Tuesday, November 28, 2006

Bernanke on the Economy

Fed Chairman Bernanke speaks on the economy here .

On GDP growth (Economic Growth)

"the pace of economic activity has moderated over the course of the year. According to the latest estimates by the U.S. Department of Commerce, real gross domestic product (GDP) increased at an annual rate of 2.6 percent in the second quarter of 2006 and at a rate of only 1.6 percent in the third quarter. These figures are down noticeably from the 3-1/2 percent average pace of growth of the preceding two years. We will receive an updated estimate of third-quarter GDP growth tomorrow. At this juncture, information about economic activity in the fourth quarter is limited, and the range of plausible outcomes remains wide. But the indicators in hand suggest that real GDP growth this quarter is likely to be in the same general range that it was in the second and third quarters"

On Inflation

" Core inflation is expected to slow gradually from its recent level, reflecting the reduced impetus from high prices of energy and other commodities, contained inflation expectations, and perhaps further reductions in the rate of increase of shelter costs and some easing in the pressures on capital and labor resources. However, substantial uncertainties surround this baseline forecast...In its latest statement, the FOMC reiterated its view that the upside risks to inflation are the predominant risks to the forecast and indicated that it is prepared to take action to address inflation if developments warrant. "

On the Housing Sector...cutting to the heart of the matter.

"Notwithstanding the sharp reduction in starts of new single-family houses, inventories of both new and existing homes for sale have increased markedly this year. For example, according to the most recent data, homebuilders currently have about 550,000 new homes for sale, roughly half again the number that has been typical during the past decade. Moreover, the official statistics likely understate the full extent of the inventory buildup, as many homebuilders have reported a sharp increase this year in the number of buyers canceling signed contracts. A home for which the sales contract is cancelled becomes available for sale once again but is not included in the official data on the inventory of unsold new homes. To reduce this inventory overhang, builders are likely to continue to limit the number of new homes under construction. "

Note: Remember your basic supply and demand. High prices combined combined with large inventories are a recipe for reductions in price and cuts in output. This is because high inventories mean surplus, so suppliers cut prices (leading to a decrease in quantity supplied) in order to induce more demanders in the market.

From a Macro point of view (if you want to learn more about this, sign up for my macro class) the direct risk from the housing sector is decreases in construction. This in itself is (probably) not enough to induce a recession unless it is combined with an indirect effect, which would come in the form of lower consumer spending. The tranmission here is that lower home prices reduce net wealth and decreaes the amount of cash someone could extract from their home to fund current consumption (in the form of home improvements, etc.). But we will see.

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