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WASHINGTON - The strength of the U.S. economic recovery remained intact in the final quarter of 2015, despite a dip in real GDP growth. Underlying private demand is expanding at a healthy pace, job growth was vigorous at the end of the year, and the unemployment rate has declined to a seven-and-a-half-year low. Inflation remains low, and some measures of wage growth are picking up. Developments abroad are weighing on export demand and acting as a headwind, but our economy is in a strong position to meet these external challenges. Indeed, private forecasters expect the U.S. economy to expand at a solid pace through the end of this year.
According to the advance report, growth slowed in the fourth quarter to an annual rate of 0.7 percent from a 2.0 percent pace in the third quarter. Three factors weighed on growth. First, inventory investment slowed sharply as businesses continued to realign their stocks, following a large build-up early in the year. Second, net exports fell further, reflecting a weakening of export demand. Third, business investment in oil and gas drilling contracted again as the U.S. energy industry continued to curb its activity in response to the plunge in oil prices over the last year and a half. Altogether, these three factors subtracted an estimated 1¼ percentage points from real GDP growth in the fourth quarter.
Meanwhile, final sales to private domestic purchasers – a measure of underlying private demand that includes consumer spending, residential investment, and business fixed investment – rose at an annual rate of 1.8 percent in the fourth quarter following a gain of 3.2 percent in the third quarter. Consumer spending growth moderated in the fourth quarter, held back in part by a drop in spending on household utilities related to unseasonably mild weather. In addition, business equipment investment fell back a bit after a very strong gain in the third quarter, and business spending on structures continued to recede because of the drop in drilling activity. However, residential investment remained strong in the fourth quarter and over the year as a whole increased 9.0 percent – a pace that was double the average annual rate of gain over the prior two years. For the year as a whole, final sales to private domestic purchasers rose at a solid 2.7 percent pace.
Turning to the public sector, federal government outlays increased, more than offsetting a small dip in state and local spending. Government spending in the aggregate was mildly positive for GDP, contributing 0.1 percentage point to both fourth-quarter and annual growth. This represents a marked improvement compared with the prior two years, when fiscal consolidation weighed on the economy and the public sector subtracted 0.6 percentage point from GDP growth in 2013 and 0.1 percentage point in 2014. Federal government spending is expected to provide a small boost to GDP this year, and continued improvement in state and local government finances has laid the groundwork for that sector to also be a small net positive for growth in 2016.
Labor market conditions strengthened notably further late in 2015. Hiring picked up sharply in the fourth quarter, with an average of 284,000 jobs per month added to nonfarm payrolls, and the unemployment rate edged down to 5.0 percent. Over the course of the entire year, employment gains averaged 221,000 per month – comparable to the strong gains posted in the mid-2000s when the economy was last near full employment. The unemployment rate declined 0.6 percentage point during 2015 and is approaching its “natural” rate, which the Congressional Budget Office estimates is slightly below 5 percent. Yet, other indicators of labor utilization indicate that there is still slack in labor markets. For example, the rate of involuntary part-time employment is nearly 1 percentage point higher than averaged from 2001-2007. In addition, some would-be workers appear to be waiting on the sidelines of the labor market until wage growth picks up further.
Energy prices have moved substantially lower over the past three months. The one-month futures price of West Texas Intermediate crude oil has fallen roughly $12 since early November to around $34 per barrel late last week. The current price of oil is $15 (or 30 percent) lower than at this time last year. The drop in oil prices has translated into lower prices at the pump as well as reduced home heating costs. The average retail price of regular gasoline currently stands at $1.86 per gallon – the lowest since January 2009. The Energy Information Administration estimates that households using heating oil will save about $460 on their heating bills this winter compared with last winter. Propane users will pay $320 less than last winter, and households that heat with natural gas will pay $60 less. While consumers and energy-using businesses have benefited from lower fuel prices, domestic energy producers have been challenged by lower oil prices cutting into their profits. Because of the substantial growth in the U.S. energy industry in recent years, the cuts in investment and employment in response to lower oil prices have weighed more heavily on the overall economy than in the past; even so, the available evidence suggests that declines in oil prices are still a net positive (albeit a smaller one) for our economy.
Falling energy prices have also played an important role in keeping inflation low. During the 12 months ending in December, the consumer price index for all urban consumers (CPI-U) rose just 0.7 percent. Consumer energy prices plunged 12.6 percent during 2015, and food price inflation slowed to 0.8 percent from 3.4 percent during 2014. Excluding both food and energy prices, the core CPI rose 2.1 percent over the twelve months of 2015, up from 1.6 percent during 2014.
Incoming data have been mixed on whether nominal compensation growth is picking up in response to tighter labor market conditions. Average hourly earnings rose 2.5 percent over the twelve months ending in December, a notable increase from gains averaging 2 percent from 2011 through 2014. On the other hand, the Employment Cost Index for private-industry workers showed compensation rising 1.9 percent and wages rising 2.1 percent over the past year, roughly in line with gains of recent years. Both data sources indicate that nominal compensation growth is still well below the pace recorded in the decade prior to the recession. However, low consumer inflation means that the as-yet limited gains in nominal compensation have translated into meaningful increases in purchasing power. These increases—along with the robust expansion of payrolls—should support household spending in the quarters ahead.
While the outlook for the economy is favorable, there are downside risks that bear watching. The International Monetary Fund projects that global growth will pick up somewhat in 2016, but the performance of U.S. exporters could be impaired further if this pick-up does not materialize. In addition, financial market developments at the beginning of 2016 illustrated the potential for global economic concerns to spill over into a tightening of financial conditions that could weigh on U.S. economic growth.
In sum, the U.S. economy made considerable forward progress in 2015. GDP increased, job growth remained strong, and the unemployment rate fell to its lowest level in more than seven years. The available information suggests that the U.S. economy will continue to experience above-trend growth this year, with activity propelled by continued solid gains in consumer spending, further recovery in the housing sector, and a boost from government spending. A consensus of private forecasters shares this view, predicting that growth will pick up to 2.5 percent in the current quarter and 2.6 percent over the four quarters of 2016.
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