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Real GDP rose at a 3.0% annual rate in the revised estimate for the first quarter, down from 3.2% in the advance estimate, although the story didn’t change much. This was the third consecutive quarterly increase in real GDP. More importantly, the economy appears to be transitioning to a more sustainable recovery, less reliant on the shift in inventories and the government’s fiscal stimulus, and supported more by consumer and business demand. Job growth, a key element in a sustainable economic recovery, has returned. Unfortunately, the economy still faces a number of headwinds in the near term.
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The National Bureau of Economic Research’s Business Cycle Dating Committee has yet to announce the ending date for the recession. Most likely, it will be June of last year. The end of the recession does not mean that everything is wonderful again. It simply acknowledges that the economy is no longer contracting. The job market is years away from a full recovery.
Data for April and early May suggest that the expansion has continued, albeit at a moderate pace, into 2Q10. Inflation-adjusted consumer spending, which accounts for 70% of Gross Domestic Product, was unchanged in April, but that followed strong gains in February and March. Moreover, the softness in April spending was due to a rebound in the savings rate. There’s a fair amount of noise in these data, and the early Easter may have had some impact, but inflation-adjusted consumer spending is likely to rise at a 2.5% to 3.5% annual rate in the current quarter. The key to sustainable growth in spending is job growth, which appeared to turn the corner in recent months.
Shipments of nondefense capital goods ex-aircraft, a rough proxy for business fixed investment, edged up just 0.2% in April (advance estimate). This softer increase followed gains of 2.3% in both February and March. So the April pause is not necessarily indicative of a recovery running out of steam.
Private-sector payrolls rose by 231,000 in April, following a 174,000 gain in March. These figures may be revised in the May Employment Report (due Friday), but they’re almost sure to remain positive. The hiring of temporary census workers is likely to have been huge in May (these jobs will be shed from June to September), boosting overall payrolls. Ex-census, payrolls are likely to have risen further – but we may see some moderation in the pace. Weekly claims for state unemployment insurance benefits have remained stubbornly high in recent weeks. This could be a reporting problem related to the extension of unemployment insurance benefits (if someone is employed briefly, then laid off again, the person would be classified as a new claim). Still, it’s not unusual to see an elevated level of job destruction and a pickup in new hiring. During the labor market boom in the late 1990s, job destruction was very high, but new jobs were created at a more rapid pace.
There are still a number of headwinds preventing the recovery from gathering a lot more speed. Problems in residential and commercial real estate will linger, although the impact should gradually decrease over time. Credit remains tight, especially for small firms (firms with fewer than 50 employees typically account for a third of net job growth during an expansion). State and local government budgets remain under severe strain, resulting in tax increases and cuts in government services, both of which dampen the pace of recovery. State and local government expenditures fell in the last two quarters, subtracting 0.3 percentage point from overall GDP growth in 4Q09 and 0.5 percentage point in 1Q10. The fiscal stimulus will ramp down into 2011, and the Bush tax cuts are set to expire at the end of this year. Uncertainty about tax policy is likely to dampen the pace of economic growth, and the stock market mood, in the second half of the year. However, when all these headwinds are added up, it’s likely that they will only cap the rate of recovery, not send us into a double dip.
Consensus forecasts for GDP growth over the next several quarters paint a moderately strong outlook. The latest survey from the National Association for Business Economics, for example, projects 3.2% growth this year and next. That sounds good, and in normal times, it would be good. Unfortunately, such a pace will not push the unemployment rate down by much. It will take a much stronger pace of growth to get the unemployment rate down significantly. The NABE consensus forecast sees the unemployment rate edging down gradually, staying above 9% into the middle of next year.
Meanwhile, core inflation measures continue to trend lower. There is no pressing need for the Fed to raise short-term interest rates anytime soon. That’s a good thing, considering the recent troubles in the global credit markets.
The European debt crisis encompasses many issues, including problems in the construction of the monetary union. However, the main catalyst has been concerns about government budget deficits (Greece, Portugal, Spain, Ireland). The solution, which should be considered a least-worse alternative, is austerity – cuts in government spending and tax increases for specific countries. Such moves dampen the pace of economic recovery and, in some cases, may lead to recession. The U.S. is not Greece. The U.S. budget deficit is currently very high (roughly 10% of GDP), but should decline as the economy recovers and temporary spending (the bank rescue and the fiscal stimulus) fade. The bigger problem for the U.S. federal budget deficit lies 10 to 20 years out, as Medicare expenditures are projected to surge. At the state and local level, budget deficits are leading to tax increases and cuts in government services. The trick will be to trim deficits without dampening growth too much.
Concerns about Greece’s budget situation have been simmering for several months, but reached a boiling point toward the end of April. Rating downgrades of the sovereign debt of Greece, Portugal, and Spain contributed to a widening in spreads in government bonds relative to German bunds and ignited worries that one or more countries could exit the euro. Fear begets more fear. A lack of clear, strong leadership seemed to make matters worse. Greece’s external debt is relatively small in the grand scheme of things. The bigger worry has been the risk of contagion. After Greece would come Portugal, then Spain, Ireland, and Italy. These last three represent a much more substantial risk to the big banks in Germany, France, and the United Kingdom.
