Smith Faculty Opinion Article	October 11, 2006
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Outlook for the U.S. Economy

Each month, I respond to the Bloomberg and Reuters surveys of Wall Street and corporate economists for the medium-term economic outlook. Here is what I submitted in the past week.

In a nutshell, economic growth should reignite as we move through the holiday season and into 2007 if gasoline prices do not significantly rebound and the adjustment in housing prices does not cause a large, abrupt increase in consumer savings. The prospects for both seem low at this time.

Growth accelerating from 3.1 to 3.3 percent over the next four quarters seems likely; however, this will not be enough to lower unemployment. Productivity growth remains good; however, the economy and labor markets will continue to under perform their potential, thanks to large trade deficits and inappropriate exchange rate and energy policies.

The second and third quarters may well prove the low point of the current economic cycle. Second quarter growth was 2.6 percent, and third quarter growth is likely to be less than 3 percent too.

In the third quarter, the housing sector slowed, and higher prices for imported petroleum in July and August took a big bite out of demand for domestic goods and services. Consumer spending continued to grow but at a slower pace. The flagging housing market and higher gasoline prices in July and August dampened consumer confidence considerably.

Happily, signs of recovery in consumer sentiments emerged after Labor Day, as large retail chains were surprised by robust apparel sales in September. That was something I predicted in my commentary on August retail sales, and have harped on repeatedly since.

Gasoline prices peaked in August and falling prices are putting more spendable income in consumer pockets, and housing values are still up about 50 percent over the last five years. Even with a moderate pullback in the housing market, Americans are much wealthier than they were two and five years ago.

The key question is: Will Americans focus on the recent modest decline in home prices and save more, or will they focus on the longer term gains they have enjoyed and are likely to sustain?

If consumers focus on the recent decline in home prices, savings performance will improve and economic growth could slow to 2 percent or less. If consumers focus on their longer-term housing gains, holiday sales will prove stronger than retailers have predicted.

My bet is that falling gasoline, heating oil and natural gas prices will be enough to ignite shopper enthusiasm, and holiday sales will be robust and beat early-September, conservative forecasts.

Although housing construction will stay below boom levels through 2007, nonresidential construction looks to be strong, and industrial capacity utilization levels have reached levels that require significant new investments in plant, equipment and software.

Overall, falling gasoline prices will give new life to the aging economic expansion, and growth will recover to about 3.2 percent in 2007. At that pace, labor markets will exhibit enough slack that wages will not threaten to reignite inflation.

Along with lower gasoline and natural gas prices, modest wage pressures will keep prices in check and the Federal Reserve will have no cause to raise interest rates anytime soon. No change in Federal Reserve interest rate policy should be expected until well into 2007.

Modest growth, constrained wages, steady interest rates, and falling energy prices will be good for corporate profits and stock prices. The stock market rally should continue, and recent Big Cap stock gains should spread into the broader market.

In 2007, the adjustment in the housing market should further benefit the stock market. In recent years, Americans have been pouring more and more of their disposable income into house payments to purchase ever more expensive houses, and saving less as a byproduct. When housing prices pull back, Americans tend to shift from investing in housing to investing in paper assets, and that includes stocks.

Disposable income continues to grow month after month, and if Americans are not taking on ever larger mortgage debt, they can afford to both spend more at the mall and invest in equities. The simple calculus of supply and demand would indicate that stock prices should rise.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.