High Unemployment and Slow Growth, the New World Order of Economics?

Markets soared on the surge in consumer confidence, however there is still a large disconnect between an increase in confidence and the action of spending money.”Consumers are not likely to spend just because they think things will get better,” said Mark Vitner, senior economist at Wachovia. “They will actually have to see them get better.”

The economy may have to grapple with a new natural rate of unemployment and a shift in consumer attitudes after this Great Recession. Much of the improvement in confidence came from the Expectations Index, which measures shoppers’ outlook over the next six months. That barometer climbed to 72.3 from 51.0 in April. Consumers’ assessment in the present situation, however, was still weak, rising to 28.9 from 25.5 last month. It also showed that shoppers were less pessimistic about the job market, even though it remains grim.

A lasting effect of the recession may be a “markedly higher” natural rate of unemployment, said Edmund Phelps, a professor at Columbia University in New York and winner of the 2006 Nobel Prize in economics. The natural rate is one that neither accelerates nor decelerates inflation. “It was 5.5 percent,” Phelps said. “Maybe it will be 6.5 percent — maybe 7 percent.” We could in fact be facing an unemployment rate greater than 8% for the next 5 years or so, and as a result the economy will face growth challenges while consumers live within their more modest means.

The U.S. financial crisis and recession have produced lasting shifts in consumer spending and savings reminiscent of the 1950s that may crimp profits and productivity, said David Rosenberg, chief economist at Gluskin Sheff & Associates Inc. in Toronto and former chief North American economist at Bank of America Corp.

“This is going to be a new era of frugality,” Rosenberg said. “This isn’t some flashy two- or three-quarter deal. This is a secular change in household attitudes.”

Slower growth in the economy will dampen equity prices. Behavior by newly ascetic U.S. consumers, whose spending drives more than two-thirds of the economy, will translate into “less return to capital and less-remarkable equity returns,” said Milton Ezrati, senior economist at Jersey City, New Jersey- based Lord Abbett & Co., which manages $70 billion. “The whole picture is muted.”

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