Productivity has been the source of most of the changes. Jobs data get revised too, but we haven’t seen revisions near the size as we’ve seen for GDP, and GDP growth is the sum of employment growth and productivity growth.

Recently, the initial estimate for 2011’s third-quarter GDP growth was revised downward from a 2.5 percent annual growth rate to only a 2.0 percent annual growth rate.

Still, even a 2.0 percent growth rate represents a nice pickup from the extraordinarily weak first two quarters. Unfortunately, much of that improvement came in the form of productivity growth rather than job growth.

It confirms our judgment last summer, when we expected the Country to avoid the second dip so many forecasters expected after the August data revisions to the first two quarters’ GDP data.

That doesn’t mean we’re out of the woods yet. The probability of one of both of two very serious events that we’ve been warning about for months seems to be increasing daily.

A significant interruption in oil supply from the Middle East would have catastrophic impacts on Western economies. The probability of such an interruption is becoming alarmingly high, in our estimation.  A week or so ago, there were headlines that a natural gas line in Egypt was sabotaged, the Kuwaiti government has collapsed, and Syrian atrocities are continuing, perhaps increasing. The likelihood of an oil-supply interruption is high, and the economic impacts of an interruption are very serious. Economic recession will affect all developed economies.

The other risk is a financial crisis associated with the breakup of the Eurozone. While the markets are giddy today with the prospect of yet more Eurozone bailouts, the bailouts are only bandages.

Fundamentally, the Eurozone is a contradiction that cannot be sustained. Some countries will have to leave it. When they do, there will be losses. Financial institutions and governments will face stresses not seen since September 2008. The resulting recession will be serious and widespread.

The saga of the Great Recession continues. Over six million people have been unemployed for more than 27 weeks, and job growth may be slow enough in the next few months that the unemployment rate rises again. Major revisions to GDP, released in late July, show that from 2007 to early 2011 the United States economy was weaker than previously understood. The consensus forecasts for the United States and World economies have been revised down.

However, these aspects, negative as they are, are not currently as important to near-term growth as the impact from the probable reduction in the number of countries in the European Union. Bill Watkins discusses the European crisis earlier in this blogspace.

The economy grew much more slowly during the first half of 2011 than during 2010. One big reason is that consumption growth slowed. I think that consumption growth will remain relatively weak for at least the remainder of this year. This is in part because I think that wealth accumulation and income growth will be weak. At this point, low interest rates do not help much. But, there is more to the consumption story. Household debt levels, despite subsiding from their bubble highs, are still too high. If households continue to reduce their debt, consumption growth will remain muted. While near-term growth suffers a bit when households save more, the long-run health of the economy is improved. Economic recovery from major asset price deflation has never been quick or pleasant, and this time is no different. Indeed, real estate prices remain low and equities are down from the first half of this year.

We forecast growth in inventory investment and in equipment/software investment. However, we are bearish on commercial structures and housing.

We forecast that government expenditures growth, which includes state and local, will remain slightly negative for the remainder of this year. It appears that governments at all levels have bumped into their budget constraints.

We forecast that trade will produce a slight drag on growth, with the trade balance deteriorating slightly. This is due to slowing world growth.

What about the Fed? They have conducted the first of their two-day policy meeting today. I expect that the Fed will announce a policy change tomorrow which could include an attempt to push longer-dated Treasury rates down and, less likely, a reduction in the interest rate on excess reserves. The market has appears to have priced in a reduction in longer rates. Despite this boost, equities are not doing very well.

A reduction in the interest rate on excess reserves would provide greater incentive for banks to loan, and this is the better idea of the two. However, this policy may not provide much benefit. The problem is that many small businesses and households are reducing debt, not increasing it.

As a result of the above mentioned forecast of the major components of GDP, our GDP forecast is bearish, significantly under the Wall Street Journal consensus of 55 forecasters for the second half of 2011 and the first half of 2012.

With the recent and forecasted weak United States and World economic growth and with a slowdown in commodity price growth, our forecast indicates that inflation will not be a problem. The secular trend in rising inflation since March will likely be broken soon, probably as soon as the September data is released in mid-October.

