By John W. Schoen Senior producer
updated 10/12/2009 10:30:15 AM ET 2009-10-12T14:30:15

Following the lead of Fed Chairman Ben Bernanke and the stock market, the nation’s top business economists, gathering here for their annual meeting, have declared “the Great Recession of 2008-09 is over.” But the forecasters aren’t exactly popping champagne corks about what they see coming next.

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After the deepest slide since the Great Depression, the economy looks like it has finally hit bottom, according to a survey of the National Association of Business Economists. The group sees the gross domestic product posting a solid 2.9 percent gain in the second half of this year.

That’s the good news. The group is less confident about the strength of the recovery, saying it is “likely to be more moderate than those typically experienced following steep declines.”

And they see a long list of problems that could weaken that recovery.

The biggest worry: a prolonged period of high unemployment following the destruction of eight million jobs since the recession began in December 2007. The economists don’t see the jobless rate falling below 9.5 percent by the end of next year. They expect only weak job growth in 2010; an average of some 107,000 net new jobs created each month in 2010. That’s barely enough to keep up with the annual growth of the workforce.

"You can have 2 or 3 percent GDP growth and not have job growth, and that in turn doesn’t help sustain economic growth,” said Stuart Hoffman, chief economist at PNC Financial Services. “Economies are like gears — they all have to engage. And you can get one wheel spinning, but if it doesn’t engage, it eventually loses momentum.”

With one in 10 workers without a paycheck, the level of consumer spending is also expected to be weak — inching up next year by just 1.6 percent. High levels of debt and trillions of dollars of lost home equity will continue to put a big crimp on spending.

Consumers may catch a break if the NABE is right about its inflation forecast, which calls for prices to rise by just 1.4 percent next year. The low inflation forecast is largely based on the conventional wisdom that the amount of slack demand and excess capacity in the economy — the so-called “output gap” — will keep pressure off price hikes for raw materials and force companies to keep their prices down.

But James Bullard, president of the Federal Reserve Bank of St. Louis, warned that given the Fed’s massive expansion of the monetary base to combat the financial meltdown, the economists may be too quick to dismiss the risk of higher inflation.

“I am concerned about a popular narrative in use today — the narrative being that the output gap must be large since the recession is so severe,” Bullard told the economists at a luncheon speech. “And so, any medium-term inflation threat is negligible, even in the face of extraordinarily accommodative monetary policy. I think this narrative overplays the output gap story.”  

With weak consumer spending expected to add little to growth, the hope is that businesses will begin to invest in rebuilding inventories that have been slashed during the recession and to buy equipment they’ve deferred replacing during the downturn. But those businesses may have trouble getting credit; just as employers are skittish about hiring, bankers say they’re having trouble finding enough solid businesses to lend to, according to Bullard.

Fed’s Bullard: Don’t discount risk of inflation
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“They want to make loans because that’s how they make money,” he told reporters. “But they don’t want to make a bad loan because that’s how that’s how they got into trouble.”

With bankers pulling back, credit has also tightened in the so-called “shadow banking” market, in which loans are packaged into securities and sold to investors. Once a ready source of capital for mortgages, student loans and credit card debts, that market has largely shut down.

“If you can’t get this market back, you’re not going to be able to finance most consumer loans,” said Gary Gorton, an economist at the Yale School of Management.

Not everyone here agrees with the consensus forecast, given the long list of underlying problems that are weighing on economic growth.

“Residential foreclosures are high, commercial foreclosures are still climbing and have not peaked, bank charges off are still climbing and they have not peaked,” said Dan Hamilton, an economist and forecaster at California Lutheran University. “If the government stops pumping a ton into fiscal spending, after that we see weakness — it could even be negative (GDP).”

Some economists here see a permanent cutback by consumers following a decade-long, debt-fueled spending spree on bigger homes, giant backyard gas grills and elaborate vacations and parties. Cornell economist Robert Frank said much of that spending was fueled by the desire to try to keep up with rapidly rising incomes at the top of the economic ladder, even as wages at the bottom were falling behind. Now, with hard times hitting all income groups, Frank thinks lower consumption levels may become part of a new attitude toward spending.

“Were not going to be unhappy because consumption is a little lower,” said Frank. “We’ll adjust.”

But workers without a job, or whose hours have been cut sharply, will have a much harder time adjusting. For those workers who do have jobs, few should expect much in the way of a raise. Economists here expect the growth in workers’ compensation to grow just 1 percent this year and 2.2 percent next year, the lowest two-year showing on record. But get ready to work harder next year: despite that meager wage growth, worker productivity is expected to rise another 2.5 percent.

The economists are also pinning their hopes on other the housing market to pull help the economy out of recession. After the steepest decline in decades, the housing industry is due for a bounce, according to the group’s forecast, with investment in residential real estate picking up by eight percent next year. That translates to a pickup in housing starts to some 800,000 next year, but below the 910,000 recorded for 2008.

That forecast comes with a caveat that the rebound could be derailed by the high levels of unemployment and the tightening of credit that has made it tough for some home buyers to get a mortgage.

Any housing rebound will also be dampened by the continuing high rate of foreclosures, now running roughly 300,000 a month, which adds further downward pressure to housing prices just as they seem to be bottoming out. Housing market skeptics also note that signs of a recovery could bring a glut of new listings from homeowners who have been sitting out the downturn, further adding to the amount of unsold homes on the market.

There’s less optimism among the economists here about the rebirth of the auto industry, despite a strong pickup in car sales thanks to the government’s Cash for Clunkers program. After hitting a 40-year low in 2009 of 10.3 million light trucks and cars, vehicle sales are expected to see a bump to 12 million next year, yet still well below the 13.2 million sales recorded in 2008.

Economists are also looking for an 11 percent pickup in corporate profits next year, which will come as good news to investors if it happens. High hopes for the economic recovery have pushed stock prices in the S&P 500 index to 140 times earnings, or three times the levels seen at the height of the Internet bubble.

Forecasters’ optimism about the economy and the stock market is tempered by some serious concerns about potential threats to this upbeat scenario. Chief among them is the swollen federal budget deficit, which is expected to hit $1.5 trillion this year.

Fed’s Bullard: Don’t discount risk of inflation
Big earnings week is ahead for Wall Street
Recession creating a lost generation

It’s also not clear how the historic moves by the Federal Reserve will play out over the long run. To support the housing market and keep interest rates low, the Fed has been buying hundreds of billions of mortgage backed securities.

Though the Fed has targeted $1.75 trillion for this asset purchase program, it hasn’t said how it might adjust the program based on economic conditions. Bullard said his colleagues on the central bank need to do a better job of signaling its plans to the markets.

“There has been little indication of how or whether these (asset purchase) amounts might be adjusted given incoming information on economic performance,” he said. This lack of clarity has created uncertainty in financial markets.”

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