The post-Katrina economy

The tragedy of Hurricane Katrina is significant and heart wrenching. As of late-September, the death toll was above 1,000 and rising, with hundreds of thousands displaced from their homes — some permanently. The around-the-clock media coverage of the disaster has poignantly revealed the pain and suffering Katrina has caused throughout the Gulf Coast region.

Although the humanitarian tragedy is readily apparent, the economic impact of the disaster is more obscure. As is often the case, the direct effects of the disaster may be significantly less than first thought. Initial fears the economic damage and the dramatic rise in oil and gasoline prices would knock the U.S. into a recession have been re-assessed and heavily discounted. A meeting between President Bush and Federal Reserve Chairman Alan Greenspan days after the storm didn’t prompt an inter-meeting interest-rate cut by the Fed, as would be expected if a recessionary shock was imminent. Rather, President Bush ordered a release of oil stocks from the government’s Strategic Petroleum Reserves (SPR), which has kept crude oil prices from rising to new record highs.

U.S. Treasury Secretary John Snow has recently voiced a consensus among many economists, both within the government and financial markets, that Katrina is likely to reduce U.S. economic growth by a half a percentage point during the second half of this year. The negative impact of the hurricane’s “first-round” effects has been largely concentrated in the third quarter. Press reports indicate that Lehman cut its third-quarter GDP forecast to 3.8 percent from 4.5 percent; JP Morgan cut its to 3.25 percent from 4.0 percent; Bear Stearns cut its to 3.5 percent from 4.5 percent, and Goldman Sachs cut its to 3.5 percent from 5.0 percent. A new Bloomberg survey found the consensus estimate for third quarter GDP is now 3.6 percent, compared to 4.1 percent prior to Katrina. However, the impact on consensus fourth-quarter GDP is far less severe — a drop from 3.5 percent to 3.1 percent.

The difficulty with Q4 expectations is they incorporate first round effects, but do not reflect second round effects, which are notoriously difficult to measure. Greenspan’s recent speech in Jackson Hole, Wyoming lauded the flexibility of the U.S. economy to rebound from such events.

Consumer spending, business confidence, and inflationary expectations were undaunted by the LTCM crisis (a high profile hedge fund that collapsed in 1998), the Nasdaq crash, the Sept. 11 terrorist attacks, and the Iraq War.

However, this characteristic cannot be taken as a given in the future. Even after doubling Secretary Snow’s estimated growth impact, the U.S. will still post the strongest growth among the G7 economies this year. The real unknown is whether the U.S. economy’s flexibility will again keep second round effects to a minimum in 2006.