Inflation will be the least of the Fed’s worries during the second half of 2011.

Downward revisions to United States gross domestic product (GDP) have driven most of the revisions. For about two years, we had trouble with the original GDP estimates. Our jobs forecasts were pretty accurate, but we forecasted productivity growth and consumer spending growth below the initial estimates. This caused us enough grief that we’ve been reviewing our models. Well, the revised numbers are entirely consistent with our original models.

Downward revisions to productivity growth and consumer spending are what drove the downward GDP revisions.

Enough bragging. What is happening to the economy? We’re seeing a weak recovery.
Increasing numbers of forecasters, spooked by weak numbers and downward revisions, are now forecasting a double-dip in the near future. We don’t think that is the most likely case.

We’ve said all along that this would be a weak and inconsistent recession, and that appears to be what we are seeing. Some encouraging data might come in this week. The next week could see weak data. This is exactly what we expect to see in a recovery where financial institutions are wounded, real estate is weak, and consumers over extended.

So, we don’t expect a double-dip recession. We expect continued slow growth, accompanied by weak real estate markets, weak consumer spending, slow job growth, and persistent high unemployment.

That would be the good news and the bad news.

Another recession is in our future though, and not just because the business cycle has not been repealed. However, the timing of the next recession is really difficult to forecast, because in part, the timing will probably be politically driven.

I have become convinced that the culmination of Europe’s problems will be a partial breakup of the Eurozone. Perhaps it will be complete breakup. It really doesn’t matter.

Any breakup will almost surely be accompanied by financial and political crises. These crises will initiate a new recession, one that will be impacting an already weakened economy. It’s likely to be very painful.

We believed that the United States economy, absent some outside shock, would slowly accelerate.

Today, we’re not so sure.  As Dan says, “Today, we know more about the truth.”

We have to run the new data through our model to be precise about the prospects for a new recession, and we’ll be doing that soon.  In the meantime, you have to believe that this is a very risky time for our economy.

This should cause Washington to be more determined to extend the debt ceiling.  Perceptions of the risks of a new recession have increased.  That makes it more likely that Washington will be blamed if they do not raise the debt ceiling.

I mentioned in the United States Highlights essay that the fourth quarter consumption growth rate of 4.1 percent, the strongest in five years, was a surprise given weak economic fundamentals. I also discussed the evidence of significant heterogeneity across U.S. regions. I would argue that California has these incongruities even more than the United States does.

California has places like Santa Barbara and Monterey, places where politicians on both sides of the aisle embrace strong “slow-growth” principles. Not far from Monterey, California has the Silicon Valley, the world’s premier location for information technology businesses. In addition, California also has places, eight counties, that have an unemployment rate greater than twenty percent. California has 27 counties where the unemployment rate is greater than fifteen percent. Bill discusses in his California essay that its DURT’y policies are effectively driving businesses and people away noting that net domestic migration has been negative for the last 20 years.

The weak fundamentals that exist for the United States exist for California but more acutely. They include: a high revolving-credit debt level as a share of income, a high mortgage-debt level as a share of income, a high residential default rate and foreclosure rate, a high banking charge-off rate, a high long-term unemployment rate, a high home ownership rate, a low construction activity rate, a low small-business profit rate, a significant structural imbalance in the labor market (too many construction workers), and a low job creation rate.

Many of the 27 counties with high unemployment rates mentioned above are suffering from the weak fundamentals more than the state as an average. In addition, some of the 27 counties are located some distance from large job centers. Some of the counties in the San Joaquin valley have been negatively impacted by not just state regulations, but federal regulations as well, where a large number of farms experienced water supply restrictions by federal order, and have discontinued operations.

In this context I present our forecast.

California’s year-on-year job creation rate has been lower than that for the United States for most of the last 48 months. In addition, California has a much higher unemployment rate than the United States.

