February 11, 2004

By David F. Seiders
NAHB Chief Economist

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Economic growth is good but inflation still is receding toward zero …
Growth of real gross domestic product (GDP) slowed down in the final quarter of 2003, as expected, but the economy still recorded a highly respectable 4.0% annualized rate of increase. This gain brought GDP growth for 2003 to 4.3% (fourth quarter to fourth quarter basis), and growth averaged 6.1% in the second half of the year.

The acceleration in economic growth during 2003 was not accompanied by higher inflation in prices of goods and services. In fact, most major inflation measures receded during the year, in some cases falling below 1% in the final months of 2003.

This was particularly true of key measures of core inflation (excluding food and energy). Indeed, inflation in the core price index for personal consumption expenditures in the GDP accounts (a favorite of the Fed) fell to an annual rate of 0.7% in the final quarter of 2003. Considering the presence of upward biases in such measures, it’s safe to say that core inflation was approaching zero as the year drew to a close — and that’s not far from outright deflation.

The labor market still is struggling but improvements finally are showing through …
Nor did the 2003 acceleration in economic growth generate much improvement in the nation’s labor market. Revised figures show that payroll employment fell by 53,000 over the course of the year, aggregate hours worked in the nonfarm business sector fell by 0.4% and average hourly earnings climbed by only 2%. Employment and hours picked up to some degree during the last four months of the year, but even these gains were meager — averaging only 63,500 jobs per month during that period. The preliminary January report was somewhat better, showing payroll job growth of 112,000, but that’s still well below par for the U.S. economy.

The Labor Department’s survey of households (rather than business establishments) paints a somewhat brighter picture of the labor market, highlighted by a gradual decline in the nation’s unemployment rate from a cyclical high of 6.3% last June to 5.6% in January. However, some of this improvement reflected erosion of the labor force participation rate rather than declines in the numbers of persons officially unemployed (actively looking for work). Broader measures of slack in the labor market — including discouraged workers who have withdrawn from the labor force and those working only part time for economic reasons — were still riding very high in January. [return to top]

Greenspan reiterates Fed’s ‘patience’ in midst of receding inflation and slack labor markets …
The Fed jolted the financial markets at the conclusion of the Jan. 28 Federal Open Market Committee (FOMC) meeting by backing away from an apparent open-ended commitment to the 1% federal funds rate target — even though the Fed still said it could be “patient in removing” this extraordinary degree of monetary stimulus. However, the initial drop in the stock market and the initial runup in long-term rates have now been reversed, leaving the 10-year Treasury yield close to 4%.

Statements by various Fed spokespersons helped calm the markets in the wake of the Jan. 28 FOMC meeting. Furthermore, Chairman Alan Greenspan’s semi-annual Monetary Policy Report to Congress, delivered today in the House of Representatives, reassured the bond markets and reduced concerns about any near-term tightening of monetary policy. While noting that the federal funds rate will eventually have to rise to a more neutral level, the chairman stressed that “the Federal Reserve can be patient in removing its current policy accommodation” because inflation is “very low” and there’s “substantial slack” in the economy. NAHB’s forecast still assumes that the first rate hike will occur at the FOMC meeting this November. [return to top]

Economic and financial market forces get housing off to a good start in 2004 …
The housing sector closed out 2003 with a rush, sowing concerns about sustainability in 2004. After all, home sales and single-family starts soared to record highs in the latter part of last year and the nation’s homeownership rate climbed to a record 68.6% by the fourth quarter. Even the multifamily sector joined the party, powered by a vibrant condo market. All in all, a tough act to follow!

We’re still short on housing market data for early 2004. However, the evolving positive performances by the real economy (finally involving the job market), as well as by the stock and bond markets, presumably are providing solid footings for housing demand — particularly for owner-occupied units. Indeed, weekly data on applications for mortgages to buy homes (MBA series) have been quite strong since the end of 2003 as mortgage rates have hung around 5.7%. Mortgage refinancings also have increased, opening up the opportunity for cash-out refis for many home owners.

