October 29, 2004
GDP growth fueled by consumer debt, defense spending
The nation’s output (gross domestic product, or GDP) grew at a less-than-expected rate of 3.7% in the third quarter as surges in both auto sales and defense spending were somewhat offset by disappointing investment and trade numbers in the report issued today by the Bureau of Economic Analysis. Consumers cut their saving to a record low 0.4% of after-tax income to increase their auto spending at a 27% annual rate. Economy-wide demand rose at a hefty 4.6% rate, but output growth was pulled down by a higher trade deficit and slower inventory growth. After rearing up to the 3% range in the first half of 2004, inflation fell back below a 2% rate for the third quarter.
Consumer demand continues to be propelled by debt rather than strong income. Consumers increased spending at a 4.6% rate in the last quarter, far above the 1.4% gain in real after-tax personal income. The last three and a half years have seen remarkably weak growth in income—particularly wage and salary income. In the last seven business cycles that have lasted as long as this one, consumption has grown at an average annual rate of 3.6% for the 14 quarters following the business cycle peak, roughly the same as the 3.4% growth in both pre-tax and after-tax income. In this cycle, consumption has grown at a 3.2% rate—somewhat slower than in past cycles, but much faster than the 1.3% growth rate of pre-tax income. Cuts in taxes (financed by government debt) have allowed after-tax income to rise at a 2.6% rate. Increased personal debt has allowed consumption to grow at the still faster 3.2% rate. Aggregate wage and salary income has increased at a pace of 0.4%, in contrast to the 2.9% pace of past cycles.
The rising trade deficit continued to pull down GDP growth by at least 0.6 points for the fourth consecutive quarter. Imports are now running 15.4% of GDP—far above exports, which are only 10.1% of GDP. The dollar has come down from its peak in early 2002, but not against the currencies of important Asian countries that have rising trade surpluses with the United States.
Defense spending rose at a 9.3% annual rate in the quarter and contributed 0.4 percentage points to the quarter’s 3.7% growth.
The slowdown in inflation provided some good news. In the first half of 2004, inflation was running at a 3% rate for domestic production and at a faster 3.5% rate for domestic purchases (largely because of higher imported oil prices). In the third quarter, prices of domestic production slowed to a 1.3% rate and prices of purchases slowed to a 1.8% rate.
The 3.5% growth rate of the last two quarters is sub-par for an economy with so much slack in the labor market and in industrial capacity. The economy generated only 100,000 jobs a month during the quarter—too slow to tighten the labor market or to generate strong growth in personal income. As a result, the strength in consumer spending has depended upon squeezing saving almost to zero and raising debt loads. This expansion of output can be sustained only if we pick up the pace of jobs and incomes.
Written by EPI Research Director Lee Price with research assistance from Yulia Fungard.
To view archived editions of GDP PICTURE, click here.
The Economic Policy Institute GDP PICTURE is published quarterly upon release of the Bureau of Economic Analysis’ quarterly GDP report.
EPI offers same-day analysis of income, price, employment, and other economic data released by U.S. government agencies. For more information, contact EPI at 202-775-8810.
