The Department of Commerce reported today that gross domestic product (GDP) – the value of all final goods and services produced in the United States – rose at an annualized rate of 3.2% in the first three months of 2010. This follows a 5.6% annualized growth rate in the last quarter of 2009.
The largest contributions to growth came from personal consumption expenditures, which added 2.6 percentage points to growth, and a rise in inventory investment, which added 1.6 percentage points. Perhaps the most encouraging sign in the report is the second straight quarter of growth in equipment and software investment, adding 0.8 percentage points to overall growth.
However, there are reasons to temper enthusiasm about today’s numbers. For one, the large contribution to growth stemming from inventory investment is unlikely to persist for many more quarters to come. Final sales—a measure stripping out the inventory contribution and thought to be a more reliable measure of underlying trends in the economy—rose by 1.6%. For another, the solid boost to growth over the past two and half years resulting from a closing trade deficit seems to be fading. Net exports fell in the quarter and subtracted 0.6 percentage points off of this quarter’s growth rate. This decline seems to ratify a trend of ever-weaker contributions from this sector to overall growth. In essence, trade flows acted as a very useful shock-absorber since the recession began, but it doesn’t seem that trade will continue to play this role as the recovery really gets underway.
Perhaps most worrying for future growth is that state and local government spending declined for a third straight quarter, and knocked a full 0.5 percentage points off of overall growth in the quarter. The last time state and local spending fell for nine straight months was from the third quarter of 2004 through the first quarter of 2005. This decline is surely in part a function of the extreme fiscal crisis facing states. Given balanced budget rules at the state-level, this implies that states will be cutting spending and/or raising taxes for years to come and hence exerting a powerful drag on growth. Fiscal relief to states from the federal government would be very useful to lessen this drag.
Inflationary pressures remained essentially flat in the first quarter, with the market-based “core” deflator for personal consumption expenditures (a closely watched indicator of inflationary pressures) rising at a yearly rate of 1.2% since the first quarter of 2009.
Even with this tame inflation, however, inflation-adjusted personal disposable income remained unchanged from the previous quarter. With flat disposable personal incomes, consumer spending can only rise if savings rates fall – which they did this quarter, declining to 3.1% from the previous quarters’ 3.9% and a recession high of 5.4%. A recovery that relies on savings rates retreating back to their pre-recession minimums would be extremely fragile.
However, even if today’s reported growth rate (which probably won’t be sustained in coming periods) was sustained for three years, the unemployment rate would still likely be higher than the peak rate (6.3%) of the 2001 recession and jobless recovery. Given that sustained, high unemployment puts severe downward pressure on wages, it is hard to see where the private demand for goods and services necessary to drive a durable recovery will come from without ever-retreating savings rates. This situation argues strongly for the federal government continuing its efforts to sustain economy-wide demand until the private sector looks ready to take the lead.
Sustaining such demand will require further action from Congress and the Obama administration – most estimates of the effect of the Recovery Act show that while it added 1-2 percentage points to the most recent quarter’s growth rate, its average contribution for the rest of 2010 will quickly fade to zero.
Unfortunately, the recession was so deep that unemployment is likely not to hit its peak until sometime in 2010. This argues strongly that private spending will be insufficient and that further policy action is necessary to keep the economy moving strongly in the next couple of years.
Today’s report shows that the economy is much stronger than it was a year ago. The first quarter of 2009 saw the end of a six–month period during which the economy had contracted at a historically fast 5.9% average annual rate. The first quarter of 2010 has seen the economy grow at an annual rate of 4.4% for the past six months. This is a huge swing in the economy’s fortunes. Yet it is still not enough to ensure that recovery in the jobs market will be acceptably fast – absent further action on jobs, the economy will see elevated unemployment rates for years to come.