By Martin Wolk Executive business editor
updated 12/20/2004 3:32:51 PM ET 2004-12-20T20:32:51

After a rapid expansion fueled by hefty tax cuts and historically low interest rates, economists are expecting a substantial slowdown in 2005, according to’s annual poll of forecasters.

That is not necessarily a terrible prospect. The economy is entering the fourth year of an expansion that began in late 2001, and more moderate growth might be more sustainable, analysts said.

But without what one analyst called the “steroids” of monetary and fiscal stimulus, the economy is also more vulnerable to the impact of higher interest rates or unexpected shocks like a terrorist attack or currency crisis.

Even though employers have added 2 million jobs over the past year, that is hardly an impressive total after the economy shed more than 800,000 jobs in the first two years of the expansion. The unemployment rate has barely budged this year, dropping from 5.6 percent to 5.4 percent, and wage growth is failing to keep up with inflation, according to David Rosenberg, chief North American economist of Merrill Lynch.

Meanwhile the personal savings rate has dropped to near zero and the nation’s troubling twin deficits -- in trade and the federal budget – are at or near record levels.

“It’s a riskier environment, even if the baseline forecast of most economists is pretty benign,” said Ethan Harris, chief U.S. economist at Lehman Bros.

Here are highlights of from our year-end virtual economic roundtable:

Overall economic growth


Rosenberg: Next year is a year that has no fiscal stimulus. It’s a year when we’re going to see the lagged impact of the Fed tightening, a year when we’re going to feel the brunt of slower global growth and a year in which we will embark on a likely uptrend in personal savings rate that will cut into consumer spending growth. When you add it all up, I think that 3 percent growth is a very prudent estimate for economic activity next year.


Ed Leamer, director, UCLA Anderson Business Forecast: The expansion that we’ve had, although young in calendar years, is old in an economic sense. Some of that aging has come from the steroids that the federal government has pumped into us.


Sung Won Sohn, chief economist, Wells Fargo: We are expecting 3.8 percent (GDP growth) in 2004 and then 3.6 percent next year, which is awfully close to the long-term potential. The economic (expansion) will be 4 years old next year, so the fact that we are right at or near the long-term potential growth rate — I think that’s pretty good.


Diane Swonk, chief economist, Mesirow Financial: We no longer need the tailwind of tax cuts and low interest rates to ensure economic growth.  Many of the factors that held back growth, like the overhang of investment and overhiring from the late 1990s, have now dissipated and opened up the opportunity to have some self-feeding momentum.



David Lereah, chief economist National Association of Realtors: The fundamentals in the housing market are still very, very good. The only difference between 2004 and 2005 is that mortgage rates will be up just a bit. My best guess is that the 30-year mortgage rate will be at 6.7 percent at the end of 2005, compared with 5.8 percent right now. That should slow sales down by about 3 percent

The good news is that home price appreciation will slow a bit — and I say good news because I think we’re going to see a little better balance between supply and demand in the housing market. The resilience of housing has been incredible.

Leamer: We see softness in the housing sector. It’s not going to be a total rout, but it doesn’t take much to take the wind out of housing. We’re at historically the highest level ever of residential investment, and that’s just not a sustainable situation. That’s going to turn around.

Sohn: If the dollar were to plunge — again, I don’t expect that — that could spike interest rates and prick the housing bubble. I don’t think there is a housing bubble for the nation but there are certain areas of the country — California, the East Coast, the New York City area, for example, where there are housing bubbles, and those could be pricked. The economic consequences for those local economies could be quite serious.

The dollar:


Gary Thayer, chief economist, A.G. Edwards: The dollar has been declining for three years — it’s just now making headlines.  We think the fundamentals are actually improving for the dollar, with the world economy slowing down and the Fed raising rates at the same time. That is a positive environment for the dollar, and we’re actually seeing some stabilization here at the end of the year.

Swonk: I think it’s more of a long-term than a short-term concern. My view is that the dollar will remain weak and continue to drift down over the course of 2005 with particular weakness against the euro. However we do have some countervailing forces helping to stop a freefall in the dollar, at least for the moment.

Sohn: I don’t fear a falling dollar as long as it drops gradually, as it has. If foreign investors get worrisome and jerky we could see precipitous decline in the value of the dollar and that would be good for no-one. That is one of the risks. There is a 10 to 15 percent chance of that happening.


Harris: This adjustment in the dollar is going to take a long time to play out. There’s always a risk that the decline becomes disorderly. In the year ahead I would say there is about a 25 percent chance of a dollar crisis. The scenario isn’t hard to dream up. If you add up the probabilities over the next several years it’s probably better than even odds for some kind of dollar crisis.

I don’t want to overstate things, but we know that concerns over the dollar and trade did play some role in the 1987 stock market crash. You need global cooperation and you’re not getting it — that’s the thing I worry about.

Federal Reserve policy
Harris: So far they have been able to hike rates 125 basis points, the economy looks fine and there is no real sign of pressure in financial markets. So why stop?

They are inching forward, looking for the point where some signs of pain emerge either in financial markets or the economy. And then they will slow down because they don’t really want to hurt the economy. It’s a finely tuned thing.

Swonk: I see them pausing, moving more like every other meeting next year. I think the Fed’s internal target is much lower than the market is assuming.

This is a legacy-building year. This is the year Greenspan makes his final mark. For him to go out on a high note he’d like to see inflation contained, rates at reasonable, not embarrassingly low levels, and employment coming back a little more robustly.

Rosenberg: I’m forecasting that the Fed is very close to the end of the tightening cycle. I know that’s out of consensus. I think it’s more or less prudent to sit back and assess the tightening to date, knowing full well there are lags involved between shifts in monetary policy and the effect on the economy. So far they’ve given no inclination that they’re ready to stop, but as you saw heading into 2001 things can change in a hurry.

The stock market
Harris: The stock market has a kind of an OK year ahead. Corporations had a big windfall gain in profits in recent years, but it’s pretty clear that their ability to squeeze their labor force has dissipated. And you’re starting to see slower growth in productivity and higher unit labor costs, so profits should be growing more in line with the overall economy rather than faster in the economy. So I think it’s a modest up year for the stock market.

Rosenberg: It’s a very rare event to have the Fed actually tightening policy in an environment where profit growth is decelerating. It’s not usually what you would say is a positive tonic for the markets.

Thayer: I don’t think there are as many potential problems in the stock market as many investors fear. The economy has been expanding for three years, and starting our fourth. The stock market has only been increasing for two years, and we’re starting our third. P-E  (price-earnings) ratios have been declining over the last year or so. Usually if the market runs ahead of things, you see the P-E has expanded.

What was the biggest economic surprise of 2004?
Thayer: Oil. When you’re trying to forecast, you can anticipate things moving quite a ways. But the move in oil prices was like four or five standard deviations out of trend.

Swonk: To think that we would have gotten this kind of growth with this high (level) of oil prices to me is just testimony to the economy’s resilience. People were looking for stagflation, they were looking for all kinds of scenarios that just didn’t materialize, which was great.

Sohn: The bottom line is that the economy has performed very well despite these unforeseen contingencies, including the spike in the price of oil. A year ago if we had known that the price of oil would go up to $55 a barrel and stay at $40 a barrel a lot of people might have said that is a prescription for recession. Especially when they see higher interest rates. But that hasn’t been the case.

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