Department of Economics
& Tornado Alley
Current Economic Conditions
in the U.S. (July 2011)
On June 24th the Bureau of Economic Analysis (BEA) published its third estimate of the real GDP for the first quarter of 2011. According to that estimate the real GDP of the U.S. increased 0.475 of 1 percent over its level in the fourth quarter of 2010. If this 0.475 of 1 percent quarterly growth rate were to continue for four quarters the increase would be 1.915 percent growth. This is not a notable rate of growth. The 1.9 percent percent rate of quarterly increase for the first quarter of 2011 is in contrast to the 3.2 percent growth rate in the fourth quarter of 2010 and 1.8 percent in real GDP for the third quarter of 2010. It should be noted that the growth rate in the first quarter of 2010 was 3.7 percent and in the preceding quarter, the fourth quarter of 2009, it had been 5.0 percent. Thus increases in the growth rate are not permanent and trends do not necessarily continue. The growth rate of the economy is volatile. And, while any increases in real GDP are welcome they are not sufficient to reduce the pool of unemployed.
To put the changes in perspective the change in real GDP between 2010IV and 2011I was that $15.9 billion more goods and services were produced in the first quarter of 2011 than the fourth quarter of 2010. In the grand scheme of things $15.9 billion is not a big deal. Even when it is put on an annual basis by multiplying by 4 it is not a big deal.
Some of the weak spots in the economy that were strengthening are not continuing to strengthen. Businesses, which in 2009 had been consistently selling off inventory without replacing it, were, prior to the fourth quarter, making substantial positive investment in inventory. In the third quarter of 2009 the rate of disinvestment was $139.2 billion ($2005). That is to say, businesses were selling off inventory and purchasing $139.2 billion less that they sold. As terrible as this was, it was an improvement over the rate in the 2009 second quarter of $160.2 billion ($2005) disinvestment per year. In the first quarter of 2010 businesses began replenishing their inventories. The investment in inventory was a positive $44.1 in the first quarter, $68.8 billion in the second quarter and $121.4 billion in the third quarter. Then in the fourth quarter this investment in inventory dropped to $16.2 billion per year. In the first quarter of 2011 the investment rose, but only to $55.7 billion per year.
The investment in plant and equipment by businesses started to drop precipitously in the fourth quarter of 2008. This is what produced the recession of 2009. This investment continued to drop during 2009. This drop reflected declining business confidence about the future of the economy. By the fourth quarter of 2009 business investment in plant and equipment was down to $1278.3 billion ($2005). The peak of such investment was the $1603.7 billion achieved in the first quarter of 2008. In 2010 the investment in plant and equipment increased. By the fourth quarter of 2010 this investment was back up to $1403.1 billion. It is notable however that the increase from the third to the fourth quarter was only $25.9 billion compared to the $32.7 billion increase from the second to the third quarter. For the first quarter of 2011 that increase fell to $11.8 billion on an annual basis.
What the Administration has failed to recognize and accept is that business investment is sensitive to uncertainty. When the Administration takes some step intended to encourage investment the fact that that step creates worry about what the next step will be can offset the positive effect of the step itself.
Below are given the economic changes that occurred in the four quarters of 2010 and the first quarter of 2011.
|The Quarter-to-Quarter Changes in the
Components of Real GDP in 2010 and 2011
(Billions of $2005)
|State & Local||2.3||2.9||−3.3||−11.9|
The changes in 2010 were changes involving recovery but at a moderate rate. The change for the first quarter of 2011 was a slowing of the recovery.
Even if the output recession has ended the unemployment rate will continue at its current high rate and may well increase.
The total change for a component of the real values cannot be derived by adding up the changes in the subcomponents because of the methodology used by the BEA. The real values for the components are separately computed using the current value figures and separate price indices. The BEA explicitly warns that the totals of the subcomponents will not necessary equal the value for the component.
Despite the fact that the changes in the subcomponents cannot be exactly related to the change in the component one can still see generally where the major part of the change in real GDP comes from.
