The U.S. economy.

• Author: Witte, Willard E.

During the past year, the U.S. economy has essentially been in survival mode. The good news as the year draws to a close is that we seem to have avoided intensive care. The not-so- good news is that the impediments to full recovery are not diminishing. Nevertheless, we expect the economy will avoid a crisis and continue to muddle through.

As shown in Figure 1, output growth in the United States decelerated for the fourth straight year during 2007. On a fourth- quarter to fourth-quarter basis, real gross domestic product (GDP) will probably grow by about 2.7 percent. By comparison, growth in 2003 reached 3.7 percent. The labor market shows a similar, but delayed, pattern (see Figure 2). During 2005, the economy was adding over 210,000 jobs each month. This slowed slightly to 190,000 per month in 2006, and has fallen to only 126,000 so far in 2007. Job growth for four of the past five months has been below 100,000. This latter level is insufficient to absorb new entrants into the labor market, causing the unemployment rate to rise from a low of 4.4 percent in March to 4.7 percent in October.

There are two basic pathogens causing this feeble performance. The more significant is the continuing collapse in the housing sector. Since peaking in late 2005, the decline has been dramatic. Housing starts, for example, have fallen by close to 50 percent. During the past summer, the situation seemed to be stabilizing, but turmoil in the mortgage market caused home sales to plummet during the fall. The weak sales environment has also become evident in housing prices, which are under pressure in most areas of the country.

The other source of negative pressure is the energy market. A year ago, oil prices were around $60 per barrel, and our expectation was that they would average about that level during 2007. Instead, there has been a steady increase, to above the $90 level as of late October.

In the face of these inflictions, it is a little surprising that the economy has held up as well as it has. The housing sector has cut overall growth by close to 1 percent. A rough rule of thumb has been that a $10 increase in the oil price will cut growth about 0.5 percent. Assuming that the economy has a sustainable growth of a little over 3 percent, it would have been easy for growth this year to have come in at a life support level around 1 percent. That the rate was more than I percent reflects several positive influences. First, the international trade picture...