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Mar 16, 2012, 07.36 AM | Source: CNBC-TV18

Will be surprised if US grows 3 %: Prof Feldstein

Martin Feldstein was Chief Economic Advisor to President Ronald Reagan and is currently the Professor of Economics at Harvard. He believes that US will be lucky to have 2% GDP growth this year, let alone 3%. Check out his comments.

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Will be surprised if US grows 3 %: Prof Feldstein

Martin Feldstein was Chief Economic Advisor to President Ronald Reagan and is currently the Professor of Economics at Harvard. He believes that US will be lucky to have 2% GDP growth this year, let alone 3%. Check out his comments.

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Martin Feldstein, Economic Professor, Harvard University
Martin Feldstein was Chief Economic Advisor to President Ronald Reagan, a deficit hawk. His tenure was marked by his candor in speaking out against high budget deficits and rising defense spending and in pushing for tax increases and a conservative monetary stance. Recently in February, he said in an interview that the American economy will also slow this year. To quote him, ďI think we will be lucky if we have 2%Ē. He is currently the Professor of Economics in Harvard University.

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: Why do you think that the US economy would weaken further in the second half of this year and whether that meant a third round of quantitative easing (QE) would come in later this year?

A: Things have gotten a bit better since the interview that you are referring to. We have seen another month of good employment numbers, some positive revisions of earlier monthsí employment numbers. We just had a retail sales figure for February which was quite positive. So in some ways things are looking better than they did a month ago.

On the other hand, that 3% GDP growth that we had in Q4 was mostly just inventory building. We take out the inventories, it was 1.1%. Thus last yearís GDP growth was just about 1.5% and the question is are we really going to do 4% point more than that or as much as 3% as some people are forecasting.

Not out of question but I think it will be surprising because most of the indicators are still negative. House prices are falling, real personal disposable income fell in January, personal consumer expenditure is a broader number, retail sales has been flat, zero increase for three months in a row. I can go on like that. It is a very mix set of statistics and then in addition to that there were strong headwinds that will make it difficult to have a robust recovery.

The higher price of oil will reduce personal real income in the US by about 1%. That is a big reduction. That could cut the growth of spending by three quarters of 1% which is a big hit. We are seeing the end of the fiscal expansion that was put in place in 2009, it wasnít very powerful one but it has come to an end. So that is a further drag. The savings rate fell last year that allowed consumers to spend more even though their incomes werenít rising. The saving rate is to fall again. If it stops falling, that takes away that scope for growth of consumer spending. I could go on. But I think the problem is that there are a number of these factors that are going to make it hard to take what looks like some increased momentum recently and turn it into very strong growth in 2012 and 2013.

Q: Well thatís the tone the FED seems to be striking as well. There are still those who believe that QE3 is likely in the second half when this weakness starts manifesting itself. Do you believe that that is the case and would you advise in favor of a QE3?

A: Easier for me to answer the second question than the first. Although they have succeeded in bringing down long-term interest rates that has been good for the stock markets and for bond holders but it really hasnít done anything for the economy. The goal was to improve home buying, house prices, residential construction by bringing down mortgage rates. And 30 year mortgage rates are down almost a 4% point from about 4.7% to under 4%. But there has been no improvement in housing.

So the fundamental problems of the housing sector, the large number of home owners that hold more on their mortgages than their houses are worth, has caused house prices to continue to fall and that holds back buying of new homes. Most of the home buying going on is in the existing home market, much of that being driven by the banks selling property that they have foreclosed on. So I donít think that a further round of QE will have any favorable impact on the economy and it would build up the balances, the liquidity that the Fed will eventually have to deal with.

Q: I gauge from your answers then that you agree with what central banks have had to do over the course of the last 3-4 years especially the ECB and the Fed. You donít think that this is leading to acid bubbles as yet or that it is the time for these central banks to start tightening or unwinding at this point in time?

A: What the ECB did especially the first LTRO was important, was necessary, was helpful. I donít know whether they really needed to do the second one because things seemed to have calmed down. The Fed probably has gone too far in the sense that they really havenít accomplished much other than bringing down interest rates and it is not clear that that is translated into any significant improvements in the weight of economic growth.

In 2010 Ben Bernanke said we are going to do QE2, we are going to buy USD 600 billion worth of bonds about half the amount of the fiscal deficit. Thatís going to lead investors to look for someplace else to put their money. Theyíll put it in the equity markets, which will put up share prices. That will lead to increased sense of wealth which in turn will lead to more consumers spending and he got it just right. All those things happened and so we had a 4th quarter of 2010 which looked quite good. People got excited and said well now we can build on that and 2011 will see more production, employment and incomes leading to further rounds of increased consumer spending but that didnít happen and the first quarter of 2011, the economy was basically flat. It grew 1/10th of 1% quarterly, 4/10th of a 1% on an annual rate. It just added USD 600 billion to the banksí balance sheet without really doing anything to have a sustained impact on the economy.

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