April
2008 Quarterly Forecast > The Nation
Why This Time Really IS Different, Part 2
Edward Leamer
Making a Recession Call is Very Serious Business
Since I took over the reins of the UCLA Anderson Forecast in July 2000, only twice has the recession risk elevated substantially, in 2000 and again in 2006. Remember that the official recession months of the 2001 downturn are April 2001 to November 2001. In December of 2000, we predicted a 60% chance of a recession in 2001. In April of 2001, we raised the probability to 90%. When the audience asked why only 90%, the answer was “humility; but trust me we are in a recession.” Meantime, almost everyone else said there was no recession, and no recession in the works. Then after the terrorist attacks on 9/11 many economists said this would cause a recession, even though the recession was already 5 months old and destined to live only two months more. It was not until December of 2001 that the National Bureau of Economic Research made it official: we really did have a recession in 2001. In other words, we got it right, and we stood alone back then.
Today, We Are in a Completely Different Position
The UCLA Anderson Forecast, since December 2005, has been predicting sluggish growth but no recession. And we are holding firm this time: no recession. This, of course, is counter to the recession forecasts that are coming from some of the most respected analysts on Wall Street.
Our no-recession story rests on two ideas. The first idea is the disconnect between housing and the labor market. This time owners are walking away from their homes in droves not because they lost their jobs, got divorced or had health problems, but only because home prices are falling all around the country. The second idea behind our no-recession story is the disconnect between the employment cycle in manufacturing and construction. Historically, the cycles in jobs in manufacturing and construction have been closely coordinated, moving up together in expansions and down together in recessions. But these two sectors disconnected in the recession of 2001. Construction jobs plowed through that downturn like it wasn’t there at all, but manufacturing took a big hit, losing 3 million jobs. Furthermore, there has been no recovery of even one job in manufacturing, which is an historic first. From this we think that it is impossible for manufacturing to contribute much to job loss in the year ahead, and without a major contribution from manufacturing we are going to have sluggish growth but not a recession.
Recent Developments
Housing starts have collapsed from their high of 2.3 million units in January 2006 to their most recent level of 1.0 million units in January 2008. We are not used to seeing this kind of collapse that is not accompanied by a recession. But as discussed earlier, this time people are walking away from their homes not because they lost their jobs, but because declining home prices have turned their net worth in the house negative.
This time things are different.
The most ominous aspect of this most ominous picture is that bump up in unemployment at the end of 2007. Never before have we had an increase in unemployment of this magnitude that was not the beginning of a recession. But keep in mind we have been well aware that the housing problems would involve substantial job losses in construction and a sluggish economy more generally, so this kind of rise in the unemployment rate is not at all a surprise. The surprise is that it took until the end of the year for the labor market to show real signs of softening.
Employment measured by the household survey continued to rise throughout all of 2007, but it did so at a much slower pace. Payroll jobs which had been growing at the 2% rate in 2006, slowed to about 1% at the beginning of 2007 and down to 0.8% at the end of 2007. This is, of course, an ominous trend that would turn the payroll numbers negative in 2009. But, so far, the labor markets are slowing but not collapsing.
Furthermore, a big component of every recession has been a significant dip in industrial production, spending and the manufacturing of consumer durables. So far industrial production is not showing anything like a recession dip, only somewhat slower growth in 2007 than in 2006. Likewise, growth of spending on consumer durables has slowed from the abnormal levels of 8% per year in the Internet Rush back in the late 1990s to still very healthy 5% at the end of 2007. The consumer is not the driver any more, but this is not a recession level correction. Not even close. As far as consumer spending and the impact of a negative wealth effect from declining home prices, if there is a quick halt to consumer spending, we will for sure have a recession in 2008.
It has been our view that the reaction to the reality of lower home prices will be slow and smooth, which is a reason to forecast slower growth in the future, not a recession.
Conclusion
Thus our no-recession forecast remains nervously intact. We see a lot of problems in the first half
of 2008 as housing remains a drag on GDP growth and weakness in personal consumption expenditures contributes as well. The big recession risk today seems not to come from the wealth effect caused by problems with collateral other than housing (the credit crunch has already killed off the housing market), but rather from the insolvency problems that lending institutions are currently suffering from.
This serious financial concern will be discussed in the following section by David Shulman.
Still, the Fed continues to dish out good news for Wall Street with ever lower interest rates. The labor market is sluggish and unemployment elevates to 5.5 percent by the end of 2008. But the housing drag on GDP dissipates in the second half of the year, and a normal economy returns in 2009.
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