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Katrina unlikely to derail national economy

Despite the devastating human suffering left in the wake of Hurricane Katrina, financial market economists generally are sticking with their conclusion that the the national economy will feel only a relatively small ripple from the deadly Gulf Coast flooding.
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Hurricane Katrina will slow U.S. economic growth in the second half of the year, but the devastating aftermath of the storm is unlikely to derail the expansion, according to government and private economists.

Many economists are estimating the storm and flooding will reduce U.S. growth by 0.5 percent to 1 percent in the second half of the year, but that will still leave the economy growing at a rate of 2.5 to 3.5 percent, a bit short of its long-term potential. Much if not all of the impact could be offset next year by billions of dollars in government and private funding for reconstruction and recovery.

While the resilient U.S. economy is unlikely to be tipped into recession, the hurricane clearly left a devastating toll on the region that will be reflected in national economic figures over coming months. Employment probably will be reduced by 400,000 jobs in coming months, according to the Congressional Budget Office report obtained by The Associated Press.

The CBO report said that Katrina’s impact was likely to be “significant but not overwhelming” to the overall U.S. economy, especially if energy production along the Gulf Coast returns to pre-hurricane levels quickly.

Because the economy has been adding jobs at a pace of fewer than 200,000 a month, the CBO figures imply that the nation's work force will shrink for at least two months, and the jobless rate will rise a bit from its current 4.9 percent.

Sharply higher energy prices are likely to be one of the longest-lasting effects of the storm,  forcing consumers to cut back on other spending or draw down their savings. Chicago Fed President Michael Moskow said Wednesday that the potential for rising inflation, exacerbated by Katrina, remains the biggest threat to the nation's economic outlook.

But analysts have been heartened that energy prices already have fallen back from last week's peak levels as refineries have gotten back on line. Oil prices fell sharply for a second straight day Wednesday, bringing the price of crude on New York markets to $64.37 a barrel, down 9 percent from last week's record peak of $70.85.

As a result, stock prices have jumped more than 1.5 percent over the past two sessions, with benchmark indexes rising to their highest levels since mid-August, well before Katrina made landfall on the Gulf Coast.

“Last week, it appeared that larger economic impacts might occur, but despite continued uncertainty, progress in opening refineries and restarting pipelines now makes those larger impacts less likely,” CBO Director Douglas Holtz-Eakin said in a letter to congressional leaders.

With up to $100 billion in damage to government infrastructure and private assets, Katrina is being compared by some analysts to the terrorist attacks of 9/11, which devastated Lower Manhattan and left several hundred thousand people jobless.

But despite the blow to consumer confidence, the economy bounced back in the months after the attack, emerging from a recession that began in March 2001, according to later assessments.

This time around, the economy has been growing at a healthy rate of between 3 and 4 percent and is in an even better position to withstand the loss of jobs and production, analysts said.

“The background to when this hit is an economy that was doing quite well,” said John Silvia, chief economist for Wachovia Corp. “That’s a very, very different backdrop from 9/11.”

Analysts also have been encouraged that the government response is likely to be massive.

President Bush Wednesday requested another $51.8 billion in federal aid for the stricken region in addition to $10.5 billion approved last week.

Mark Zandi, chief economist for, said the sharp criticism of the Bush administration and state and local agencies could spark a government response that is more massive than it would have been otherwise. He estimated that $50 billion in government and private aid and insurance compensation will pour into the region.

Senate Minority Leader Harry Reid estimated the disaster will cost the federal government $150 billion. All that money will be pumped into the regional economy, boosting economic output next year.

“By this time next year I think the effects on the macro economy will largely have faded,” Zandi said.

While analysts generally are optimistic that the economy will withstand the hit from Katrina, there are several caveats and uncertainties.

Confidence could plunge if consumers panic over high gasoline prices and a related inflation spike, and that could have a damaging ripple effect on business, said Ethan Harris, chief U.S. economist for Lehman Bros.

“It is way too early to judge whether those secondary effects are going to be big and really hurt the national economy,” he said.

One positive signal is that the stock market so far has taken the disaster in stride, he said.

Another big unknown is how the Federal Reserve will react to the crisis. Fed Chairman Alan Greenspan and other policy-makers are scheduled to meet Sept. 20 and had widely been expected to raise short-term interest rates another quarter-percentage point.

That move has been thrown into doubt, with some traders and analysts now predicting the Fed will leave rates unchanged for the first time since beginning the rate-hike campaign in June 2004.

Analysts are “very, very divided” on what the Fed will do, said Mary Ann Hurley, a trader at D.A. Davidson & Co. in Seattle.

“Some people think the economy is resilient and the Fed is going to continue its tightening cycle,” she said. “On the other hand we don’t know the magnitude of the impact on the national economy yet.”

In his remarks Wednesday, the Chicago Fed's Moskow said the Fed's assessment of the risks facing the economy after Katrina is still evolving, although he said the storm is clearly different than previous hurricanes.

"The scale of destruction clearly is larger," he said. "Furthermore, the hurricane has damaged portions of our nation's energy and transportation infrastructures."

But his focus on the danger of inflation implies that the Fed ultimately is still likely to raise short-term interest rates higher.

Hurley and some other analysts said the Fed’s rate-setting panel  could decide to simply “take a pass” and make no conclusions until more information is available, as it did when it met in the days leading up to the U.S. invasion of Iraq in 2003.

She and others said economic outlook remains clouded by the question of how consumers will respond to the shock of seeing a great American city brought to its knees, along with the new reality of sharply higher energy prices.

“I think it’s legitimate to be more concerned today than a week ago that the economy could falter,” Zandi said. “The key here is consumer and business confidence. If consumers pull back, then business will follow and this could turn into a much more significant problem. If consumers hang tough, the economy probably will be OK."

Many traders think policy-makers might choose to stay on the sidelines at their next meeting Sept. 20 rather than continue their steady rate-hike campaign.