Katrina and Rita Hurt U.S. Economy, The Conference Board Reports

Oct. 17, 2005
From an energy standpoint, the storms could not have come at a worse time for U.S. consumers and businesses

Soaring energy prices and the enormity of Hurricanes Katrina and Rita will have a significant impact on the U.S. economy, putting upcoming holiday retail sales at risk. But the economic havoc generated by the two deadly hurricanes in and of itself is unlikely to trigger a recession, The Conference Board reports today.

"While the economic damage assessment is still underway, it is already clear that the impact from Hurricanes Katrina and Rita will be the biggest among natural disasters in recent U.S. history," says Ken Goldstein, senior economist of The Conference Board. "But economic growth could slow down enough to make it feel like a recession, even if one does not occur technically."

The economy will feel like it is moving forward as early as the first quarter of 2006 and this momentum will continue into the spring as massive rebuilding gets underway. Long-term trend growth should be back on track in the second half of 2006.

But the fallout from the hurricanes will have a major impact on the economy and the business cycle:

* It has already produced energy-price shocks that will cut into consumer spending.
* The magnitude of damage to lives and property is still being measured.
* Consumer confidence has fallen, a further danger sign for consumer spending.
* The labor market continues to cool off.


"From an energy standpoint, the storms could not have come at a worse time for U.S. consumers and businesses," says Goldstein. "While Katrina wasn't necessarily a bigger storm than Hurricane Andrew that crippled southern Florida in 1992, it disrupted energy supplies at a time when the balance between supply and demand was already precarious. Hurricane Rita's impact was less than Katrina's because it largely spared the chemical and proto-chemical facilities in the region."

The loss of natural gas production will be felt more than the loss of crude oil, since it cannot quickly be replaced either with imported oil and gas or drawn from the United States' Strategic Petroleum Reserve.

But economic growth was already losing steam before the hurricanes hit. The Conference Board says that the impact of Katrina-Rita will intensify the economic slowing that was already underway, with the main impact felt in the third and fourth quarters of this year. The key number to watch will be consumer spending.

Beside energy shocks, the hurricanes could:

* Erase as many as half a million jobs.
* In terms of incomes or output, the losses could mount as high as half a trillion dollars, which would slow the economy to a growth rate of less than 2 percent for at least one quarter.
* Faced with higher energy prices, higher interest rates, and slower job growth over the next few months, consumers' willingness and ability to spend will be severely tested. If consumers curb their spending, it could spell major trouble for retailers in the rapidly approaching holiday season.
* On the positive side, energy prices can be expected to fall back in the near future and government and private sector spending on reconstruction is already adding jobs in the areas directly affected by the hurricanes. Oil prices will likely stay in the range of $60-$65 per barrel for the rest of 2005, and then ease to about $55 during the first half of 2006.
* So far, the Federal government has authorized three times more aid for Katrina than for the 9/11 terrorist attacks. Longer term, there are questions about how this new government impacts the Federal budget deficit. At this early stage, it is hard to precisely estimate the economic loss, but it is clear that the storms created much more damage than any other disaster in recent memory. Insured loss estimates range between $20-$60 billion, and total economic loss estimates are now between $100-$200 billion.

In 2006, the economy will recover and resume a growth path closer to its long-term average rate of about 3.5 percent. The overall growth rate for the year will be 2.5 percent. The outlook assumes the Federal Reserve Board will not raise the federal funds rate higher than 4 percent. Should the Fed continue to hike rates and the yield curve invert, the outlook will be significantly worse.

Looking back more than 40 years, and examining several critical events that might qualify as potential business cycle shocks, only two can be connected with the onset of a recession: the OPEC oil embargo (October 1973) and Iraq's invasion of Kuwait (August 1990).

"History tells us that the overriding factor foreshadowing the economic impact of a disaster is the direction the economy is already following," says Goldstein.

The 9/11 terrorist attacks hit the economy during the late stage of an ongoing recession. Their immediate cyclical effect, although severe, was not enduring. The economy started recovering soon after, in part because the recovery process had begun before the attacks.

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