Forecast: More of the Same...Unless Things Change
The last recession is now four years behind us, and growth of real GDP has been quite good for the past three years. The economy also has shown an impressive ability to shake off serious shocks, including the  unprecedented hurricane season in the fall of 2005. Momentum in the global economy (along with reassuring developments in world energy markets) bodes well for the U.S. economy down the line, and the next economic recession is not yet in sight. The early stages of the current economic expansion were not strong enough to strengthen the U.S. labor market, as a dramatic surge in labor productivity allowed businesses to meet growing demands for economic output with fewer workers. But labor market conditions have improved substantially since mid-2003, at least on a national basis  Rising labor costs, along with some inevitable pass-through of high energy costs, are likely to place additional upward pressure on core inflation (which excludes food and energy prices) in 2006. However, core inflation shouldn't move above the upper end of the Federal Reserve’s apparent “tolerance range.”

The Fed wants to get monetary policy into a “neutral” position (neither stimulating nor impeding economic growth), and minutes from the meeting on Dec. 13 show that it believes this  process is nearly complete. Another quarter-point rate hike is likely at the next FOMC meeting on Jan. 31 (Fed Chairman Alan Greenspan’s last meeting), and monetary policy most likely will be held steady during the first year of Ben Bernanke’s tenure as Fed Chairman. Long-term interest rates have changed little since mid-2004, despite the Fed’s systematic increases in short-term rates. The flattening of the yield curve alarmed financial markets and forecasters—since inverted yield curves were followed by economic recessions in the past (although the inversions are no longer a reliable predictor in today's world). Long-term rates actually have firmed up in recent months, and should increase further in 2006. Thus, the yield curve will not invert decisively in 2006, as long as the Fed manages monetary policy as expected. [ return to top ]