Brooklyn's Progress
February/March 2005

By Joel L. Naroff, Ph.D.

As we look out over the economic horizon, for the first time in almost five years it appears that we may have what I call a normal year. That’s not to say something surprising will not happen that would cause conditions to change. But after going through a stock market collapse, a recession, 9/11, accounting scandals, a war and an energy price spike, it would be nice if there were no major problems to overcome.

Over the last year and a half, the economy re-accelerated sharply. Those days look to be behind us. The economy expanded at a moderate 3.1% rate at the end of 2004. This was well below the entire year’s 4.4% pace and was the slowest quarterly rise in nearly two years. 

Despite the moderate overall growth, there were some hopeful signs. Households and businesses went hog-wild in the last three months of 2004. Business investment in equipment and software was as nearly out of control at the end of the year as it was in the summer. 

So, where was the slowdown? If you believe the Commerce Department, defense spending was flat. Yeah, right. Anybody in the market for a bridge – cheap? Also, in spite of the weak dollar, exports fell sharply. Huh?

Looking forward, it is likely those trends will change dramatically. Job growth remains disappointing. Payroll gains averaged only 170,000 for the past six months. If consumption is to stay solid, consumers have to earn their money not through tax cuts or debt refinancings, but the old fashioned way – through more jobs. Right now, that is not happening.

On the other hand, the nation’s unemployment rate fell to 5.2% in January, the lowest rate since September 2001. The labor market is tightening even if the number of new positions being created is not that great.

Moderation or not, in early February, the Fed raised the funds rate for the sixth time since June 2004. And, it looks as if they could do a lot more.  

Why does the Fed feel rates should go up? Because inflation may not stay tame. The weak dollar may lead to higher import prices, a point Fed Chairman Greenspan made recently. Rising import costs mean accelerating inflation. Productivity gains are slowing. This year, they likely will be half of what we had been seeing and that too will put pressure on prices. Finally, energy costs are too high. Although firms have been eating those expenses, any chance they get to pass them through to consumers, they will.

All these factors imply that inflation should accelerate this year. And if that happens, longer-term rates, such as mortgages and motor vehicle loans will rise as well. The wonderfully low loan rates we now enjoy may disappear this year.
 
The economy remains in solid shape. Growth will be neither too hot nor too cold – it will be just where it should be: At a sustainable, Goldilocks pace.

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, “America’s Most Convenient Bank,” is a leading retailer of financial services with 320 convenient stores in New Jersey, New York, Pennsylvania and Delaware. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.