On May 9, European finance ministers agreed to a stabilization fund, worth up to €500 billion, to be supplemented by an additional €250 billion from the International Monetary Fund (which brings the total size to roughly $1 trillion). Swap lines between the U.S. Federal Reserve, the European Central Bank, the Bank of England, the Bank of Canada, and the Swiss National Bank were reopened. These moves and the size of the EU/IMF stabilization fund caught speculators off guard – at least, for a day. A lack of details and the realization that the problems were still there soon sent global equity markets down again. The EU/IMF plan has merely bought some time. The challenge will be to use that time wisely. The response from global investors does not appear to be optimistic.
Aid to Greece was conditional on severe austerity moves, cuts in government pensions and wages. This led to protests in the streets – and the television images of these protests generated more concerns, particularly among U.S. investors. Austerity is also being self-imposed by the potential problem economies.
These countries are recovering from the global financial crisis. The last thing you want to see in a fledging recovery is tighter fiscal policy (higher taxes, cuts in government spending). That weakens the recovery. However, the prescription here is seen as the least-worse alternative. Financial conditions, and in turn, long-term economic growth, would be worse if these budget problems were not addressed. The bottom line is that we’re looking at a slower pace of recovery in Europe in the near term.
Budget issues aside, some of the worries about the euro go back to its construction. With its own currency, a country could devalue, making it more competitive. With a common currency, that’s not possible. In the U.S., fiscal policy can address downturns that are more severe in some states, but not in Europe. We could ultimately see a strong fiscal authority in Europe, but that’s not expected anytime soon.
In general, the level of exchange rates is not a major worry for policymakers. The key issue is the speed of adjustment. Sharp moves in the currency markets discourage global trade and investment. Intervention could provide temporary restraint on currency movements, but would have to be a coordinated effort. Interestingly, rumors about possible intervention were enough to check the dollar’s rise last week.
So how does the U.S. budget situation compare to Greece? Greece’s budget deficit had been projected to rise even further as a percentage of GDP in the years ahead. In contrast, the U.S. budget deficit is expected to fall to about 3.5% of GDP in four or five years, as the economic recovery leads to a rebound in revenues and temporary spending fades. Longer term projections are more worrisome. Demographic issues (the retirement of the baby-boom generation) may require minor adjustments to Social Security, but Medicare spending is projected to rise sharply (and this is nothing new, we’ve know about the problem for many years). We need a credible plan on how to deal with the situation in the years ahead.
State and local budgets in the U.S. remain under enormous strain, leading to tax increases and cuts in government services (which have subtracted a few tenths of a percent from GDP growth in the last two quarters). Revenues should improve as the economy recovers, but tough choices will have to be made over time regarding taxes and spending at every level of government. This implies that the pace of economic growth will be somewhat lower than it would be otherwise.
The European debt crisis is largely regional. There will be positive and negative effects on the U.S. economy – some weakness in exports to Europe, but the flight to safety has already lowered long-term interest rates and reduced oil prices, both of which will help aid the U.S. economic recovery.
The April Employment Report was surprisingly strong. Private-sector payrolls rose much more than anticipated and gains were broad-based across industries. The unemployment rate rose unexpectedly, but that was due to a surge in labor force participation. Still, this is just a start. We’d like to see much stronger job growth from here, but that doesn’t seem likely given the number of headwinds.
Nonfarm payrolls rose by 290,000 in April and figures for the two previous months were revised higher. Just 66,000 of the April increase in payrolls was due to the hiring of temporary workers for the census. Job growth continued in construction, manufacturing, and retail. Temp help employment continued to rise and average weekly hours edged higher, both consistent with an increase in hiring ahead.
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The unadjusted payroll figure was impressive, rising by 1.158 million from March (1.084 million in the private sector). Hiring typically picks up strongly in the spring. The April unadjusted gain in payrolls was the steepest in years.
The unemployment rate rose to 9.9% in April (9.863% before rounding), up from 9.7% in March. That increase does not signal weakness. Rather, labor force participation rose to 65.2% (vs. 64.9% in March). Many discouraged workers (who have given up looking for a job and aren’t officially counted as unemployed) begin to look for jobs again as the labor market starts to recover. The number of unemployed who were reentrants to the labor force rose to 3.7 million in April.
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Still, the unemployment rate has remained high in recent months and it will take much stronger job growth in the months ahead to push the unemployment rate down significantly. Even at a pace of job growth at 250,000 to 300,000 per month, it would take six or seven years to push the unemployment rate down to 5.0% again (remember, it’s not just the jobs lost during the recession, but also the growth of the working-age population over time). The good news is that the employment-population ratio has begun to trend higher. The bad news is that it has a very long way to go to get back to where it was before the financial crisis.
In April, 6.7 million people had been unemployed for more than half a year – that’s 45.9% of all the unemployed. These people are losing valuable job skills over time and their future earnings are expected to be reduced for up to 10 years. In addition, many new entrants to the workforce aren’t picking up the job skills they would normally get. Elevated unemployment rates coincide with huge social costs – and these problems aren’t unique to the U.S. Governments around the world face considerable challenges in getting people back to work.
So where does this leave us? There are continued headwinds in the near term (tight credit, strains on state and local government budgets), but there appears to be enough positive momentum to carry us forward. Yet, while the economy is getting better, the road to a full recovery will be lengthy.
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