Consumers' purchases in 2010 increased in all general categories; durables goods, nondurable goods and services. The level of personal disposable income in the fourth quarter of 2009 was $11,028.7 billion in current value dollars. In the first quarter of 2010 this had increased to $11,070.4 billion. This is an increase of 0.38 of 1 percent. The consumer price index for February of 2010 increased by 0.34 of 1 percent over its value in November of 2009. This means that real disposable income was roughly unchanged in the first quarter of 2010 over the fourth quarter of 2009. So consumers were increasing their real purchases at a rate of 3.6 percent per year out of a 0 percent increase in real disposable income.
A quick review of the current state of economy is in order at this point.
A macroeconomic review of the economy should start with real Gross Domestic Product. This is the output of final goods and services produced with the U.S. valued in the year 2005 prices. The quarterly figures are seasonally adjusted.
The picture was remarkably smooth until the downturn in 2008IV. The variations in the growth rate from quarter to quarter are barely perceptible until the decline for 2008IV. The variations are there however, as shown in the graph for quarter-to-quarter growth rates which was shown previously.
There was an identifiable source for the slowing down of the economy which is revealed below. If any macroeconomic problem is developing it should show up among the various components of aggregate demand.
Barely noticeable until 2008III is a downward trend in gross domestic investment purchases, shown in red in the above graph. Almost always if there is a macroeconomic problem it is manifested in a decline in investment purchases. Therefore the levels of investment need a closer look.
The problem is clearly the decline in residential construction investment. This is not just a recent development. Residential construction investment has been declining since the last quarter of 2005. There was also a problem with the decline in inventory investment culminating with a net sell-off of inventory in the last quarter of 2007. Net inventory investment goes through some radical fluctuations. During 2006 the upward fluctuations in inventory investment offset some of the decline in residential construction. In 2007 the downturn in inventory investment coincided with the continuing decline in residential construction.
In previous recessions the source of the problem was a decline in the investment in plant and equipment. In the 2009 recession the level of business investment in plant and equipment, shown in the graph as Equipment & Software and Nonresidential Structures, was not declining up until 2008III. It declined only after a barrage of pronouncements that the economy was in a recession and that it was going to be a long one and hence any company that continued to increase its productive capacity would be foolish. Thus the crisis in the financial markets due to the effective bankruptcy of Fannie Mae and Freddie Mac in September of 2008 induced fear in businesses that any increase in their productive capacities would be wasted. The decline in the production and purchases of automobiles and residential housing supported that fear.
It is notable that the price level declined in the fourth quarter of 2008 by about 1.0 percent or 4.1 percent on an annual basis. This raised the real rate of interest by about 4.5 percent. This means that despite the nominal rate of interest being low the real rate increased significantly. This could account for some of the decline in investment in plant and equipment, but the price deflation was probably an effect of the output recession rather than a cause of it.
Whereas between 2008II and 2009II real GDP ($2005) declined by 3.83 percent, investment in plant and equipment declined by 19.7 percent. The selling off of inventory and not replacing it (negative inventory investment) increased by $123.1 billion ($2005) over this period. This $123.1 billion decline in inventory investment along with the $569.8 billion ($2005) decrease in investment in plant and equipment accounts for 135 percent of the $513.8 billion ($2005) decline in GDP over that period.
The investment in residential structures has been steadily declining since 2006I. The problems of this sector are separate from the recent recession. However this continued decline contributes to the decline in demand for U.S. output.
The decrease in investment in residential housing over the period was $118.5 billion. This amount along with the declines in investment in plant, equipment and inventory accounted for 158 percent of the decrease in real GDP in the recession. There were other declines, such as $162 billion in consumer purchases, and some positive influences, such as an increase in net exports of $145.6 billion. (This was an increase from −$476.0 billion to −$330.4 billion.) Government purchases increased by $61.7 billion ($2005). The point is that the real economic problem is in private investment.
