Bernanke goes to Capitol Hill
In his first appearance in front of Congress as the Chairman of the Federal Reserve Bank Open Market Committee (FOMC), Ben Bernanke outlined uncontroversial views on the economic performance of the U.S. in 2005 and predictions for 2006. He acknowledged that the 1.1 percent growth rate in GDP in the 4th quarter was likely due to the effect of hurricanes Katrina and Rita. However, he countered pessimism over future economic growth:
He also noted the pressures on inflation in 2005 and the possibility for further increases in inflationary expectations in 2006. While inflation excluding food and energy (which are volatile, and therefore unreliable for predicting future inflation) was only 2 percent in 2005, Bernanke noted that
What was interesting was Bernanke’s discussion of the prospect of a fall in consumption, which has held up the economy for the past couple years (and which has led to the first negative savings rate since 1933). He pointed out that:
The full report is clearer on the link between house prices and consumer spending:
Were house prices reduce significantly and quickly, the repercussions could affect the entire economy through the corresponding reduction in consumption in favor of savings as people’s perceived wealth shrinks dramatically. In addition, the new bankruptcy law has made it more difficult to discharge debt. The full report describes the effect of the law:
With bankruptcy harder to use to reduce indebtedness, the possibility of a sharp drop in housing prices would be even more devastating. As people refinance mortgages, the amount they owe increases. If the value of their house suddenly drops, there will be a significant overhang between their debts and assets that cannot be eliminated through bankruptcy. As more and more people realize the limits of the new law, there may be more hesitation to purchase a house, which could have the perverse effect of creating bankruptcies by precipitating the very drop in housing prices that created the fear of the new bankruptcy rules. It’s a bit of a long shot, but it’s possible. Whether or not events transpire this way, a fall in housing prices is one of the biggest domestic threats to economic growth in the next few years along with the rapidly increasing budget deficit. While the deficit decreased from 2004 to 2005, the Congressional Budget Office (pdf) predicts that the deficit for 2006 will be about $20 billion higher than in 2005 at $337 billion, not counting supplemental appropriation for the wars in Iraq and Afghanistan and much of the hurricane relief. The CBO optimistically estimates these will cost between $20 and $25 billion. The major international threat is the prospect of a sharp spike in energy prices. The full report highlights concerns about future increases in oil prices:
This highlights concerns over both the supply of and demand for oil but doesn’t account for any unforeseen events that could disrupt the supply of oil, such as Iran’s nuclear stand-off, Nigeria’s instability in the major oil producing region, Venezuela’s increasingly distant relationship with the U.S. and Russia’s use of control over energy as a political tool, as demonstrated by their shut-off of gas to Ukraine on January 1, 2006 for several days.
The full report presented to Congress is available on the Federal Reserve’s website.
“the most recent evidence--including indicators of production, the flow of new orders to businesses, weekly data on initial claims for unemployment insurance, and the payroll employment and retail sales figures for January--suggests that the economic expansion remains on track.”
He also noted the pressures on inflation in 2005 and the possibility for further increases in inflationary expectations in 2006. While inflation excluding food and energy (which are volatile, and therefore unreliable for predicting future inflation) was only 2 percent in 2005, Bernanke noted that
” Prices of consumer energy products jumped more than 20 percent, with large increases in prices of natural gas, gasoline, and fuel oil.”
What was interesting was Bernanke’s discussion of the prospect of a fall in consumption, which has held up the economy for the past couple years (and which has led to the first negative savings rate since 1933). He pointed out that:
“given the substantial gains in house prices and the high levels of home construction activity over the past several years, prices and construction could decelerate more rapidly than currently seems likely. Slower growth in home equity, in turn, might lead households to boost their saving and trim their spending relative to current income by more than is now anticipated. The possibility of significant further increases in energy prices represents an additional risk to the economy; besides affecting inflation, such increases might also hurt consumer confidence and thereby reduce spending on non-energy goods and services.” (italics added)
The full report is clearer on the link between house prices and consumer spending:
”some observers believe that home values have moved above levels that can be supported by fundamentals and that some realignment is warranted. Such a realignment - if abrupt - could materially sap household wealth and confidence and, in turn, depress consumer spending.”
Were house prices reduce significantly and quickly, the repercussions could affect the entire economy through the corresponding reduction in consumption in favor of savings as people’s perceived wealth shrinks dramatically. In addition, the new bankruptcy law has made it more difficult to discharge debt. The full report describes the effect of the law:
”A large number of households filed for bankruptcy in the weeks leading up to October 17, the date when a new bankruptcy law took effect. […] After the new law became effective, filings fell sharply to a level significantly below the average of recent years, and they have since remained low”
With bankruptcy harder to use to reduce indebtedness, the possibility of a sharp drop in housing prices would be even more devastating. As people refinance mortgages, the amount they owe increases. If the value of their house suddenly drops, there will be a significant overhang between their debts and assets that cannot be eliminated through bankruptcy. As more and more people realize the limits of the new law, there may be more hesitation to purchase a house, which could have the perverse effect of creating bankruptcies by precipitating the very drop in housing prices that created the fear of the new bankruptcy rules. It’s a bit of a long shot, but it’s possible. Whether or not events transpire this way, a fall in housing prices is one of the biggest domestic threats to economic growth in the next few years along with the rapidly increasing budget deficit. While the deficit decreased from 2004 to 2005, the Congressional Budget Office (pdf) predicts that the deficit for 2006 will be about $20 billion higher than in 2005 at $337 billion, not counting supplemental appropriation for the wars in Iraq and Afghanistan and much of the hurricane relief. The CBO optimistically estimates these will cost between $20 and $25 billion. The major international threat is the prospect of a sharp spike in energy prices. The full report highlights concerns about future increases in oil prices:
Growing conviction among traders that oil-market conditions would remain tight in future years pushed the price of the far-dated NYMEX oil futures contract (currently for delivery in 2012) from an average of $38 per barrel for January 2005 to about $61 per barrel for January 2006”
This highlights concerns over both the supply of and demand for oil but doesn’t account for any unforeseen events that could disrupt the supply of oil, such as Iran’s nuclear stand-off, Nigeria’s instability in the major oil producing region, Venezuela’s increasingly distant relationship with the U.S. and Russia’s use of control over energy as a political tool, as demonstrated by their shut-off of gas to Ukraine on January 1, 2006 for several days.
The full report presented to Congress is available on the Federal Reserve’s website.
posted by Biafra27 at 3:52 PM
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