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Assistant Secretary of the Office of Economic Policy Mark J. Warshawsky Statement for the Treasury Borrowing Advisory Committee of the Bond Market Association

(Archived Content)


In the three months since the Committee's last meeting, economic activity continued at a solid pace, core inflation remained steady, and the labor market improved.  The year 2005 marked the fourth straight year of expansion and, in our view, economic performance was right on target.  Real GDP grew 3.5 percent on an annual average basis, in line with the Administration's projection of 3.6 percent growth made at the beginning of the year.  Personal consumption expenditures grew by 3.6 percent while business investment in equipment and software rose at a double-digit pace for the second straight year.  Residential building was a source of strength again in 2005: housing starts hit a 33-year high, and single family homes sales posted a fresh record.  The unemployment rate declined from 5.4 percent to 4.9 percent by the end of 2005.   Nonfarm payrolls increased by over 2.0 million. 

Inflation rates in 2005 were remarkably similar to those in 2004: headline inflation was 3.4 percent last year, about the same as in 2004.  The CPI's energy component rose by 17 percent during both years.  Core price inflation (excluding food and energy), too, was unchanged from the previous year, at 2.2 percent.  All of these indicators suggest that, though the economy was buffeted by the Gulf Coast hurricanes and the related spike in energy prices, it recovered quickly and is on firm footing.

The just-released advance figures for the fourth quarter of 2005 suggest that real GDP advanced at a relatively low 1.1-percent annual rate.  Fourth-quarter real GDP growth was restrained by a slowing of real personal consumption expenditures and business investment, a drag from international trade, and a drop in Federal defense spending.  These forces were only partially offset by a rebound in inventory investment.  

A deeper look at the accounts suggests that the factors that held down fourth quarter growth are temporary.  The one-percent annual rate increase in consumer spending in the fourth quarter was mainly a reaction to the third quarter's auto sales surge, fueled by employee pricing incentives.  In the final months of the year, it appeared that consumer spending was again on the rise, providing a strong starting point as we entered the new year.  Oil imports, which temporarily surged to take the place of shut-in production following the hurricanes, subtracted about 0.5 percentage point from GDP.  With Gulf of Mexico production largely back on line, that oil import surge is not likely to continue this year.  Finally, the sharp decline in defense purchases in 2005Q4 is not likely to be repeated in early 2006 and may even be reversed. 

In recent years, the economy's resilience in the face of a range of unprecedented shocks has been perhaps its most outstanding characteristic, and that resilience was evident once again in the face of the energy price shock of the past two years.  The expansion has continued with solid growth of real GDP, steady job creation, and low core inflation.  The economy remains well-positioned to maintain healthy economic and employment growth with benign inflation.  The Administration's forecast for 2006 projects a real GDP increase of 3.4 percent over the four quarters of the year, essentially in line with the pace in 2005.  The rate of headline inflation as measured by the consumer price index is projected to fall by a full percentage point to 2.4 percent.  The unemployment rate is expected to remain near 5.0 percent, and job growth should be on the order of 176,000 per month.  In short, real GDP and payrolls will continue to grow steadily, while inflation remains tame.

Some analysts suggest that the negative personal saving rate that emerged in 2005 casts a shadow over the outlook for the economy, as efforts to rebuild personal saving could threaten personal consumption.   In 2005, the personal saving rate declined to ‑0.5 percent, the lowest in more than seventy years.  The decline in personal saving was the result of a two-decade downtrend in which it appears that a combination of measurement and fundamental issues played a role.   The trend seems unlikely to be reversed in an abrupt or severe fashion.

Personal saving in the national income and product accounts is calculated as the residual when personal outlays are subtracted from disposable personal income.  The national accounts measure income from current production and therefore do not fully reflect the resources that households have available to fund consumption, such as capital gains on corporate equities, mortgage equity withdrawal, or distributions of pensions to retirees.  Adjusting disposable income for some of these developments would help to explain part of the decline in personal saving.  Another part of the decline may paradoxically be reflecting the success in the economy.  In 1982, when the personal saving rate was at its peak, the economy had suffered runaway inflation and severe recession.  Over the past two decades, the economy has become much more stable, likely reducing the perceived need for precautionary saving.  In addition household net worth has grown on its own and, relative to disposable income now stands at a level well above that of anytime from the 1950s through mid-1990s.  Because for most households, the purpose of saving is to build wealth, the surge in wealth that has occurred has likely reduced the incentive to save.

In sum, the decline in the saving rate is a long-term phenomenon driven by a variety of factors and some of the factors such as rising equity and housing values and low interest rates are acknowledged to be positives for the economy.  A less-rapid rise in wealth, an increase in interest rates, or a reduction in home equity extraction may reverse the path of personal saving.  But consumption growth can still be well-maintained as employment continues to expand and wages rise.  As a result, we are optimistic about the prospects for personal consumption and the economy overall as we enter 2006.