The one-shot gimmicks to increase demand will be accepted gladly by business but they will not encourage businesses to investment in increased capacity. Businesses realize that the temporary stimuli will not be there in the future. They may only help them sell off existing inventory. The only measures that have a chance of encouraging businesses to replace inventory and increase productive capacity are the ones which are permanent.
In the past there were decreases in investment in plant and equipment which led to recessions and the recessions were then declared. In 2008 a recession was declared and as a result of the financial chaos of September 2008 businesses accepted this declaration and began to reduce their investment in plant and equipment and sell off inventory without replacing it. Now it is necessary to unconvince businesses of there being a recession which will continue for the foreseeable future. As pointed out above the reduced value of investment in plant, equipment and structures along with the disinvestment in inventory was enough in themselves to keep the economy in serious recession.
There is a persistent worry among politicians and the general public about international trade. In particular the general public interprets the decrease in the value of the U.S. dollar with respect to other currencies as evidence of a deterioration in the U.S. economy. On the contrary the decreased value of the dollar has reduced the U.S. balance of trade deficit. Countries often devalue their currencies to stimulate their economies. China has maintained about a 400 percent undervaluation of its currency to ensure that no one in the world will be able to underprice its products.
The recent past the level of U.S. imports has exceeded its exports by about a half trillion dollars per year but since the third quarter of 2006 this deficit has been declining. The figure for 2009II indicates a decrease in the trade deficit of 55 percent compared its value in 2006I.
The levels of purchases by the Federal and the State & Local governments after having continued what seemed to be an inexorable rise declined slightly in 2009 and remained level in 2010. This was largely in purchases by state and local governments, probably due to a decline in their tax revenues. Federal defense expenditures also declined slightly, due to factors unrelated to the recession.
Consumer purchases also tended to have a steady, regular rise, until after the financial crisis of September of 2008. However, as shown below, consumer purchases of durable goods, nondurable goods and services went up slightly in 2009 up slightly in 2010.
It is very significant that the decline in demand for U.S. production is was primarily in private investment.
It must be noted that these statistics, although stated in dollar amounts, reflect the volume of consumer purchases rather than the actual expenditures on the items. There is a general concern about particular items such as gasoline. The following is a graph of the nondurable purchases shows, among other things, that purchases of energy products such as gasoline and fuel oil have been declining in recent quarters, due to higher prices, but in 2008IV and 2009I went up slightly, due to lower prices.
Generally consumer nondurable purchases, in real terms, went up in 2009I, back down in 2009II and then up in 2009III and thereafter.
Consumer durable purchases generally have been increasing but there was a significant decline in the fourth quarter of 2005 and a downward trend in 2007 which continued through the third quarter of 2008. This downward trend is primarily due to the decline in motor vehicle purchases but there has also been a slight decline the purchase of household equipment such as television sets, furniture and electronic devices but this decline was only from 2008II to 2008III, after the impact of the 2008 tax rebate was felt in the second quarter. The impact of the tax rebate will be considered in more detail later. However there was an upturn in durable goods purchases in 2009I, even in motor vehicle purchases.
This points up the fact that the current recession is now based up on the decline in businesses investment purchases which was brought about by the public promotion of pessimism about the future of the economy.
The purchase of services now involves a greater dollar amount than the purchases of durable and nondurable goods combined. The trends in the levels of some services are of special interest. Note once again that the trends are in the quantities rather than the levels of expenditures.
The nature of housing services requires some explanation. Housing services includes the expenditures for rent but also an imputed value for the owner occupied housing.
The amount of medical services consumed continues to increase at an extraordinary rate. The graph displays the trend in the quantity of medical services. This apparent trend in the quantity of medical services provided may reflect a finer and finer division of the billing of medical services. In the past medical diagnostic procedures were performed and interpreted in one office visit; now there is one office visit for the procedure and a second one to get the interpretation of the results. This would show up as a spurious increase in medical services provided. Also the trend in the cost of medical services is not shown in the above graph.
