Previously published March 21, 2011
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.
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.
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.