Is Good Economic News Good for Democrats?

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So which game is the chairman of the White House's Council of Economic Advisers playing? In a newspaper interview published today, Edward Lazear said that the housing slowdown will affect "a very significant chunk" of the economy's growth in the third quarter–3Q GDP comes out Friday–and that the slowdown is "going to hit us."

Is he playing the "get the bad news out of the way early" game, or he is playing the "lower expectations can generate a positive surprise" game? A case can be made for both. If Lazear has been chatting lately with Treasury Secretary Henry Paulson, it might be the latter. The economics team at Goldman Sachs, Paulson's old firm, is predicting that the economy expanded at just a 1 percent annual rate during the past three months, with the housing slump "bending but not breaking" the economy. The firm declared the following in a new report: "The point of maximum deterioration in housing activity has probably passed. The sharp downturn of the past year seems to have brought total housing starts–single-family starts, multifamily starts, and mobile-home shipments–close to the level justified by the underlying demographics (as best we can measure them)."

Upside Surprise?

But others, such as economist David Gitlitz of TrendMacrolytics, think an upside surprise – something in the 2.5-to-3.0-percent range–is possible. As Gitlitz explained to me in an E-mail: "I've never bought the idea that the housing 'bust' poses a major risk to growth. The great bulk of consumption growth over the past few years can be almost entirely explained by income growth, so the housing wealth effect has had a very small contribution. As a direct contributor to GDP growth, residential construction has had some significance–averaging about half a point. But the loss of that contribution in the last quarter was fully offset by nonresidential structural investment, which I expect to continue. So, all in all, I think the housing slowdown is a nonevent from a macro perspective."

From a purely political perspective, a weak GDP report might be better for the White House and worse for Democrats right now. Few voters have a real feel for the ups and down of big-picture economic numbers. But they know the stock market. And they know that the Dow has been hitting record highs, an easy-to-understand sign that the economy is in healthy shape. So in one of those "good news is bad news" scenarios that Wall Streeters love to spin, a strong GDP report might sink stocks because investors might interpret it as raising the odds of more Fed rate hikes. (The Federal Reserve's Open Market Committee – the group that raises or lowers interest rates – is meeting today and tomorrow.)

And whenever the Fed raises rates, investors worry that it will overdo things and kill the economy. If the stock market takes a sharp fall on Friday, it would severely weaken the administration's pre-election case that the economy is humming along nicely. So as topsy-turvy as it sounds, a good GDP number on Friday might be good news for Democrats.