Playing the Field

Five Drags on Economic Growth

 John Tuccillo, Ph.D.  |    January 24, 2007

It appears that 2004 will be the first completely good growth year we’ve had as an economy since 2000. Supported by tax cuts that have increased the spending power of most Americans, the economy is finally pulling out of the doldrums that becalmed it in the first years of the century. True, the large job losses of the past two years have not yet been made up — it’s possible that George W. Bush may be the first president since Hoover to end a term with fewer jobs in existence than when he started it — and it appears they will not likely be made up in 2004. But there appears to be progress. The last economic report of the old year contained an increase in factory orders and the first of the new year confirmed this, leading to speculation that companies will soon start hiring more workers. That will certainly happen sometime during the year, and it will spur growth. Growth itself soared to 8 percent in the third quarter of 2003 and stayed high at 4 percent in the fourth quarter.

The question is whether it will be fast enough or large enough to counterbalance five drags on growth that will be present in the economy this year.

First, interest rates will rise. This is inevitable either because the economy is growing or because the federal deficit is rising. Recently, the fed has kept rates pretty well stable, and at their March meeting reaffirmed their concern over job creation. They have taken no policy actions in over a year. The rhetoric coming from the Open Market Committee meetings, however, indicates that the members are looking carefully at the recent upsurge in growth. Although they may not touch interest rates for the remainder of this year, they are probably looking for the opportunity to raise them. Additionally, the federal deficit is ballooning, and is now estimated at nearly a $0.5 trillion for the fiscal year. This means the federal government will be an active borrower in financial markets, increasing demand and raising rates. Since foreign borrowers hold a substantial portion of our debt (and need to be convinced to hold even more), an interest rate rise is even more likely.

Second, housing is already slowing down and will continue to do so in 2004. This is also inevitable as rates and prices rise and some of the demand for homeownership is satisfied. The booming housing market that we have enjoyed for more than five years is clearly not over quite yet. There is a strong demographic push for home ownership and the Federal government has made an increase in the homeownership rate a national priority; witness the recent endorsement of zero down payment loans by FHA. But, the market has clearly broken and activity will cool a bit. Prices will also moderate, and the combined effect will be a reduction in dollar volume for housing market activity in 2004. Figures from the end of 2003 and early 2004 suggest it has already begun.

Third, job creation has not yet recovered. To match the growth of the labor force, we need to create 150,000 net new jobs each month. More workers are coming into the market than there are new jobs. Even in the past four months, when jobs have been increasing, the average growth has only been 90,000. The numbers for January and February were far below that average and were extremely disappointing relative to both expectations and the needs of the market. The drop in the unemployment rate is misleading since it reflects numbers of workers dropping out of the labor market more than it demonstrates increases in employment.

Fourth, energy prices are soaring. Some forecasters are predicting gasoline prices at $3 per gallon or above this summer. This has three negative effects. First, it can increase inflation generally. For example, as fuel costs rise, so do airline fares and shipping costs. Increases in inflation lead to increases in interest rates. Second, consumers find they can buy less of other goods when they pay more for gasoline. This slows growth. Finally, consumer confidence suffers when a high profile commodity like gasoline increases in price. This leads to declines in consumption and reduced growth.

Finally (and here’s the wild card), we don’t yet know the full impact of productivity growth on the demand for labor. Labor productivity has been growing faster than the economy as a whole. This means output growth can be accomplished without increasing employment. If this relationship continues through 2004, employment growth will continue to lag and the recovery will be weak. On the positive side, productivity growth appears to be slowing.

So we now have a race. Can the rebound in the economy offset the drags being imposed on it? Unlike most forecasters, I’ll not tell you how the race will end. Rather, I’ll just suggest what to watch and let you reach your own conclusions. To handicap the race, keep your eye on employment and on the other four drags. These four variables will tell you much about what’s to come in 2004. If interest rates rise by more than a full percentage point by the summer, the recovery is done-any less and we’re OK. The corresponding threshold numbers are a 10 percent decline in housing dollar volume, 150,000 net new jobs per month, gas prices holding above $2.75 per gallon into the fall and equal growth rates for productivity and GDP. Place your bets, ladies and gentlemen: the horses are at the gate!

John Tuccillo, Ph.D. is an economist, consultant and author. He works with a variety of companies in the real estate, mortgage banking and technology industries. From 1987 to 1997, he was chief economist for the National Association of REALTORS®. His latest books are New Business Models for the New Economy, published by Dearborn in 2002, and How a Second Home Can be Your Best Investment (with Tom Kelly), published by McGraw-Hill in 2004. His web site is and he can be reached at

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