Alan B. Krueger Assistant Secretary for Economic Policy & Chief Economist
Recent U.S. economic data provide indications that the economy is stabilizing. Declines in GDP and employment have moderated, housing activity appears to be bottoming, and financial markets have stabilized. Boosted by fiscal stimulus provided by the American Reinvestment and Recovery Act (ARRA or the Recovery Act), and by other programs designed to support the financial system and stabilize the housing sector, the economy is expected to grow moderately in the second half of 2009, and growth is expected to strengthen into 2010.
The broadest measure of economic activity – real GDP – continued to decline in Q2, but the decline was the smallest in a year. Real GDP fell 1.0 percent at an annual rate in Q2, after falling 6.4 percent in Q1 and 5.4 percent in 2008Q4. Real GDP has fallen 3.9 percent since 2008Q2, the largest four-quarter decline on record (since 1947, the earliest available data for the quarterly GDP series), and by 3.7 percent since the previous business cycle peak in 2007Q4. Government spending supported Q2 GDP growth, but the rate of decline in private spending also slowed--a precursor to a return to positive GDP growth in the second half of the year.
Consumr spending fell 1.2 percent in Q2, after a very modest increase in Q1. Consumers cut their spending sharply in the second half of 2008 in response to declining house and stock prices and the disruption in financial markets that limited access to credit and cut consumer confidence. Some of those factors have begun to reverse. Consumer confidence has trended higher since February, when it was nearly back to the 30-year low reached in the fall of 2008 according to the University of Michigan/Reuters consumer sentiment survey. Although sentiment retreated in July, it still remains well above the February low. Stock prices have risen more than 40 percent since reaching a low in early March, and are up over the year. Consumer income has been boosted by ARRA's tax cuts and transfer payments. In May, according to the Bureau of Economic Analysis, nominal disposable personal income (DPI) was about $207 billion (nearly 2 percent) higher than it otherwise would have been without the Making Work Pay tax cuts or the one-time payments to eligible recipients (mostly Social Security recipients). By adding to disposable income, ARRA is helping to bolster incomes and support consumer spending, thereby preventing an even larger pullback in aggregate demand.
The decline in business investment in plant and equipment also slowed in Q2. In Q1, business investment plummeted nearly 40 percent at an annual rate, the largest quarterly decline since 1952. In Q2, spending fell at about a 9 percent annual rate. Residential investment posted another significant decline in Q2, although there were some signs in monthly data that the housing market is stabilizing. New home sales, for example, rose 11 percent in June (although they are still down more than 20 percent from a year ago). Existing home sales have also risen recently--up for the third straight month in June. In June, existing single-family homes sales were up 7 percent from their January low. Single-family housing starts in June were up over 30 percent from their February low.
Inventories of unsold homes are dwindling. Home inventories are down to levels not seen since 1997. At the current sales pace, the supply of new homes on the market has fallen to the lowest level since late 2007, an 8.8-month supply. Increased home sales and lower inventories are easing downward pressure on house prices. Both the Federal Housing Finance Administration (FHFA) house price index and the Case-Shiller price indexes edged higher in May, although both remain well below year-earlier levels. For the Case-Shiller 20 city index, the May price increase was the first upward movement since the middle of 2006.
Exports were a key contributor to growth before the recession began but have slumped since, partly as a result of the worsening recessions in our major trading partners. The slide in real exports eased in Q2; exports fell 7 percent at an annual rate, compared with a 30 percent decline in Q1 and a 20 percent decline in 2008Q4. Real imports also dropped sharply, reflecting a decline in U.S. demand. In Q2, imports fell more than 15 percent at an annual rate, after dropping nearly 40 percent in Q1. Because imports have been falling more than exports, on a net basis, foreign trade has provided a boost to growth over the past three quarters. In Q2, net exports contributed 1.4 percentage points to GDP growth, only about half the boost provided to growth in Q1. The positive contributions from net exports during the recession may be reversed when the U.S. economy begins growing again, as imports are likely to rise faster than exports.
