Commentary | Economic Growth

GDP Preview: The parachute deploys as Recovery Act takes hold

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Update: See EPI’s GDP Picture for July 31, 2009

A July 31 Commerce Department report is expected to show that the U.S. economy contracted at a 1.5% annualized rate in the second quarter of 2009, according to a consensus of Wall Street economists polled by Dow Jones Newswires. If their forecasts are accurate, it would be a substantial improvement over the previous six months, when the economy contracted four times as fast — at a 6% annual rate.

A substantial portion of the improvement registered in the second quarter can be attributed to the effects of the American Recovery and Reinvestment Act (ARRA). Both Goldman Sachs and Mark Zandi of Moody’s have estimated that ARRA added approximately three percentage points to growth in the second quarter. Both of these estimates are confirmed by the Economic Policy Institute’s own calculations.

A second quarter annualized GDP contraction of 1.5%, instead of the 4.5% contraction that would have occurred without the Recovery Act, translates into approximately 720,000 jobs that were created or preserved as a result of the ARRA. Given that actual job loss in April, May, and June of this year totaled 1.3 million, this means that job loss would have been more than 50% higher without the moderating influence of ARRA.

Essentially, most forecasters assume that were it not for stimulus funds provided under the Recovery Act, the economy would have continued to contract during the second quarter of 2009 at a rate roughly in line with the previous six months. A GDP report showing a notable slowing in the rate of contraction would indicate that the recovery package is working at least as well as expected, and perhaps even a bit better. Goldman Sachs has actually revised upwards its expectation of ARRA’s effect on second quarter growth, given that its implementation has been faster than initially expected.

Unfortunately, the overall economy is in much worse condition than what was anticipated at the start of the year, when the Recovery Act was being crafted to create or save roughly 3.5 million jobs. Between President Obama’s election (when the debate over a recovery package began) and the signing of ARRA into law in February, roughly 2.7 million jobs were lost. This means that the underlying deterioration of the economy was so rapid that it swallowed the equivalent of 80% of the positive jobs effects of ARRA in the four months before its enactment.

Signs of ARRA’s impact in the upcoming GDP report are likely to be broad-based. The personal tax cuts and the one-time payment to Social Security recipients can be expected to raise disposable personal incomes by roughly $37 billion relative to the non-ARRA baseline in the second quarter. This should, unless there is another very large increase in the personal savings rate, lead to increased consumer spending.

Further, the cash transfers from the federal government to states should raise state and local spending $31 billion higher than it would have been without ARRA. However, even this substantial increase is not enough to fill the budgetary hole facing states. Cutbacks to state and local spending could remain a drag on economic growth for the near future. The size of this drag, however, is clearly much smaller than it would have been without the stimulus. These two influences, combined with anticipated increases in federal infrastructure spending (expected to have modest second-quarter effects that will greatly accelerate in the near future) may also serve to stabilize business spending on equipment and software, which shrank by an astounding 34% in the first quarter of 2009.

Although the GDP release on Friday is likely to confirm the boost the economy has received from ARRA, it will also confirm that the underlying trend in the economy is one of pronounced and prolonged weakness. While ARRA’s impact will start waning in mid- to late 2010, there is no guarantee that the broader economy will have fully recovered by that time. Even if GDP growth turns positive by then, most labor market forecasts predict that the unemployment rate at the end of 2010 will still be at least twice as high as it was in December 2007, the peak of the previous business cycle. In short, even when GDP begins to grow again, the necessity for fiscal relief and public investments will continue.

Update: See EPI’s GDP Picture for July 31, 2009