Economists have raised their estimates for economic growth in 2011, but they have mixed views on whether the unemployment rate will come down.
While an improved economy should bode well for state and local governments, most will still face severe budget problems, particularly with the loss of federal stimulus funds.
Economists have become more optimistic about the economy, with the Federal Reserve buying Treasurys through June 2011 and the new tax law extending Bush-era tax cuts for two years.
Earlier this month, economists at JPMorgan Chase revised their real gross domestic product growth estimate to 3.5% for 2011, on a fourth-quarter to fourth-quarter basis, from 3.0% previously. Their estimate for consumer spending was revised up to 3.5% from 2.6%.
Economists at Goldman Sachs are forecasting real GDP growth of 3.4% in 2011 from 2.7% previously.
"We're fairly bullish on the economy," said Scott Minerd, chief investment officer at Guggenheim Partners. The combination of the Fed's monetary policy plus the tax cut extension "only reinforces the view that next year's growth will be stronger," he said.
A poll of economists conducted by the Securities Industry and Financial Markets Association (SIFMA) estimated real GDP would increase at a 2.6% annual rate in 2011, according to the median estimate. The 21 economists also forecast a 9.2% average unemployment rate for 2011.
The SIFMA estimates are more pessimistic than the Federal Reserve's forecast for 2011, which was released in November. The Fed forecasted 3.0% to 3.6% real GDP growth for 2011 and an unemployment rate between 8.9% and 9.1%.
If 2011's GDP growth comes in less than forecast, then the unemployment rate will likely remain high, some sources said.
Kevin Schultze, managing director at Stone & Youngberg, contends that next year's GDP growth will "not [be] sufficient to make an appreciable dent in the 9.8% unemployment rate."
For state and local governments, the persistently high unemployment rate means "the ice will continue to get thinner and thinner," he said. Economists differ on what will happen with employment. Some said economic growth in 2011 will not be strong enough to rein in the unemployment rate, which stands at 9.8%. Others said they see factors conducive to employment growth next year, such as an increase in temporary hires by companies and stronger business productivity.
"All the pieces are there for a better employment market," said Robert DiClemente, senior U.S. economist at Citi.
Stagnant job growth in 2010 stemmed partly from businesses' "post-financial stress syndrome," DiClemente said. The recession's fallout "makes businesses more skittish about the outlook," he said. "I don't think we should underestimate what damage has been done to the entrepreneurial spirit."
But a key concern among economists is the extent to which there will be long-term unemployment — workers without jobs for a year or more, sources said.
Many of these long-term unemployed workers come from the construction and manufacturing sectors and "will be left behind," as the recovery continues, said Lakshman Achuthan, managing director of the Economic Cycle Research Institute.
"There's ultimately not a job for them," he said. "Most will never get their jobs back."
Low interest rates and unemployment benefits will be of little help to these unemployed workers. Ultimately the cost of the long-term unemployment problem will fall on state and local governments, he said.
But even if economic recovery continues at a good clip and unemployment drops, state and local governments will still face budgetary challenges, particularly with the loss of stimulus programs and funds.