Our Insider's View of the Economy

Richard DeKaser writes the Practical Economics column for Kiplinger.com and contributes to The Kiplinger Letter and Kiplinger's Personal Finance. He is president of Woodley Park Research and a director of the National Association for Business Economics.

What's your outlook? I'm optimistic. I expect gross domestic product to grow by 3.5% in 2010. Midwestern farm states that avoided the housing debacle and continue to enjoy firm commodity prices are doing well. Areas laden with excess inventory in residential or commercial real estate are flagging, such as Florida, the Southwest and parts of California.

What's driving the recovery? In a recession, businesses and consumers defer discretionary purchases. When growth resumes, there's catching up to do. Take autos. Sales have been below the replacement rate -- the number needed to compensate for retired vehicles -- for over a year. Also, we've seen negligible growth in business spending on plants and equipment. Those are the drivers now: demand for discretionary items and spending on production capacity. We also have a big swing in inventories. Businesses are restocking, and the pickup has been better than expected.

What are the headwinds? Two financial headwinds are preventing the economy from skyrocketing. First, wealth levels are far below what they were in 2007, despite a nice rebound in stock prices and a stabilization of home prices. Household net worth peaked in the second quarter of 2007 at $65.9 trillion; presently, it's at $54.9 trillion. People feel -- and in fact are -- less wealthy, so they spend conservatively.

And the other? Tight credit is restraining growth, principally affecting consumers and small businesses -- a huge chunk of our economy. As the economic expansion matures, fears of a relapse will diminish and lenders will be more forthcoming. But we will not return to hyper-easy credit conditions for many years.

What's your take on inflation and interest rates? As long as unemployment remains high and compensation gains meager, there is little prospect of higher inflation. But after next year, the Federal Reserve will have to make sure it's not a problem. Long term, interest rates are going higher -- that's a no-brainer.