'Good year' Ahead for U.S. Economy, Kohn Says

The U.S. economy should experience a "good year" in 2007 with moderate growth and lower inflation, said an influential Federal Reserve official on Monday.
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"Conditions appear to be in place for a good year for the U.S. economy, one market by growth that is moderate and sustainable and by inflation that will be lower than last year's," said Donald Kohn, the Fed's vice-chairman.

Kohn's views on the economic outlook are considered important by other top Fed officials. Kohn has spent his entire career at the central bank, rising to become a top Fed staffer under former chairman Alan Greenspan before he was appointed to the board.

In October, Kohn first said a soft landing appeared likely, even though it "seems too good to be true."

With two months more economic data in hand, Kohn stuck to his soft-landing forecast.

"The economy appears to be weathering the downturn in housing with limited collateral effects and inflation appears to be easing with the aid of lower energy prices, well-anchored inflation expectations, and competitive labor and product markets," Kohn said in a speech prepared for delivery to the Atlanta Rotary Club.

Kohn stressed it was too early for the Fed to lower its guard against inflation, suggesting the central bank will retain its hawkish inflation language after its next meeting on Jan. 30-31.

"Despite the recent favorable price data, I believe it is still too early to relax our concerns about whether the run-up in price pressures in the spring and summer of last year is truly unwinding and whether it is unwinding rapidly enough to forestall a pickup in inflation expectations," Kohn said.

Kohn said he expects a very gradual decline in inflation, but cautioned that this outcome was "by no means assured."

Economic outlook
In his outlook for the economy, Kohn said that economic weakness in the second half of 2006 was largely due to housing and autos and forecast that these dampening effects would dissipate over the first half of the year.

"When this process is completed, the rate of economic growth should pick up to something in the neighborhood of the growth rate of the economy's potential," Kohn said. Economists generally put the economy's potential growth rate around 3% real GDP growth.

Kohn said he saw some "very tentative signs" that the decline in housing activity will not spill over and reduce other forms of consumer spending.

But Kohn acknowledged that uncertainty about "where we stand in the housing cycle remains considerable."

"In my own judgment, housing starts may be not very far from their trough, but the risks around this outlook still are largely to the downside," Kohn said.

Kohn dismissed fears that recent weakness in the factory sector was the leading edge of a recession.

"In my view…what we are seeing in the recent information on factory output and capital spending is not the leading edge of general economic weakness but instead an adjustment to a sustained pace of expansion, that, necessarily is less rapid than that from mid-2003 to mid-2006," Kohn said.

Greg Robb is a senior reporter for MarketWatch in Washington.