Fed official: Current trends bode ill for future recovery

Kevin Rademacher

Thursday, May 29, 2003 | 11:13 a.m.

The longer the national economy relies on low-interest home and automobile loans to pull it along, the riskier the future will get, Robert Parry, president of the San Francisco Federal Reserve Bank, said Wednesday.

That course leaves the economy at the mercy of consumer spending trends.

"It's a little surprising consumer confidence has held up as well as it has in the face of a jobless recovery," Parry said after a speaking at a meeting sponsored by the Nevada Development Authority.

Should consumer spending wane, those economic drivers could slow.

But despite residential construction being a key contributor to its economy, Las Vegas might be the exception to his warning, Parry said.

"Economists have always worried about Las Vegas," he said. "How can it continue to grow? And it has ... I am surely not going to start betting against it."

For the near future, the housing market could get a boost from another interest rate cut, Parry said. With the economy still recovering slowly, he said the Federal Reserve "still would have room to give a boost to the economy" with a possible rate cut.

Over time, however, the housing market could be vulnerable to rising interest rates, Parry added. While indicators show interest rates are unlikely to rise soon, he said most economists agree that rates are likely to go up eventually.

A rate hike, however, would likely be driven by positive economic news.

"There is a very good side to that," he said. "If rates go up, it's an indicator of a strong economy."

That means that while some buyers may be pushed out of the housing market because of higher rates, new jobs and stronger wages could allow others to enter the market.

Overall, Parry gave Las Vegas high marks for weathering the national recession, the effects of Sept. 11, 2001, and recent setbacks in the tourism industry associated with the war in Iraq and the SARS (severe acute respiratory syndrome) epidemic.

In each case, he said Southern Nevada suffered losses but continued to exceed national economic performance numbers. That praise, however, was tempered with the reality of looming tax increases facing Nevada.

"The trade-off between a state's attractiveness to businesses and residents and its long-term fiscal stability can be a difficult balancing act, but one that must be achieved in order to maintain the underlying vitality that has made Nevada a nationwide growth leader," Parry said.

Nationally, "it appears that the economy is still mired in the soft patch we hit last fall," he said. Gross domestic product grew only about 1.9 percent in the first quarter of 2003.

Additionally, he said employment growth was "stagnant" during that time.

"Looking ahead to the rest of 2003, the most likely outcome -- and the one that a lot of forecasters share -- appears to be that the slow first half will give way to a modest pickup in the second half," he said.

As growth rebounds slowly, excess capacity in labor and product markets will not be consumed.

"That means that core inflation -- which is already low -- is likely to trend down even lower," Parry said, adding that the rate could fall below 1 percent this year.

As inflation falls, he said "the threat of deflation is minor."

The economy is enjoying stimulus in several forms, including a favorable interest rate environment, increased defense spending related to the war in Iraq and "of course the ink is still drying on the latest tax cut package," he said.

Parry said he supported many of the provisions of the new tax package, including the treatment of dividend taxes, a reduction in capital gains taxes and lower tax rates. He did, however, express concern.

"The thing that concerns me is that at some point later on, when we don't have this much slack in the economy, we will continue to run deficits," Parry said.