Economic Indicators | Economic Growth

Inventory blip boosted growth but won’t last

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GDP Picture for January 29, 2010

by Josh Bivens with research assistance from Kathryn Edwards

The Commerce Department reported today that gross domestic product (GDP) grew at a 5.7% annual rate in the fourth quarter of 2009, the second consecutive quarter of growth and the largest gain since 2003. In the previous quarter, the economy grew at a 2.2% annualized rate. GDP is the total market value of goods and services produced in the U.S. economy, and it is generally considered the most comprehensive measure of economic activity.

While this headline figure of 5.7% is strong, it must be taken with several grains of salt. First, given the depth of the jobs-hole the recession has left (10.6 million needed to just bring the economy back to its immediate pre-recession unemployment rate), growth of even 5.7% sustained for an entire year would likely knock only a percentage point off of today’s 10% unemployment rate. Even if the economy sustained this growth for the next three or four years this jobs-hole would still not be totally filled in.

This growth will likely not be sustained for anywhere near that long. Over half of this quarter’s growth, 3.4 percentage points, was due to rising inventories. Given that inventory changes are one of the more volatile components of GDP, and that short-term maintenance of inventories are common at the beginning of recoveries, this inventory contribution, while welcome, will surely not provide a sustained boost to GDP growth throughout the coming year. Final sales (GDP with inventory changes stripped out) grew only 2.2% in the quarter.

A measure of the strength of demand coming from U.S.-based households and businesses (final sales to domestic purchasers, a measure that excludes export growth and includes import growth) grew at only a 1.7% rate in the quarter, actually decelerating from the third quarter growth rate of 2.3%. In fact, this quarter saw the largest divergence since 1987 between the overall GDP growth figure and the growth rate of domestic demand. In short, nothing about today’s report should lead to upward revisions in forecasts for economic growth over the next year, which generally hover around the 3% mark. This projected pace of growth would likely not even drive the unemployment rate below 10% by the end of 2010.

It should also be noted that after the fourth quarter the contribution to growth from the American Recovery and Reinvestment Act (ARRA) will begin to quickly wane. For the fourth quarter, we estimate that ARRA added roughly 2.6 percentage points to the annualized growth rate and created or saved between 460,000 to 640,000 jobs. While the recovery act is performing almost exactly as advertised, the signs point to its impact ebbing well before the economy is near its pre-recession level of labor market health.

Personal consumption expenditures grew at a 2.0% rate and actually decelerated relative to the previous quarter when, buoyed by the cash-for-clunkers program, they grew at 2.8%. A more encouraging sign is that business spending on equipment and software grew at a 13.3% rate, up from 1.5% in the previous quarter. Before the third quarter of 2009, equipment and software investment contracted for six straight quarters.

Exports grew substantially faster than imports for the quarter (18.1% versus 10.5%, respectively), so net exports contributed roughly 0.5 percentage points to the final growth figures.

Federal government spending was essentially flat in the quarter, as defense spending fell at a 3.5% rate while non-defense spending grew by 8%. State and local spending fell for the second straight quarter, contracting at a 0.3% rate. State and local spending has contracted for four of the last five quarters as states try to fill budget holes with spending cuts. Without further fiscal relief to states, this large sector will continue to be a drag on overall growth.

While consumer spending on autos fell, total motor vehicle output contributed 0.6 percentage points to the final growth figures after an even stronger contribution in the third quarter. Given that motor vehicle sales reached historic lows during the depths of the recession, the overall health of this large sector could be key for a sustained recovery.

One encouraging sign from today’s report was the growth in personal incomes minus government transfer payments (e.g., nutrition assistance, unemployment insurance, etc.). This is a very rough proxy of household income growth generated by the private sector. The fourth quarter of 2009 saw 1.1% growth, the first in this series in a year. Despite this growth, however, the level of personal incomes minus transfers remains below the level that prevailed in the first quarter of 2006. In short, personal incomes not buoyed by government transfer payments are lower today than they were almost four years ago.


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