No cause for relief—austerity will indeed drag hard on the economy in 2013 and 2014

The normally excellent Neil Irwin and Ylan Q. Mui at Wonkblog are mostly wrong, I think, in arguing that the economy is “holding up surprisingly well” in a year of austerity. The data they cite to make this judgment are rising prices in both the stock market and home prices and falling gasoline prices.

But rising stock prices are actually pretty irrelevant to most American families, and today they mostly reflect the stunningly high profit margins of American corporations. These profit-margins in turn are boosted by extremely weak wage-growth, as inflation-adjusted wages for the vast majority of American workers have fallen in each of the last three years. In short, one could easily make the case that today’s high stock prices are actually mostly a sign of bad news for American workers.


Rising home prices do indeed spur consumption across the board. But given that today’s home prices are in line with long-run historical averages, and given as well that we know bad things happen when these prices rise above their long-run historical averages and people begin borrowing against their appreciated home equity, rising home prices are, to me, a sign of worry, not celebration. A part of the macroeconomic bundle that led to the crisis was a sharp fall in the personal savings rate, as people bought consumption gains by  borrowing against the value of their homes (as opposed to being able to purchase these consumption gains with robust wage-increases). And guess what? Last quarter’s modest-but-decent growth in consumption spending was accompanied by a large fall in the savings rate, as it reached its lowest level since before the Great Recession began.

Falling gas prices do indeed free up room for more consumer spending on other goods in the near-term, but I think everybody would agree that these declines really shouldn’t be relied on going forward.

Irwin and Mui also note that the growth rate in the first quarter of this year slightly exceeded recent year averages. But part of this was a simple bounceback from the dismal growth from the last quarter of 2012—and both quarters can be largely explained (for good and bad) by the very volatile (and trivial over the long-run) business inventory component of the economy. Below is a graph showing final demand growth—GDP growth  minus the influence of changing business  inventories—in recent quarters. There’s really not much to see  in the first quarter of this year that should drive optimism.

final demand


Finally, the labor market remains dismal. As Irwin himself has noted, the employment-to-population ratio of workers between the wages of 25-54 (probably EPI’s favorite “desert island indicator”) remains deeply depressed and has recovered very little of its fall during the Great Recession.

The desire to find some good news is understandable, but there’s very little in recent data to suggest that the economy can overcome the drag of austerity and provide a real recovery anytime soon.