In June, Federal Reserve Chairman Ben Bernanke characterized the state of the United States economy as such: "The risk that the economy has entered a substantial downturn appears to have diminished over the past month or so."

The economic stimulus package passed by Congress in early 2008 was meant to help remedy the gloomy picture on consumer spending. Yet the rise in gas prices alone has absorbed the entire tax rebate for many households. After a brief rebound in May, economic confidence among businesses and consumers dropped drastically in June, with the number of those who think the U.S. economy is getting worse expanding. The Federal Reserve's latest updated Beige Book report says consumer spending is mixed, weak or slowing in nearly all districts.

The two-headed threat of inflation and economic sluggishness has most of us expectedly glum about the state of the economy — which in turn has business owners and economists increasingly (and understandably) worried about growth in the coming months.

In a speech at the Federal Reserve Bank of Boston's 53rd Annual Economic Conference, Bernanke stated:

Over the remainder of 2008, the effects of monetary and fiscal stimulus, a gradual ebbing of the drag from residential construction, further progress in the repair of financial and credit markets, and still-solid demand from abroad should provide some offset to the headwinds that still face the economy. However, the ongoing contraction in the housing market and continuing increases in energy prices suggest that growth risks remain to the downside.

Despite some signs of improvement, companies in the U.S. remain cautious on the economy as they battle rising costs and squeezed profit margins, according to a survey released by the National Association for Business Economics (NABE) on July 21 (registration required).

Of the 101 economists at businesses and industry associations surveyed, nearly half (45 percent) of respondents said they had become more pessimistic about the outlook for the year as a whole compared with their views in April. Only 13 percent were more optimistic than before.

"More firms reported higher sales, but also higher materials costs and lower profits, in the second quarter than in the first quarter," Ken Simonson, chief economist at Associated General Contractors of America, said in a statement.

A record 75 percent of respondents reported paying more for materials in the past quarter, the highest share since firms were first asked in 1994. In contrast, only 25 percent of panelists said wages increased last quarter, more than a 10 percent drop from the first quarter. Moreover, 77 percent expect non-labor input prices to rise in the next three months.

While soaring commodity prices continue to squeeze profit margins, so do tight credit market conditions.

For a second consecutive quarter, reports of falling profit margins (30 percent of respondents) outnumbered reports of rising margins (17 percent). Corporate profits peaked in spring 2007 and have fallen sharply since. Domestic investment in the private sector has also fallen sharply.

"Two vital forms of credit used by companies — commercial and industrial loans from banks, and short-term 'commercial paper' not backed by collateral — collectively dropped almost 3 percent over the last year, to $3.27 trillion from $3.36 trillion," the New York Times recently said based on Federal Reserve data. "That is the largest annual decline since the credit tightening that began with the last recession, in 2001."

The New York Times continued:

The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.

Of course, 41 percent of NABE respondents stated that tightening credit conditions have affected their business negatively, up from 39 percent in April and 26 percent in January.

At the time of the NABE survey, the share of respondents who expected a "substantial slowdown" in housing markets over the next six months had already dropped to 29 percent from 45 percent in April. It should not go unsaid that members of the NABE were polled June 19 to July 10 — before mortgage lenders Fannie Mae and Freddie Mac further stirred the credit markets.

Faced with fallout from credit and housing troubles, and burdened with high energy and materials costs, employers have cut jobs in each of the first six months of this year. Fortunately, 51 percent of firms told NABE they expected to hold payrolls steady, albeit with a cautious approach to hiring. While 29 percent of employers expected to boost them, 20 percent expected to cut jobs (through layoffs or attrition).

As for small businesses, nearly eight out of 10 owners told Discover Financial Services they believe the U.S. economy is getting worse. As reported in the June 2008 Small Business Watch, that was the highest level recorded since the inception of the monthly index in August 2006. Moreover, 53 percent of owners said that economic conditions for their business are getting worse, compared to 47 percent in May.

In most aspects, the economic impact on business is being passed on and felt by the consumer, whose confidence last month barely climbed from its lowest level in more than a decade.

More than a third (35 percent) of NABE respondents said their firms raised prices in the latest quarter. Price increases were especially prevalent in the goods-producing and transportation, utilities, information and communications sectors. Even more respondents (41 percent) expect to raise prices in the third quarter than in April, when 34 percent expected to raise prices in the second quarter.

Everything, it seems, is working against the consumer.

So much so that almost half of the 4,000 consumers polled for Discover's latest Small Business Watch (June) believe the "American dream" is dead.

Resources

NABE Panel: Continued Caution but Some Signs of Improvement
National Association for Business Economics, July 21, 2008

FRB: The Beige Book
The Federal Reserve Board, July 23, 2008

Semiannual Monetary Policy Report to the Congress
by Ben S. Bernanke
Board of Governors of the Federal Reserve System, July 15, 2008

Outstanding Issues in the Analysis of Inflation
by Ben S. Bernanke
Board of Governors of the Federal Reserve System, June 9, 2008

Worried Banks Sharply Reduce Business Loans
by Peter S. Goodman
The New York Times, July 28, 2008

False Dawn
by John H. Makin
American Enterprise Institute for Public Policy Research, May 30, 2008

Small Business Watch
Discover Financial Services, June 2008

The Conference Board Consumer Confidence Index Holds Steady
The Conference Board, July 29, 2008