NAHB’s official forecasts envision modest slippage in home sales and housing production as 2004 moves along, and the projected erosion is associated with a projected updrift in the interest rate structure. It remains to be seen whether or not that pattern will materialize. Stay tuned. [return to top]

The federal budget moves to center stage in the evolving political debates …
Rightly or wrongly, the federal budget deficit is turning out to be a complication for the Bush Administration as the election year gets into full swing. After all, the deficit declined and then burst into surplus during the Clinton years, and the deficit has returned with a vengeance since George W. Bush took office. The deficit hit $375 billion in fiscal 2003 and is projected by the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB) to approach or exceed $500 billion in fiscal 2004 — an all-time high.

This has prompted charges of fiscal irresponsibility by the Bush Administration. The Bush camp has responded that the President inherited a flagging economy and that three years of recession and sub-par recovery can account for about half of the budget deterioration since 2000 — deterioration that is, by its nature, only temporary. Another one-fourth of the deterioration is attributed to the acceleration in federal spending for defense and homeland security, and that’s characterized as essential for the safety of U.S. citizens in today’s unstable global environment. The remaining one-fourth can be associated with the Bush tax cuts of 2001 and 2003, but the White House says those cuts should help pay for themselves over the long term by stimulating work effort, capital investment and incomes of both businesses and households.

The White House also says that policy changes to address the deficit should focus primarily on discretionary outlays other than those for defense and homeland security, and that the Bush tax cuts should be made permanent rather than repealed or allowed to expire (most provisions have expiration dates). Indeed, those principles shaped the President’s budget proposal for fiscal 2005 (released on Feb. 2). [return to top]

Budgetary controls eventually will be critical to the interest-rate structure and housing …
A key issue for the housing industry regards the impacts of federal budget deficits on the interest rate structure — an issue that’s being elevated by Democratic contenders and downplayed by the White House. Recent research at the Federal Reserve suggests that it’s not just the size of the deficit that matters but the deficit relative to the size of the economy (deficit/GDP). Furthermore, a temporarily elevated ratio doesn’t boost rates when the economy is operating below potential, as it did in 2001-2003.

But when the economy is operating at potential, with a low and stable unemployment rate, the research suggests that each percentage point rise in the deficit/GDP ratio will raise long-term interest rates by 25 basis points. Furthermore, prospective increases in this ratio can affect long-term rates in advance, as investors in bonds assess future market pressures.

CBO and OMB estimate that, if current laws and policies remain unchanged, federal deficits will begin to decline after fiscal 2004 and the deficit/GDP ratio will fall sharply from this year onward. If the Bush tax cuts are made permanent (as proposed by the President), the projected deficits are higher in the future but the deficit/GDP ratio still recedes over time.

These projections assume a tight rein on growth of federal discretionary spending, and it’s easy for investors to be suspicious of that presumption. To help reassure the markets, Congress should reestablish the procedural budgetary rules that were allowed to expire in recent years, including limits on overall discretionary spending and the so-called PAYGO rules. In today’s Monetary Policy Report to Congress, Chairman Greenspan described such rules as a “critical element…to help fiscal policy makers make the difficult decisions that are required to forge a better fiscal balance.” [return to top]

Want more economic information? Find it in our publications.
Find more in-depth information in our three economics publications, Home Builders Forecast, Housing Market Statistics and Housing Economics. All are availaible by subscription. 

  • Home Builders Forecast includes analysis of single-family and multifamily residential activities, residential remodeling and the full range of nonresidential construction as well as the macroeconomic factors such as GDP, employment and interest rates that drive construction. If your business depends on reliable estimates of housing starts, construction spending and remodeling activity, Home Builders Forecast is designed to meet your needs.
  • Housing Market Statistics contains an overview of important developments and trends that serves as an executive summary of the current industry situation. It also contains annotated charts depicting movements in key indicators and tables providing monthly, quarterly and annual data for more than 250 variables.
  • Housing Economics provides a rigorous monthly overview of the economy, along with monthly data for more than 100 local markets and in-depth analyses of the niches and nuances of home building markets. Available online or in print, it is written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

To learn more or to order any of these three NAHB economic publications, visit the Economics Publications Information section of the NAHB Web site or call 800-223-2665.

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