Faculty Examine U.S. Economic Footing

(Left to Right) Nichols Trustee Robert B. Kuppenheimer, Vice President & Managing Director of Distribution Development, Nuveen Rittenhouse Investments; Jane Sneddon Little, Vice President & Economist, Federal Reserve Bank of Boston; President Debra M. Townsley, Ph.D.

Robert B. Kuppenheimer welcomes Jane Sneddon Little to Nichols' campus

"Clearly the U.S. economy is going through a very difficult period"

(Bernanke, 4/2/08)

Nichols faculty had an opportunity to reflect on the U.S. economic condition at a dinner hosted by President Debra M. Townsley and Nichol Trustee Robert B. Kuppenheimer on April 17th in Daniels Auditorium. Guest speaker was Jane Sneddon Little, Vice President and Economist for the Federal Reserve Bank of Boston.

Little began her presentation by quoting Federal Reserve Chairman Ben S. Bernanke as he testified before the Joint Economic Committee in Congress on April 2, 2008: "Clearly the U.S. economy is going through a very difficult period." While the Federal Reserve does expect that the gross domestic product may contract slightly, it is forecasting that economic activity will be strengthen in the second half. Little stated that she thought the tax rebate would help stimulate the economy and that housing activity would stabilize.

"How did we get to this difficult period?" Little queried the audience. The past two decades have brought robust growth, punctuated by two brief recessions and declining inflation and unemployment. The primary drivers of growth over much of the past decade have been consumption and residential investment. But since the mid-1990s, home mortgages have accounted for an usually large share of credit market debt owed by the non-financial sector.

Housing prices are falling nationally, particularly in metropolitan areas. In Boston as of Jan. 2008, home values dropped -10.9 percent! From 2004 to 2006, home prices grew faster than fundamentals (such as family income), and housing became increasingly less affordable. As a result, housing construction and sales have fallen 55 to 60 percent from their peaks, yet the inventory to sales ratio for new single-family homes is at its highest level since 1981.

Falling house prices have led to rising foreclosures nationally. In Massachusetts, the counties hardest hit are Barnstable, Suffolk, Essex and Worcester. Rising foreclosures have had a spillover affect on financial markets, creating liquidity problems and raising the cost of funds for a variety of borrowers, from banks, to corporations and students, and causing banks to tighten credit standards in a wide array of markets.

Reflecting business uncertainty and declining demand, private employment has now fallen for four months. In addition, declines in housing and equity wealth and record high oil and grain prices are dampening consumer confidence, now at a recession level, and therefore, consumer spending as well.

As for inflation, while upward price pressures remains a concern, most analysts expect that inflation will moderate as resource slack builds. Historically, inflation always falls during a recession.

Most forecasters are optimistic that the expected slowdown or recession will be brief and that output growth will return to a near-potential pace in the second half of this year. Little stated that there were two key factors for this:

1. Consumption and housing construction are widely expected to stabilize by mid year, thanks to timely fiscal stimulus
   
2. The Fed's policy response to recent financial and economic development has been innovative, forceful, and timely

Little discussed some lessons learned from recent financial developments. First: regulators and investors need to exercise heightened vigilance at times of rapid financial innovation and at times when new players are entering into new markets. Second: financial institutions and regulators need to be more imaginative regarding stress tests. Third: central banks need good information and some form of regulatory authority over any financial institution that has access to its credit facilities. Fourth: capital adequacy should be stronger. Fifth: Monetary policy makers need to rethink their approach to asset prices.