U.S. Economy: Good & Bad News

As many appear excited by the resent spate of positive economic news, we need to exercise some caution.

It is true that the economy may be turning around with big U.S. corporations planning to spend again. Today’s Wall Street Journal indicated that these companies have been saving cash and reducing debt for the past two years. Now new investing is anticipated. Per the WSJ:

Big U.S. companies have cleaned up their balance sheets and, flush with cash, appear open to using it in 2011 on factories, stores and even hiring…

Profit growth for corporate America likely will slow in 2011, partly because companies will be up against tougher year-earlier comparisons and partly because higher sales are prompting them to invest more in plants and equipment and, in some cases, hire more workers.

Even with the positive economic news, it does not mean a lot of new jobs will be created. As addressed by Nobel Prize winning economist, Paul Krugman, it will take numerous years for the unemployment level to drop.

First of all, [the U.S. economy has} to grow around 2.5 percent a year just to keep up with rising productivity and population, and hence keep unemployment from rising. That’s why the past year and a half was technically a recovery but felt like a recession: G.D.P. was growing, but not fast enough to bring unemployment down.

Growth at a rate above 2.5 percent will bring unemployment down over time. But the gains aren’t one for one: for a variety of reasons, it has historically taken about two extra points of growth over the course of a year to shave one point off the unemployment rate.

So if the U.S. economy grows at 4.0 percent annually for the next 5 years, we would see the unemployment rate drop only 1.0 percent annually. Thus at this rate, we would see unemployment drop from 9.8 percent to 8.8 percent by the end of 2011.

But it is unrealistic to anticipate the economy to grow at 4.0 percent annually for consecutive years, especially when the Federal Reserve Bank is only anticipating the U.S. economic forecast is between 3.0 to 3.6% in 2011.

With likely strong economic growth, we’ll see unemployment drop, but not quickly to full employment. It may be a number of years until we experienced when unemployment rates around 4.0-5.0 percent.