California’s rate of construction activity has dropped to a very low level due to an over-supply of housing. Because real estate markets are still adjusting to a lower level of home demand, driven by the weak fundamentals described above, we forecast weak construction activity for at least the next two years. The residential chart is shown here, the commercial forecast has a very similar pattern.

The lack of participation of the housing market in the recovery is partly what makes the recovery so weak. A new home has what economists call a large “multiplier” effect on the economy. I am referring to an Input-Output multiplier. This is where production in one industry has impacts on other industries due to the demand for intermediate products and materials. These products and materials create demand in other industries adding to total economic activity.

A new home has large impacts on other industries both when it is being built and right after it is sold. While it is being built the inter-industry demand for intermediate products and materials (furnaces, windows, carpet, cabinets, etc) creates significant stimulus. When sold, the new inhabitants often embark on a spending campaign lasting many months, one that brings in the desired furnishings, furniture, appliances, etc. Many of the purchases are large in dollar volume.

Because California’s housing market is in worse shape than the United States’ housing market our forecast of California building activity and job creation is weaker than it is for the United States. With slower GDP and with more of a construction worker over-supply, California’s job market will be weaker than the U.S.’s.

California’s somewhat slower economic and job growth implies that the unemployment rate will not decrease very quickly.

The Recent Evidence

The United States economy continues to surprise me. Fourth quarter real consumption growth of over four percent, the fastest growth rate in five years, seems anomalous in the face of many fundamentals. I remind myself and the reader that one quarter’s worth of data does not make a trend.

The United States economic fundamentals include: a high revolving-credit debt level as a share of income, a high mortgage-debt level as a share of income, a high residential default rate and foreclosure rate, a high banking charge-off rate, a high long-term unemployment rate, a high home ownership rate, a low construction activity rate, a low small-business profit rate, a significant structural imbalance in the labor market (too many construction workers), and a low job creation rate. Some of these combine to the reality of a weak labor market, and some of these combine to the realization of a weak real estate market.

Those were the negatives. There are some positives: historically low interest rates, high corporate profit rates, and high rates of technology adoption and per-worker output growth rates. Of course, the low interest rates are a disincentive to save.

Returning to the four percent consumption growth rate in quarter four, there are a couple of more points to consider: one was just mentioned, which is the low interest rates, and two is there may have been statistical and accounting issues that led to the strong fourth-quarter result.

A final point about low interest rates: if debt levels are too high then long-term economic health requires debt-reduction, but this will be slower with historically low interest rates.

The February BLS Employment Situation showed job strength unseen thus far in the recovery to the Great Recession. I note in a recent blog, (http:/www.clucerf.org/blog/), that if this strength is maintained for a few months more, the labor market will finally look healthier. This might be a “big if” though, because of the relatively long weak fundamental list noted above, and we have experienced more than the normal share of world events that cause too much economic uncertainty, (earthquakes, along with Middle East violence and governmental instabilities), in just the past month.

Geographic Heterogeneity

Given that the December 2010 unemployment rates in North Dakota, Nebraska, Wyoming, Iowa, and Minnesota were 3.8, 4.3, 6.4, 6.1, and 6.9 percent respectively and given that the unemployment rates of California, Georgia, Nevada, and Florida were 12.5, 10.4, 14.9, and 12.0 percent respectively, it is easy to guess that any statistical test of economic equality across states would be rejected with flying colors.

While we see weak fundamentals in the national economic data, we recognize that there are parts of the country, mostly but not exclusively in the middle of the country, that are economically healthy. Many of these economically healthier areas were not as impacted by the increases in home ownership and excess building activity as California, Georgia, Nevada, and Florida.

Our Forecast

While our jobs forecasts have been relatively close to actuals in the past year or so, our GDP forecasts have been noticeably pessimistic. We are trying hard to fix this, but one of our difficulties is that we still see fundamental weakness. The reconciliation is to boost our productivity, (output per worker), forecast, which we have done for this time.

We still model consumption growth as falling a bit during 2011 and then rising somewhat again in 2012. I use an intervention technique in the consumption model to explain the inexplicably rapid consumption growth rate in the fourth quarter. The intervention remains in place for 2010 quarter 1 then vanishes in quarter 2.
While Investment growth was negative in the fourth quarter, we forecast positive growth through the next two years due mostly to inventory building and equipment/software investment.

