As expected, the economy grew more quickly at the beginning of this year than at the end of 2012, according to this morning’s GDP release. Real GDP was up at a yearly rate of 2.5% over the first quarter, compared to a mere 0.4% in the prior three months.
But only slightly beneath the surface, the report showed continuing weaknesses in the US economy and, consistent with the unexpectedly weak March jobs report, hints at another softening of demand in recent months. Expectations were for growth above 3% but disposable income, a critical driver of growth in our 70% consumption economy, fell sharply, down 5% in real terms, partly due the loss of the payroll tax break (another factor here is that income was elevated at the end of last year due to bonuses and tax shifting, so part of this is bounce-back).
The two main factors propelling the economy forward last quarter were firms restocking their shelves (inventory build-up adds to GDP growth) and strong spending by the stalwart American consumer, drawing not on their income but on their savings. Since the inventory component is both highly volatile and less indicative of current demand, it’s useful to look at final demand, essentially GDP without the inventory build-up. This measure grew 1.5% in real terms in the first quarter, down from 1.9% in the last quarter. Again, this less volatile measure tracks demand more closely than the headline number.
Given the slowdown in disposable income, accelerating consumer spending was partly financed by spending out of savings, as the savings rate fell two percentage points, to 2.6%, the lowest savings rate since 2007q4, the quarter in which the recession began. With diminished savings and the fading of stimulus measures like the payroll tax break, future consumer spending will depend more on income growth from jobs and wages, a potentially risky linkage, given recent slowing in the job market.
Housing continues to be a bright spot as residential investment was up almost 13% on an annual basis. Housing has now been a positive contributor to growth for two-years running, adding 0.3% to the 2.5% growth rate for the first quarter.
But the government sector more than offset housing’s contribution, shaving 0.8% off of the growth rate, with across the board declines in defense, non-defense, and state and local public spending. Since 2010q1, the public sector has, on average, taken half-a-percent from real GDP growth per quarter.
As opposed to the annualized quarterly numbers cited thus far, it’s useful to look at year-over-year measures of real GDP growth to get a flavor for the underlying trend in the data. As the figure below reveals, growth by this measure is down a bit over the last six months, with the economy growing slightly below its trend growth rate of around 2%. If this underlying pace of growth persists, it will be very difficult to generate the jobs needed to “legitimately” bring down unemployment rate (meaning through job growth, not through people leaving the labor force).
Though economic growth is reliably positive and key sectors, like housing, are improving, the virtuous growth cycle—where increasing demand begets more hiring which leads to broad-based income growth which further expands job and earnings opportunities—has never taken hold in this recovery, now over three years old. No small part of that outcome should be assigned to contractionary fiscal policy, evident in today’s report in both weak disposable income and the persistent drag from the government sector.