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

H.L.: What’s your prediction for the U.S. economy in 2010?

M.L.: I expect the U.S. economy to continue to recover with healthy growth. The probability of a double-dip recession is very low. Consumer spending should grow only modestly, certainly slower than prior economic rebounds. However, businesses have slashed inventories, capital spending, and employment, and in 2010 they will be increasing production and employment. Housing will continue to rebound, and exports will be a major source of strength, reflecting a global economic rebound and the lag impact of the weaker dollar.
Will the dollar continue to weaken?

M.L.: I don’t profess to be a foreign exchange expert, however, the Federal Reserve is expected to extend their low interest-rate policy even after other central banks start raising rates. U.S. fiscal policy is a disaster, and global portfolio managers know it. These factors suggest that the dollar will fall further as a natural adjustment to the high U.S. trade and current account deficits.
 What do you mean when you say fiscal policy is a disaster?

M.L.: Deficit spending is so large it is unsustainable. My concern is not the current budget deficits but the fact that they are expected to persist even when the economy gets back to potential and full employment.
I would note that official long-run projections assume the unemployment rate will get down to below 5 percent.

Current government policies point toward high unemployment for a long time to come, which will perpetuate poor budget outcomes.

It’s not just the sustained high budget deficits and dramatic increases in government debt: It’s what we’re deficit- spending for. Most of the deficit spending is for income support and does not add to productive capacity. That translates into slower longer-run growth — that means slower growth and lower standards of living — and higher costs of financing government debt for future generations.

Actions speak louder than words, and the current thrust of fiscal policies is downright scary. I’m optimistic about the economy for 2010, but we and future generations are going to pay the price for the financial crisis and the government responses to it.

What do you think will happen when the federal stimulus money stops flowing?

M.L.: Rather than be concerned about when the fiscal stimulus stops flowing, I’m looking forward to it. The private sector has gone through painful adjustments — for example, the sharp declines in housing prices and activity and the huge inventory liquidation and job losses — and has not begun to grow.

The government’s capital infusions and the Federal Reserve’s liquidity provisions into the financial system have helped to stabilize financial markets, and the Fed’s purchases of mortgages have contributed to lower mortgage rates. These have helped repair household balance sheets.

I am concerned about whether the Fed will be able to gracefully exit from its quantitative easing and low interest rate policies without upsetting the economy. However, independent of the significant positive impact of the Fed’s policies, I am much more skeptical about the efficacy of the lasting stimulative impacts of the government’s fiscal policies. Therefore, I project sustained economic expansion, even when the government’s fiscal stimulus package funs its course.

How long do you think job losses will continue?

M.L.: I expect employment will begin to grow in early 2010. Businesses responded very aggressively to the decline in product demand due to the financial shock in 2008. A total of 6.5 million jobs were cut, and the unemployment rate soared. That was associated with unprecedented inventory reduction, cuts in capital spending, and a sharp fall-off in exports. Now, product demand has begun to rebound gradually.

I expect only a small portion of those jobs will be rehired in 2010, but the job numbers will turn positive nonetheless. On top of this, nearly 1.4 million government jobs will be added for the 2010 census, and if history is any guideline, not all of those jobs will be temporary.

With the jobless rate still high, do you see consumer spending staying weak?

M.L.: At the initial stages of prior economic recoveries, consumer spending bounces even before employment rises. Ion response to the increase in product demand, businesses hire and the increase in income supports sustained consumer spending. I expect that trend will unfold in 2010. However, consumers are continuing to deleverage, and the unemployment rate will remain very, very high, and this will constrain the growth in consumer spending relative to prior economic recoveries.

The stock market’s surge since March has been way ahead of the economy’s recovery. Do you expect a stock market correction soon and then a resumption of the market’s rise?

M.L.: I am not a stock market strategist but would like to make a simple observation: Even though the stock market has enjoyed a dramatic rebound, it’s still remains below its level just prior to the collapse of Lehman Brothers and the financial crisis of fall 2008. Back then, the economy was already in recession, and profits were falling, and analysts were revising down their profit expectations.

Presently, the economy is rebounding. Profits are rising rapidly, benefiting from businesses’ aggressive constraints on operating costs, and the Fed signals it will keep rates low for an extended period. So why shouldn’t the stock market get back at least to its pre-crisis level? I’ll leave the timing and short-term price swings to the stock market strategists.

Do you think there will be effective new regulation of derivatives and the other unregulated financial instruments that played a role in the financial meltdown?

M.L.: Yes. Some of the derivative products will be traded through newly established exchanges with tighter regulations that avoid future problems, but the broader issue is whether the new regulatory apparatus will address the true causes of the financial crisis, and this is a complex issue.