January 31, 2015
The Commerce Department reported that GDP grew at a 2.6 percent annual rate in the fourth quarter, roughly a half point below most forecasts. This brought growth for the year (fourth quarter to fourth quarter) to 2.5 percent, a modest slowing from the 3.1 percent rate in 2013. Since GDP is the broadest measure of overall economic activity, the weak quarter and weak year-round performance might seem to fly in the face of all the upbeat news we’ve been hearing on the economy recently. But, most news coverage seemed determined not to let the data spoil the story.
For example, the Post told readers:
“For all of 2014, the U.S. economy grew at a 2.4 percent pace — a relatively dreary number much in line with the previous years of a long recovery. But that number is somewhat misleading: A brutal winter in the northeast led to a sharp contraction in the first quarter. Since then, the nation has seen its best nine-month stretch of growth since 2003 and 2004.”
Actually, instead of the 2.4 percent (I get 2.5 percent) pace being misleading, the comment about the next 9 months is misleading. The economy shrank a 2.1 percent annual rate in the first quarter, a drop that was clearly in large part due to the weather. However the strong growth reported for the next two quarters was in large part due to the first quarter shrinkage.
To see this point, assume that the actual rate of growth in the economy is 2.8 percent annually, or 0.7 percentage points a quarter. Now suppose that the economy goes into reverse in a quarter due to weather so that we show that it shrank 0.5 percentage points (2.0 percent annual rate). If the economy returns to its trend path in the following quarter, then it will grow by 1.9 percentage points (0.7 percentage points for the quarter’s trend growth, 0.7 percentage points for the first quarter, and 0.5 percentage points to make up for the drop). This 1.9 percentage point quarterly growth translates into roughly a 7.6 percent annual rate.
This exercise is overly simplistic, but that is basically the story of the rapid growth in the second and third quarters. This growth cannot be understood without reference to the decline in GDP in the first quarter.
The NYT seemed to largely ignore the data altogether, with a lead paragraph telling readers:
“Powered by healthy spending from increasingly optimistic consumers, the American economy is emerging as an island of relative strength in the face of renewed torpor and turmoil elsewhere in much of the world.”
Wow, 2.5 annual growth! That should embarrass China with its 7.4 percent growth. Those interested in comparisons with our own past recoveries should know that growth averaged 5.2 percent over the three years 1976-1978 and 5.4 percent over the years 1983-1985. Still feel like celebrating?
Looking a little deeper, inventory accumulations added 0.8 percentage points to growth as final demand grew at just a 1.6 percent annual rate in the fourth quarter. This will be a drag on growth in future quarters since inventories will almost certainly not continue to accumulate at the same pace, which was extraordinarily rapid.
There was also much praise for the strong growth of consumption, which virtually all the economists cited expected to continue. This seems unlikely. The strongest component of consumption for both the quarter and the year was durable good sales, primarily driven by auto sales. Car sales have indeed bounced back sharply. The problem is that high current sales make continued strong growth less likely. The 2014 sales rate was more than 2 percent above the 2007 sales rate. While it certainly can go still higher in 2015, it is unlikely to go much higher. In other words, it is not likely that we will see large increases in car sales in 2015 from 2014 levels.
The other part of the story is that consumption can only outpace income growth if consumers save less. (Sorry folks, this is definitional. If people consume more, they save less, and vice-versa.) As folks may know from reading other articles in the newspapers, most families have very little saving. This applies even to the baby boomers who are near retirement, if they have not already retired. The middle quintile of households headed by someone between the ages of 55–64 had just over $170k in wealth according to the 2013 Survey of Consumer Finance. (This figure includes equity in a home and holdings in defined contribution retirement accounts.)
The current saving rate is 4.6 percent of disposable income, a very low level by historical standards. Those predicting that consumption will continue to grow rapidly are predicting that the saving rate will fall further in 2015, meaning that our near retirees are likely to see little, if any, improvement in their wealth status.
Of course they may expect more rapid income growth for ordinary workers, but if so, other data released on Friday should dampen those hopes. The Labor Department reported that its employment cost index rose by 0.6 percent in the fourth quarter, down slightly from a 0.7 percent increase in the third quarter. While the decline is too small to pass any test of statistical significance, clearly wage growth is not accelerating. So if there is some basis for thinking that ordinary workers are about to see a surge in income, it is not clear what it could be.
All of this should not be taken as gloom and doom. The economy is growing, more people are getting jobs and the labor market is tightening. But the reality is that we still have a far way to go to make up the damage from the downturn and the pace of improvement remains very slow. The “happy days are hear again” stuff is just another story of irrational exuberance.
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