Forcasting the Years Ahead Pose a Serious Term Paper

Pages: 10 (3138 words)  ·  Bibliography Sources: ≈ 8  ·  File: .docx  ·  Level: College Senior  ·  Topic: Economics


The years ahead pose a serious difficulty for all analysts. Although chairman Alan Greenspan is trying to present the situation from an optimistic perspective, things do not seem so bright as Mr. Greenspan has presented them to the Senate and to the House of Representatives. Huge public debt and current account deficits have brought a significant deterioration of the U.S. public debt. Commentators see things differently, but the forecast prepared by Mr. Greenspan seems a little exaggerated.

Chairman Greenspan based his testimony on the principle that expansion is self-sustaining and that the result is not merely quantitative (a faster pace for the economy), but also qualitative (broad-based expansion and notable gains in employment). Higher performance has lead to higher demand and, as a consequence, to a rise in inflation. Capital spending has also increased in the second half of the year. The cause was higher profits and a lower cost of capital, as well as the tax incentives of 2002 and 2003. It would seem that the real economy is constantly expanding, as orders and shipments in non-defense capital goods are on the rise and cannot be fulfilled on the spot.

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Mr. Greenspan is also optimistic about the employment rate. Although managers were reluctant to hire more people in the last few years, simply trying to avoid higher costs, it would seem that the time of lower unemployment has come. This tendency is accompanied by a shortage of cash flow for fixed capital and inventories, which is indeed something to be taken into account, considering the recent history of the American economy. The proportion of temporary hires relative to total unemployment is on the rise, which could make one believe that business caution is no longer such an important factor across markets. The conclusion Mr. Greenspan arrives to is that the conditions on the labor market are improving.

Term Paper on Forcasting the Years Ahead Pose a Serious Assignment

Such improvements would surely bring, in Chairman Greenspan's opinion, important follow-on effects for household spending. That would add to the beneficial effect of the support originating from cuts in personal income taxes over the last period. Although this idea is true, the premise whereon it is based may not be accurate. The Chairman of the Fed is perhaps too optimistic about the perspectives the economy is currently facing. Additionally, he says that mortgage rates are still an option to consider, despite being higher than in the previous period.

Higher consumer prices, excluding food and energy, have been rising more rapidly in 2004 than in 2003. This rise is attributed by Mr. Greenspan mainly to inflation, fueled by higher energy prices, but it would seem that significant increases of profit margins have also influenced the price rise. Higher profit margins are not something to be afraid of, simply because the competition on the market will make its presence felt and the prices will go down to more normal levels.

The price surge is even more interesting, as an economic phenomenon, as consolidated unit cost for the non-financial corporate business sector have declined during the first half of 2004. The output per hour increased by more than 6%. Non-labor fixed costs per product have also experienced important drops. Therefore, the conclusion Mr. Greenspan draws is that "at least from an accounting perspective," the 1.1% increase in the prices of final goods and services produces in the non-financial corporate sector can be attributed to a rise in profit margins rather than rising cost pressures.

Competition is already starting to move prices to more adequate levels. 2003 was a great year for business productivity, and although the levels in 2004 are above the long-term average, the values of 2003 are now only a fond memory. Productivity rates are running below hourly compensation, which is truly something to be troubled by. Price stability is not yet under threat by these higher labor costs, especially if competition will bring the profit margins down. However, Chairman Greenspan is worried that "we cannot be certain that this benign environment will persist and that there are not more deep-seated forces emerging as a consequence of prolonged monetary accumulation."

As far as capital markets are concerned, it would seem that, except energy prices, investors are not really taking risks such as terrorism and the costs of the Iraq war into consideration. Equity prices and capital goods spending have reached higher values than in the previous years, and the fear of economic stagnation has significantly diminished. Inflation is still a concern, but credit spreads remain low and market-based indicators of inflation expectations have receded.

After presenting this more than optimistic perspective on the nation's economy, Mr. Greenspan turns to the intentions policy makers should consider in the near future. The well-being of the economy is attributable to the considerable monetary accommodation put in place starting with 2001, which now begins to look as unnecessary. Aggregate demand is sustainable and employment is expanding broadly, so the Chairman of the Fed suggested that monetary relaxation should end. Mr. Greenspan continues by making a short analysis of the effects of such a measure. The long period of low interest rates has allowed for a restructuring of household and business balance sheets. Long-term debt was cheap to get and was a very profitable alternative to other financing methods. Mortgage debt also substituted the more expensive consumer credit. The economy had recovered from a series of shocks with the help of low interest rates, but it would seem that returning to more sound credit price values is now a necessary process.

Expecting such measures, the capital markets have adjusted in anticipation. Non-commercial investors established short positions in ten-year Treasury note futures, in the process of switching from mortgage-backed securities. Still, large proportions of the outstanding obligations of businesses and households are long-term, fixed-rate debt. Therefore, the tightening of the monetary policy should not have a considerable effect on them. The ones who are bound to lose are financial intermediaries and other creditors that extended loans or purchased securities in recent years at relatively low long-term interest rates. However, their strong financial position should be more than enough to counterbalance the negative effects.

Mr. Greenspan ends by stating that the Fed is prepare to act flexibly, but is not willing to divert from the basic objective whereon it has founded its policy in the last 25 years, i.e. creating an environment of price stability which leads to a long-term growth of the economy.

One objection that could be made to Mr. Greenspan's testimony is that the effects on foreign trade were not mentioned at all. Increased interest rates would mean a more competitive dollar on the international forex markets. The value of the dollar will rise compared to the main international currencies. Export would be affected, and that is not certainly something policy makers would want, since deficits are already at record highs. Also, the excessive optimism of the Chairman of the Fed is not shared by other forecasters, who do not seem to think that expansion is self-sustaining, as Mr. Greenspan sees it. He also concentrates, perhaps, too much on prices and costs. After all, these are problems that market mechanisms will eventually solve. The real problem stands in the huge public debt, mostly fueled by recent defense expenditures, and in the enormous current account deficit.

It would seem that not all analysts have such an optimistic view on the future economic development. According to the CBO's Current Economic Projections, although the Nominal GDP will increase by 5.7%, the real GDP will actually increase by only 3.8 in 2005, which is less than what it managed to do in 2004. The unemployment rate is lower, but not quite as low as Chairman Greenspan would like it to be: only 5.2 compared to 5.5%. The analysis provided by CBO shows indeed higher interest rates. (2.8% for three months and 4.8 for ten-year treasury note rates). The Congressional Budget Office also expects higher fiscal revenues, which are in tone with the current administration war plans: Tax bases (Corporate book profits) go up 2.3% relative to the GDP, compared to 2003. The modification of wages and salaries is quasi-irrelevant.

The problem is that the economy does not seem capable to build on its own expansion. For instance, the annual growth for the 2005-2010 period is predicted at only 3.2%, compared to the 3.5% of the 1950-2004 period. What is even more troublesome is that the forecast for the 2001-2015 period is even worse: 2.7%.

Labor productivity is indeed higher: 2.4% compared to 2.2, but that doesn't help much. As far as the monetary policy is concerned, interest rates are sure to rise: double for a short-term and somewhat larger for long-term: 2.8 compared to 1.4 for three months, 4.8 compared to 4.3 for ten years. Consumer spending will probably increase, according to the CBO, as the Consumer Price Index increases at a slower pace: 0.3%.

It is easy for everyone to see that this forecast, although sharing some of Chairman Greenspan's conclusion, is somewhat more pessimistic about the country's future… [END OF PREVIEW] . . . READ MORE

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