Confluence of structural and cyclical change clouds outlook for 2008 and beyond.

A third main concern would have to be inflation. The November 2007 Consumer Price Index (CPI) showed a year-over-year spike of 4.1 percent. While the CPI for 2007 came in at 2.8 percent, prospects for continued commodity and energy price increases will put further upward pressure on domestic inflation.

Finally, perhaps of most concern would have to be the pace of job creation. Slower job growth will further erode consumer confidence and place a drag on spending.

Q2. Looks like housing will be a drag on the economy for most of 2008. Can anything be done to stem the hemorrhaging in the housing sector?

There are currently proposals for loan modification programs and counseling service items on Congress' agenda, and the Bush administration has brokered a voluntary-driven agreement that would freeze about 1 in 5 subprime mortgage rates for a number of years. Another change would allow Fannie Mae to increase its loan threshold to $729,750. The Federal Reserve is also getting into the act by proposing new rules on mortgage lending, one of which would require lenders to verify applicants' incomes. Even the FBI has entered the fray, seeking to determine fraudulent activities associated with mortgage lending practices. Such initiatives are addressing only the fringe elements of the housing crisis and are unlikely to solve the core issue of just plain bad mortgage loans. Already, numerous financial institutions are estimated to have writedowns totaling $100 billion. Critics of such programs complain that government intrusions into the mortgage market would only be rewarding those who took out risky loans and would ultimately disrupt the mortgage lending market for years to come. The best prospect for housing rests with lower mortgage rates (restoring affordability) and a return to a more rational process of assessing suitability for granting or refinancing a mortgage. Mortgage rates have fallen below 6.0 percent and could stay there for most of 2008. The key factor will be the size and pace of foreclosures. While estimates range as high as one million foreclosures in 2008, focusing attention and resources in this area would go a long way in keeping the housing market from imploding.

Q3. Consumers have weathered numerous storms in the past, such as the dot.com bust and historically high gasoline prices. Now comes the subprime debacle. Will 2008 be the year we see a significant downshift in consumer spending?

Consumer spending was particularly dismal during the fourth quarter of 2007, raising concerns that consumers were going into hibernation. While consumers remained marginally positive during the last recessionary period, prospects for an actual decline fundamentally depend upon two factors: the pace of job creation and rising incomes. Another factor analysts point to is known as the wealth effect. Over the past few years home equity lending was touted as propelling consumer spending forward to lofty heights. With the drying up in home equity lending, the stock market was expected to take over the role of providing a wealth cushion under the consumer. But, after reaching record levels in mid 2007, the stock market has experienced a precipitous downturn due to higher oil prices and the spreading credit squeeze. Only one thing could trump the growing consumer pessimism caused by feeling less wealthy and believing that a recession is on the horizon--that's job growth. While the unemployment rate stood at 4.8 percent for February 2008, consumer confidence has plunged to its lowest level in five years. Taken as a whole, consumer spending will be painfully slow for the first half of 2008, with tax rebates adding a boost to consumer spending for the second half of the year. The key component to gauging the health and attitude of consumers will be their spending on durable goods. Spending on autos, appliances, and electronics, albeit subpar, will determine if the economy can stay on a positive growth trajectory.

Q4. U.S. businesses appear reasonably sound financially and are anticipated to take up some of the slack due to softening consumer spending. What can we look forward to from the business sector?

Businesses have already taken up some slack, with solid nonresidential construction investments absorbing some of the housing construction job losses. Equipment and software spending gained a little momentum during the second and third quarters of 2007, but expectations are that this spending sector might be the first to show signs of weakness during the first half of 2008. The Institute of Supply Managers Index has fallen below the 50.0 mark, and industrial production has been trending downward. Recent surveys have shown that CEOs' confidence levels have slipped to their lowest level since 2000, and 2008 opened with negative job growth. The main problem is that businesses are likely to take a "wait and see" attitude. Since business spending is correlated to hiring, any delay will most likely contribute to the malaise in the job market. Even with expanded tax incentives from the stimulus package, business spending can be expected to be subdued for the first half of 2008 as the slowdown unwinds. However, with better prospects for consumer spending later in the year, businesses will respond and resume spending and hiring plans for the second half of 2008. The key component to gauging business attitudes will be hiring in the business services, information, and financial activities sectors.

Q5. The Federal Reserve is in an aggressive mode to cut the federal funds rate to keep the soft landing from becoming a hard landing. Will the prospect of more interest rate cuts ahead be enough of a cushion to steer the economy clear of a recession?

The roller coaster ride of the federal funds rate over the last few years seems to have created as many problems as it has resolved. Since there is a lag between an interest rate move and its ultimate effect on economic activity (generally considered a year), recent cuts will have no immediate impact on spending. However, there is an immediate effect that is more related to confidence by convincing financial markets that the Fed is steering the ship in the right direction. Since a 100 basis points cut in September 2007, two dramatic cuts of 125 basis points in January and 75 basis points in March, the federal funds rate stands at 2.25 percent. Such a dramatic swing is unprecedented and opens the door to a potential loss of credibility if the moves don't work. While the interest rate cuts will make money cheaper, there remain questions as to their impact on spending, since debtors gain, but savers lose. Right now, the Fed is more worried about the slumping economy and pumping up liquidity to negate the effects of the credit crunch than it is about inflation. In the past, particularly during the inflationary period of the early 1970s, the Fed was criticized for lowering interest rates in the face of rising inflation. A key inflection point will be the next Fed meeting on April 30th where it will decide once again between recession (further cuts) and inflation.

Q6. There was a mad stampede to get some kind of government stimulus package passed to stave off a recession. The mantra was that it must be timely, targeted, and temporary. Will such a stimulus package resuscitate the economy?

A check in the mail should make those who receive it feel a little better about their situation. At an estimated $160 billion, the stimulus plan was hammered out in record time, with checks to be written and delivered starting in May. Some higher income groups are excluded from the plan, while individuals who don't usually pay any income taxes will get a check if they file a return. However, many analysts are concerned that the stimulus plan will increase the federal deficit, causing lasting economic consequences beyond 2008. There are still lingering questions concerning the impact of a previous stimulus package in 2001. Most analysts agree that the rebates boosted spending, but there is considerable debate over just how much. Some of the 2001 rebates were used to pay off debts rather than to make purchases. In the best case scenario, the new stimulus package will kick in during the second half of 2008, just as economic growth is anticipated to be improving.

Q7. Now it is time to pull out the proverbial crystal ball and make a forecast for 2008. Will there be a recession in 2008?