Pre-empting the Irrational Exuberance Over Strong Economic Data

July 07, 2015

Dean Baker
Al Jazeera America, July 7, 2015

View article at original source.

Economists and economic reporters often get carried away about short-term movements in the economy. The problem is that they often assess economic data without considering the larger economic context. This can lead them to exaggerate the good or bad news about the economy. Since most economists and economic reporters move in herds, we can get dramatic tales of booms and busts in the business section that don’t correspond to anything in the real world.

We were treated to one such artificial boom late last year and at the start of 2015 based on positive economic data in the second half of 2014. For example, MSNBC headlined a web piece, “U.S. economic growth soars, reaches 11-year high.” Newsweek headlined a Reuters piece it ran, “Boom: U.S. economy takes off in the 3rd quarter.” The usually astute columnist Matt O’Brien told readers: “the economic boom is here to stay.”

This bout of euphoria quickly faded with the cold of winter. Suddenly we had pieces complaining that consumers no longer were prepared to spend like they used to. The Washington Post ran a piece speculating that consumer psychology had been permanently changed by the 2008–09 recession and people were just not prepared to spend like they used to.

The Wall Street Journal went a step further with one of its economics reporters writing a column to “stingy American consumers” begging them to spend more money because the economy is counting on them. The good news is that the latest data show that American consumers are spending more, although probably not as a result of the letter from the Wall Street Journal.

There is a simple explanation for this rapid switch from boom to bust, as well as for the original boom: the weather. The weather was unusually bad throughout the Northeast and Midwest this year. There was an unusually large amount of snow with major metropolitan areas like Boston hitting new records.

When there is a large amount of snow on the ground and the streets are blocked, people are less likely to do things like go out to dinner or shop for clothes at the mall. They are also likely to put off things like buying a car or looking for a new house. As a result, consumption is likely to be much weaker than would otherwise be the case.

It is important for this story that the winter is worse than normal. Boston gets snow almost every winter. This always discourages people from going out to eat and other types of consumption. However this is corrected in our data, which are seasonally adjusted. So it doesn’t matter that we get six inches or a foot of snow in the Northeast, that’s what is expected. It affects our data when we get six feet of snow, which was the case in Boston this year.

In short, the end of the boom and the subsequent slump in consumption was simply the result of an unusually bad winter. There was no problem of consumers’ psyche being permanently damaged by the recession. (As a side point, consumption is actually quite high relative to income, not low as is often asserted.)

It turns out that weather not only explains the end of the boom, but it also explains the boom itself. Just as an unusually bad winter gave us negative economic growth in the first quarter of 2015, the same thing happened in the first quarter of 2014. Bad weather led to a sharp slowdown in consumption spending and an actual decline in construction. In addition, a brief federal government shutdown caused government spending to shrink in the quarter.

The result was a decline in GDP of 2.1 percent in the first quarter of the year. But this decline virtually guaranteed sharp growth in subsequent quarters. After all, the people who put off buying a car in January or February because of the snow didn’t decide they weren’t going to buy a car, they just decided they would buy one later. In the second quarter, consumption of durable goods, the category that includes car and other expensive items like stoves and refrigerators, grew at a 14.1 percent annual rate. It grew at a 9.2 percent annual rate in the third quarter. This sort of uptick from an unusually weak quarter was the basis for the boom that widely touted in the business press.

This point is worth noting, because we are about to go down this path again. The decline in GDP in the first quarter was due to the weather, not the underlying weakness of the U.S. economy. This means that when the economy recovers from this shrinkage in the second and third quarter of this year, growth will be considerably faster than its trend rate since we are making up the ground lost in the first quarter.

This is a totally predictable story for anyone who follows the economy closely. Unfortunately, many of the people who write and speak about the economy don’t follow it closely. As a result, we are likely to hear much talk about the economy’s extraordinary growth and a new boom in the second half of this year. Be prepared to ignore it.

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