The majority opinion among private economic forecasters is that the U.S. economy is in the last phase of adjusting to a series of disturbances from energy and housing markets. Most forecasters expect the economy to resume its growth, at a rate close to its longer-term trend, sometime in next year or perhaps earlier, depending on how soon the depressing effects of the housing markets start to wane.
Inflation, which has been uncomfortably high more often than not during the past few years, seems to be heading back toward an acceptable range, although evidence on this point is not conclusive. Drawing a bead on the inflation trend is tricky because there are many measures of inflation itself and of its underlying trend, termed core inflation. All the measures tend to paint to a similar picture over time horizons of a few years, but we are in one of those periods when convergence is not yet evident: Some scorecards still show inflation hanging above 3 percent, while others indicate that it has fallen to 2 percent or below.
Housing conditions are equally unclear. In terms of sales volumes and unit prices, new and existing homes have not been moving congruently for much of the past year. New and existing homes are not perfect substitutes for one another in either features or location, and we use different sources to estimate their sale prices. On average throughout the country, sales volumes have fallen more for new homes than for existing ones, but prices for new homes appear to be holding up somewhat better than those of existing homes.
The housing market is important, not only for individual owners and would-be owners but also for its potential macroeconomic implications. As housing credit markets tighten up, it is uncertain how the subsequent wave of adjustable-rate loan refinancing will play out. For some homeowners, higher interest payments will undoubtedly forestall spending elsewhere; for others, refinancing may not be possible at all. Apart from that, to the extent that consumption formerly was supported by cash-out mortgage refinancing, higher interest rates and more fragile housing valuations are likely to become constraining influences. Yet, so far this year, consumption spending on the whole appears sound.
The U.S. economy’s rebalancing after these housing and energy shocks takes place in the context of a much larger and more profound rebalancing of world economic activity. Unless China, India, and a slew of other countries that are relatively new entrants to global trading and financial markets abruptly slow down or reverse course, the economies of the United States and other developed nations may be entering a long period of adjustment
The energy market is one of the most important markets being affected by this rebalancing. Over extended periods of time, as we have seen, energy is subject to substantial price swings, which can affect both economic growth and measured inflation. Unless rising energy prices are offset by price movements for other goods and services, inflation will rise. If people view energy price increases as largely transitory, they are not likely to foresee an enduring connection between events in the energy market and the general inflation rate. Indeed, during the past few years, longer-term inflation expectations have held relatively steady in the face of elevated short-term inflation, a sign of public confidence in the Federal Reserve. However, as investment advisors are fond of saying, past performance is no guarantee of future results. However, monetary policymakers would be unable to ignore persistent price increases for energy or for other goods and services, if those increases were accompanied by a notable deterioration in inflation expectations.
While an expanded world economy offers promising opportunities for all who join, it introduces fresh complications as nations work to harmonize their trading practices and agree on mechanisms for resolving their disputes. Global economic expansion also provides greater scope for prices, interest rates, and exchange rates to fluctuate as differences in national savings propensities, regulatory systems, labor market practices, and other forces influence patterns of consumption, investment, labor utilization, and productivity within and across countries. It is easy to underestimate the strength and duration of these forces, for they play out incrementally over time and often reveal themselves in prosaic ways. But play out they do.