The Patient's Pulse Is Getting Stronger

The economy has taken a turn for the better. Its February heartbeat--payroll employment--was the strongest since May, 1990, before the recession began. That improvement is the most encouraging sign yet that this sick economy is off the critical list and beginning its convalescence.

But don't expect handsprings anytime soon. The 164,000 jump in February jobs was not broad. January job losses, now totaling 149,000, turned out to be far heavier than first reported. Last month's unemployment rate rose to 7.3%--a 6 1/2-year high. And the structural ills that extended the recession--especially heavy consumer debt--will also sap the strength of the recovery.

Nevertheless, the economy's prognosis looks much better after the February job report than it did after the January report. In addition to the turnaround in payrolls, both the workweek and weekly earnings more than recouped their large January losses. Based on the January job data alone, real gross domestic product in the first quarter appeared headed for a decline. Now, real GDP seems to be at least holding its own--or perhaps growing a bit.

The best indicator of that is overall hours worked, a good proxy for real GDP growth. In January, hours worked stood well below their fourth-quarter average, reflecting the month's job losses and a plunge in the workweek from 34.5 hours in December to 34.3 hours.

But in February, the workweek shot up to 34.7 hours--the longest in nearly three years. Combining that advance with the month's job gains shows that hours worked in the current quarter now stand well above the fourth-quarter level--a good sign for growth (chart).


The most important implication of the February job report, though, is that the vital signs of consumers are improving. Before households can lead a recovery--as they must--they will need better cash flow and less debt. There is now growing evidence of both.

Lower interest rates and refinancings are already helping households, although further rate declines now are a long shot. The strength of the job data probably rules out any chance of another near-term cut in interest rates by the Federal Reserve. However, income gains may be ready to take over the job of boosting consumer spending right where past rate declines leave off.

Indeed, one of the big surprises in last month's employment report was the large gain in paychecks. Weekly earnings jumped 1.5%, to $364.35 in February (chart), helped by the longer workweek and a 0.3% increase in the average hourly wage, to $10.50. Although part of that earnings gain reflected a bounceback from a 0.7% drop in January, weekly pay so far this quarter is running well above its fourth-quarter pace.

The February rise in weekly pay was the largest since 1982, but the big difference now is that inflation is less than half of what it was back then. That means consumers are enjoying an increase in their buying power. After adjusting for inflation, weekly earnings this quarter are up 1.1%, at an annual rate.

Those pay gains and the increase in nonfarm jobs last month suggest a generous rise in personal income in February. In fact, after adjusting for inflation and taxes, real spendable income is shaping up to post growth this quarter in the range of 2% to 3%, at an annual rate. That extra cash is why retail sales look a lot better now than they did at yearend, and it could give recession-weary consumers a nice lift this spring.


However, one crocus doesn't make a garden. In order to avoid a repeat of last year's false start, job and wage growth will have to continue making progress in order to guarantee a sustainable consumer rebound. Moreover, the pace of job gains is likely to be far below the normal recovery experience. Corporate restructurings, particularly in the service-producing industries, will limit employment growth.

One result: The unemployment rate will be slow to fall, especially as people sense better employment prospects. Early in a recovery, the labor force typically grows faster than new jobs open up. Since November, the labor force has grown at an annual rate of 3%--the fastest three-month pace in three years. That partly explains the 0.4 percentage-point jump in the jobless rate since November, despite a gain in civilian employment.

In addition, job growth promises to be below the usual recovery pace in the very sectors that have accounted for the recession's job losses. Since the downturn began in July, 1990, employment in manufacturing, construction, and retail trade has declined by more than 1.9 million (chart). Jobs in the remaining 60% of nonfarm industries have increased by just over half a million.

The signs from these sectors were mixed in February. Manufacturing employment rose slightly, the first gain in six months. But excluding a 30,000 bounceback in the auto industry after January shutdowns, factory jobs fell. Still, industrial production in February undoubtedly rebounded strongly from its large January loss. Construction employment fell by 30,000, despite the housing recovery.

Retail jobs posted the bulk of the February advance in payrolls. They rose by 133,000, following losses for six consecutive months. The gain partly reflected seasonal-adjustment quirks, but it was large enough relative to past declines to suggest that retailers are busier.



The stubborn uncertainty about future job conditions is one reason why consumers continue to shun most forms of debt. And because of existing debt burdens, credit-financed spending will not play the same strong role in the coming recovery that it has in past upturns.

Consumers keep whittling down their IOUs. In January, installment credit fell for the third consecutive month, dropping $183 million. Installment debt outstanding now equals 16.9% of disposable income, down from its 18.6% peak of late 1989.

However, some households are just switching one form of debt for another. Home-equity loans are rising, as homeowners take advantage of the lower rates and tax breaks. Since the end of 1990, when the interest on most consumer credit was no longer deductible, installment credit has fallen nearly $6 billion, to $729.2 billion. But home-equity loans and installment debt combined have not lost any ground at all. In January, the combined debt totaled slightly more than $800 billion (chart).

Even when home-equity loans and installment debt are combined, though, consumers are still unloading their debt burdens. The growth in equity loans and installment credit has been slow enough to lag behind even the modest gains in incomes. The total of installment credit and home-equity loans stood at 18.6% of disposable income in January, up a bit from December's six-year low. But the ratio probably dipped in February, given the month's gain in pay.

In addition to the reduction in installment debt, consumers are also finding it less difficult to pay off their biggest IOU: their mortgages. According to the Mortgage Bankers Assn., the rate of mortgages that were delinquent 30 days or more fell to 4.78% in the fourth quarter, down from 5.07% in the third quarter.

Lower interest rates have created a flood of refinancings and a drop in the monthly payments on adjustable-rate mortgages. Lower mortgage costs have lessened the financial strain on strapped consumers who otherwise may have defaulted. Lower mortgage payments have also freed up more cash for many homeowners.

To be sure, this process of reliquification has only just begun. It will take a long time for consumers to feel financially healthy again, and that will be a drag on the recovery. What's also needed is a few more gains in jobs and incomes like the ones posted in February. Then, while the economy may not be ready to do backflips, consumers could at least spend fast enough to get the patient up and around.

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