Latest GDP Report Shows U.S. Economy Still Waiting for Liftoff
Forecasters had been expecting the U.S. economy to grow at an annualized rate of 3 percent in the first three months of 2013. The advance estimate released this morning by the Bureau of Economic Analysis was therefore disappointing -- output only increased at an annualized rate of 2.5 percent. It's easy to overstate short-term changes in the data, as well as the importance of surprises. The broader takeaway, however, is clear: Growth continues to be sluggish. It might get a lot worse as the tax increases and spending cuts from earlier in the year finally start to bite.
Digging into the data, the main sources of growth were personal consumption and inventory accumulation, while net exports and government spending cuts were the big headwinds. Private investment spending barely increased in the first quarter. The inventory growth is basically meaningless since it offsets most of the large contraction in inventories that occurred in the fourth quarter of 2012.
On the other hand, the increase in personal consumption was the largest since the end of 2010. The question is whether this is sustainable. Unfortunately, the answer is probably "no." After all, the BEA reports that real disposable personal income collapsed at an annualized rate of 5.3 percent even as real spending increased at an annualized pace of 3.2 percent. The mismatch led the personal savings rate to plunge from 4.7 percent to 2.6 percent.
Consumption growth won't be able to continue at this pace without some combination of rising personal income and increased borrowing. Right now, the outlook for both is negative. Incomes are already declining because of the tax hikes and spending cuts. Households have been repaying and defaulting on their debts for years. It's not clear why they would suddenly stop, especially given reasonable concerns about their future earning power.
Some might think that rising house prices could lead to a "wealth effect" that would make people feel more comfortable borrowing and spending. Federal Reserve Chairman Ben Bernanke is among those who have articulated this view. An important new essay by Amir Sufi, an economist at the University of Chicago, persuasively argues otherwise. The "wealth effect" was always most potent among those with the worst credit and the least wealth outside of housing. For the most part, those people have lost their homes to foreclosure. They won't be in a position to buy new ones and will instead have to live in rental housing. In fact, rising house prices could even restrain consumption:
The marginal 5% of Americans who switched into and out of homeownership over the last decade have high marginal propensities to consume out of wealth and income. During the boom, these households consumed aggressively out of home equity. Now that they are again renters, an increase in house prices represents a loss in wealth, given that they must pay higher rents going forward. This will mitigate any positive effects of house prices on household spending.
Data watchers should also be worried by all the numbers that have been coming out since March. On the whole, the information we have been getting about the health of the economy has been overwhelmingly negative. I wrote about some of the bad news a few weeks ago. Since then, things have been getting worse, with the notable exceptions of initial claims for unemployment benefits and housing starts.
Meanwhile, the economies of our major trading partners continue to falter. The ongoing depression in the euro area will not help U.S. exports, nor will the slowdown in China. Falling commodity prices associated with slowing demand from Chinese buyers could be bullish for the U.S. economy and work like a tax cut for American consumers and businesses. A revival of the Japanese economy could be helpful, although the stated strategy of yen devaluation to stimulate exports won't do much for the U.S.
The GDP report didn't tell us much that we didn't already know. It should remind us, however, of the dangerousness of fiscal austerity when the economy is still so far from recovering.
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Matthew C Klein
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