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Marshall J. Vest
Forecasting Project Director
March 1, 2009
These are nervous times. The economy is plunging, and measure after measure brings more bad news. The “talking heads” on TV continue doing their sensationalist best to convince viewers that the Fed’s rescue efforts are not
working (they are, patience, please). Additionally, statements from Washington about business conditions
haven’t been particularly reassuring either.
Confidence on the part of both
consumers and business leaders
has fallen to record lows, and fear
dominates
our
collective psyche.
This is typical of recessions.
History tells us that just
when
everyone
capitulates
to the idea
that conditions will never improve,
recovery begins.
The recession is nearing its nadir.
As of mid-February, the most recent data available stretches through year end. It paints a pretty bleak picture, but that is not unexpected. The economy was in free fall as 2008 came to an end, and expectations are that the first quarter will be equally depressing. Six months from now, with data for the second quarter, we should see clear evidence that recessionary forces are diminishing. In the meantime, talk show hosts will sensationalize every negative report and intensify peoples’ fears. There has never been a better time to develop a new hobby and turn off the talking heads.
In late February, Congress passed a $787 billion fiscal stimulus plan and introduced a $275 billion program to facilitate modification of home mortgages. Also, the U.S. Treasury, with Secretary Geithner now in charge, made significant revisions to the TARP rescue plan approved last fall, including changing its name to the Financial Stability Program (FSP). A key element of FSP is expansion of the Federal Reserve’s Term Asset-Backed Securities Lending Facility (TALF) from a $200 billion lending limit to $1 trillion. TALF provides funding to purchase securities backed by assets such as credit card debt, auto loans, student loans, and residential and commercial real estate loans. It is essentially a structured investment vehicle backed by the Fed! This will significantly increase the flow of credit to the private sector, while banks struggle to meet capital adequacy requirements. These measures, in addition to those put in place last fall, will contain the damage currently being wreaked and provide support for the economy’s recovery. The federal government and the nation’s central bank have committed nearly $10 trillion to the rescue. By comparison, total annual output of the U.S. economy is $14 trillion. This is an unprecedented amount of stimulus and it will work, given time.
The recession is nearing its nadir during the current quarter and will loosen its grip as spring arrives. With luck, and the enormous boost from the federal government, the economy should be back on track by year end – maybe sooner. At this point, patience is a virtue.
Recent evidence shows that the recession so far is similar to the severe recessions of the mid-1970s and the early-1980s. Looking at Arizona data (Exhibit 1), we find that residential building activity (as measured by building permits) has fallen to less than 85% of its peak level. That compares to declines of 74% and 71%, respectively, during the two earlier periods. Nonfarm employment is down 5.7% so far, compared to a 4.5% peak-to-trough decline in the mid 1970s, and 2.2% in the early 1980s. Inflation-adjusted retail sales fell 10.7% in the 1970s recession and 33.1% in the early-1980s. In the current recession, sales have fallen 20% so far.
The current recession still has not bottomed out, and it will no doubt exceed these two earlier recessions as measured by both depth and duration. But it will fall far short of the declines suffered during the great depression.
Current Recession is Comparable, So Far
Arizona has been hit harder than any state, with the exception of Nevada. Arizona’s economy entered the recession three months earlier than the national economy, and will likely emerge later. Using nonfarm employment as the yardstick, we expect the bottom to come in the second quarter of 2010. Some 220,000 jobs will be lost, an unprecedented decline from peak to trough of 8.2%. That puts the number of jobs back to the level of early 2005. It is expected to take until the end of 2012 for employment levels to regain the peak of 2007Q3 (Exhibit 2).
The lion’s share of losses will be in the construction industry. That industry will lose half of its workers over a four-and-a-half-year slide from its 2006Q2 peak to the bottom in 2010Q4.
Recovery Will Come Late to Arizona
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Personal income increased by only 2.7% in 2008, the smallest increase in at least four decades. We expect aggregate income to decline by 1.1% this year and grow by only one percent in 2010. In inflation-adjusted terms, 2008-2010 will bring a three row stretch of declines. In the mid-1970s and early 1980s recessions, real income declined in 1975 and again in 1982.
Declines in retail sales (including restaurants and bars, food, and gasoline) also have been unprecedented. This aggregate sales measure fell 4.6% in 2008 and would have been worse were it not for the 8.2% increase in gasoline sales. With gasoline prices now half what they were just six months ago, the aggregate sales measure will fall by 7.6% in 2009. The following year should see a nice rebound of 6.5-7.0%, as all components recover from very depressed levels. For the narrowly-defined retail component, the annual changes for 2008-2010 are -8.9%, -3.7%, and 7.0%, respectively.
Arizona’s unemployment rate stood at 6.9% at the end of 2008. Unemployment is predicted to peak at 9.5% by year end 2009, and average 8.8% for all of 2009 and 2010.
Population growth has slowed to the lowest rate in the past five decades. According to the U.S. Census Bureau, Arizona’s population grew by 2.3% in 2008. Look for an increase of only 1.4% this year and 1.7% in 2009. In sheer numbers, population increases by 92,000 this year and 110,000 in 2010. The rate of growth remains below 2.5% through 2015.
This recession will undoubtedly go into the record books as the longest and most severe since World War II. Thankfully, actions of the Federal government and the Federal Reserve to boost aggregate demand and to keep credit markets working will limit further damage. Patience -- and faith that conditions will soon improve -- are needed now. 
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