It is notable that Americans spend about one hundred and forty percent more on medical services than on food purchases and about one fourteen percent more than on housing. Clearly something is amiss in the matter of medical care in America and the public subsidy of medical care is not solving the problem but instead making it worse.
Around 1900 America allowed the medical profession to create a cartel arrangement in which the production of doctors was artificially restricted. Medical schools were bullied with a threat of the loss of their accreditation into cutting their admissions to a fraction of what they had been. The reduced supply of doctors resulted in substantially increased income for doctors. However even though the medical profession created the opportunity for economic rents those rents did not entirely stay with the doctors. Medical schools increased the prices of their services so that doctors typically begin their practice with enormous debts from their medical education.
By cutting back the supply of doctors the cartel arrangement was able to create monopoly prices. The public subsidy of medical care just meant that the monopoly prices went even higher. The inadequate supply of doctors resulted in doctors being overworked and hence having little time to mull over the conditions of their patients. For more on this topic see Medical Cartel. For material on the high cost of pharmaceuticals see Pharmaceuticals.
Up until the fourth quarter of 2008 the only major component of consumer demand that was faltering was the purchases of motor vehicles. However there were components of investment demand which are closely connected with consumer demand which were faltering. These are residential housing construction and net investment in inventories. Up until the financial crisis prompted by the bankruptcy of Fannie Mae and Freddie Mac in September 2008 there is no evidence of an output recession. Even the slight and not statistically significant decline in real GDP from the second quarter of 2008 to the third quarter is easily accounted for by the fading out of the effect of the 2008II tax rebate. There was an employment recession but that subject to different causes than an output recession. See Employment Recession.
The output recession began with the effective bankruptcy of Fannie Mae and Freddie Mac in September of 2008. That led to the collapse of some financial enterprises and the bailout of others. The collapse did not have to go beyond those firms. However because the declared bankruptcies of Fannie Mae and Freddie Mac by their managements were unexpected by the markets there ensued a widespread panic among stock market investors which led to sharp declines in stock prices. This in turn brought further panic and a loss of consumer and business confidence in the future of the U.S. economy. Business investment in increased capacity is highly volatile. If businesses perceive no need for increased capacity then their investment purchases can go to zero. When consumers become pessimistic about the economic future they may reduce their purchases a few percent; business investors faced with the same circumstances eliminate all of their purchases.
In 2008IV business investment in plant and equipment to increase productive capacity dropped 5.9 percent compared to 2008III; this is an annual rate of decrease of nearly 24 percent. In 2009I this investment dropped 10.9 percent compared to the level in 2008IV, an annual rate of 43.5percent decrease. This could be characterized as the level of investment in plant and equipment being in freefall.
In contrast, after the financial crisis of September 2008, consumer purchases decreased only 1.1 percent between 2008III and 2008IV and went up 0.5 of 1 percent in 2009I. Clearly the problem is business confidence. Politicians have focused on saving financial institutions so that they can lend funds to those who want to make investments in increased capacity. But who would want to borrow to increase capacity in a recession. The media and politicians with their proclamations of RECESSION!! in early and mid-2008 destroyed business confidence and brought about a real recession. It remains to be seen whether business confidence can be revived. Business confidence is like a balloon and it is pretty difficult to unpuncture a balloon.
For more on the global impact of the 2009 recession see Global Recession and Global Recovery.
Currently (2011) the economy is growing but not robustly and there is still weakness in the elements of business investment. Gross Private Investment is still only 79 percent of what it was in the first quarter of 2006. Investment in inventory which was fueling the recovery dropped to a negligible level in the fourth quarter of 2010. It has returned to significant levels in the first quarter of 2011 but not to the levels it reached in the second and third quarters of 2010. The Administration can very easily offset everything that it does to stimulate the growth of the economy by creating uncertainty about its future actions and policies. Uncertainty about present and future government policies strongly discourages investment in plant and equipment.
HOME PAGE OF Thayer Watkins