Our trade forecast has little impact on the future evolution of GDP as it remains relatively constant at just under a $400 billion dollar deficit for the forecast horizon.
The final major expenditure component of GDP, Government expenditures, is assumed to contract during the next two years. This is due to the state and local segments of the public sector, which are two-thirds of government. Because state and local governments have constitutional balanced-budget requirements, and revenues are weak in most localities, we reflect these fundamentals in the public sector expenditure forecast.

Despite our efforts to boost our GDP forecast, it is still weak relative to the Wall Street Journal consensus. Hopefully, February’s job strength is maintained for some number of months so that we can raise our forecast relative to consensus when we publish again in June.

With GDP growth at 2.5 percent and anemic job growth we might presume that third quarter labor productivity was strong and that was corroborated by Labor Department statistics that were published Wednesday. They reported that third quarter productivity rose 2.3 percent, which followed a 2 percent decline during the second quarter.

Our recent economic forecasts have been decently close on job growth but pessimistic on GDP growth, which means that we are missing strength in labor productivity. As we prepare for our next United States and California Economic Forecast release December 15, we are keeping this in mind.

The three of us were the lineup at last year’s event.  Pausen and Roberts were optimistic, and I was not.  I was correct, and they were not, and that is a problem.  My wife will tell you that, in spite of my antiquity, I have the emotional maturity of about a 12 year old.  My natural inclination is to get to the lectern, turn to my colleagues, put my thumb on my nose, waive the fingers above my hand, and say “Nanner nanner told you.”

Of course, that would be unacceptable, and not because of professional standards.  Professional standards can be violated, if your timing is good, you smile, and you use the right tone of voice.  The real problem is that I live in a glass house, and one of the things I learned from my father was that people who live in glass houses shouldn’t be tossing stones.  As sure as the sun will come up in the morning, I’ll be the one who’s wrong one day.  It is the nature of the forecasting business.  It has to be.

So, I’ll be polite,….but you can bet I’ll find a way to enjoy the moment.

In other labor market indicators, long term unemployment levels rose from 6.72 million to 6.76 million people and the unemployment rate fell a bit from 9.9 to 9.7 percent. From the establishment survey, we see that Construction, Retail Trade, Information, and Financial/Real Estate continue to lose jobs.

This is exactly in line with our U.S. economic forecast. Our forecast is weaker than consensus because we believe that fundamental weaknesses still remain. The fundamental domestic weaknesses include: residential real estate, commercial real estate, banking, and household balance sheets. There are also foreign weaknesses, especially in Europe. Each of these job-losing sectors, except the Information sector, is related to the fundamental domestic weaknesses. Unfortunately, we believe that a conservative economic forecast is the most accurate one.

Government consumption and investment expenditures declined by 1.8 percent, driven by a 3.8 percent decline in State and Local Government. Federal Government expenditures, both defense and non-defense, were up modestly. (State and Local Government expenditures are 60 percent of Government spending.)

Exports grew about six percent while imports grew about nine percent.

This press release is based on preliminary data and will be revised. However, it appears to indicate a few things:

• Residential real estate investment is not out of the woods yet
• Commercial real estate investment is also not out of the woods yet
• The strength of consumption and the weakness in disposable personal income imply that the savings rate is falling. This has at least a few implications:
o If the household sector does not rebuild its balance sheet future spending will be weak
o The decline in the quantity of loanable-funds, other factors being equal, would contribute to a rise in interest rates. This does not necessarily imply that rates will rise, as this is just one of many factors impacting interest rates at this time.
o Household default rates and personal bankruptcies will remain high
• In contrast to the fourth quarter of 2009 where trade boosted the economy, trade was a drag on the economy in the first quarter of 2010
• It is difficult for the Federal Government to spend enough to offset the declines in State and Local government spending, thus negating the Federal Keynesian-style fiscal expansion policy