Job losses continued through June and the unemployment rate continued to rise. Since the recession began in December 2007, the unemployment rate has risen by 4.6 percentage points. In June the conventional unemployment rate stood at a 26-year high of 9.5 percent. The unemployment rate including marginally attached workers and those working part time for economic reasons rose to 16.5 percent in June and has risen by 7.8 percentage points since December 2007. Since December 2007, the number of unemployed persons has jumped from 7.5 million to 14.7 million. Additionally, there were nearly 9 million part-time workers in June that would have preferred full-time employment. The amount of time spent unemployed has lengthened considerably since the start of the recession. The median number of weeks unemployed surged to 17.9 weeks in June, the most since this series began in July 1967. Nearly 30 percent of the unemployed in June had been jobless for 27 weeks or more.
Nonfarm payrolls have contracted by roughly 6.5 million jobs through June since the recession began, and 3.4 million of those jobs were lost in the first six months of 2009 alone. But like the Q2 GDP report, the most recent jobs reports suggest some stabilization: monthly job losses averaged nearly 700,000 in Q1, but slowed to an average decline of 436,000 in Q2. Weekly data on initial claims for unemployment insurance through the end of July continue to point to further job losses, but also signal some improvement. The four-week moving average of initial claims was 559,000 in the week ending July 25 th, down nearly 100,000 from the four-week average peak in early April. Unfortunately, unemployment and employment tend to be lagging indicators. As President Obama has said, History does show you need to have economic growth before you have job growth.
Inflation was little changed during the second quarter. The headline consumer price index was down 1.4 percent over the year ending in June, the largest 12-month decline since 1950. Falling energy prices have been the key factor in the headline price decline. Energy prices declined 26 percent over the past year, with gasoline prices down nearly 35 percent. Food prices were flat in June and were up 2.1 percent over the past year, much less than the 5.3 percent rise during the preceding year. The core CPI (all items less food and energy) was up 1.7 percent in the 12 months through June, well below the year-earlier pace of 2.4 percent and still close to 2004 lows. Core inflation was 1.2 percent at an annual rate over the three months ending in June.
Credit market conditions have improved in the second quarter. The LIBOR-OIS spread – a measure of what banks perceive as the credit risk in lending to one another – fell to just above 30 basis points at the end of July, far below the peak of 365 basis points reached on October 10, although still above the 9 basis-point historical average. Corporate bond spreads have narrowed, suggesting a rising tolerance for risk. The spread between Baa-rated corporate bonds and the 10 year Treasury note fell to less than 350 basis points in late July, well down from its early December peak of 616 basis points. The Baa bond yield itself fell below 7 percent in late July, after rising to about 9.5 percent in mid-October when financial market disruptions intensified.
Measures of credit market flows also indicate an improving financial sector. The three month average (May-July 2009) for non-financial corporate bond issuance was $39 billion, more than double the average of $15.3 billion for the 3 months ending in October 2008. Total U.S. issuance of asset-backed securities was $14.6 billion in July (of which $12.6 billion was from Term Asset-Backed Securities Loan Facility), up from a low of $424 million in October 2008. The resumption of more normal credit flows is a critical element for supporting the economic recovery.
Private forecasters predict real GDP to be rising moderately through the second half of 2009, with growth accelerating into 2010. Improvements in unemployment tend to lag behind GDP growth, and many forecasters see the unemployment rate rising to 10 percent and above at the end of this year through the beginning of 2010.
A key element in the outlook is the Recovery Act. As mentioned above, tax cuts and one-time payments to eligible recipients are providing a boost to consumer income, which in turn is helping to stabilize consumer spending and help families to rebuild their balance sheets. At the same time, the spending provisions of the Act are gaining traction. The initial phase of the Act has been working through tax cuts and transfers to households to support income, saving and consumption, including the Making Work Pay tax credit, payments for Unemployment Insurance, and one-time payments to Social Security and other eligible beneficiaries. Going into the second half of the year, economic stimulus will emphasize support for necessary state programs and providing funds for infrastructure investment, as well as continuing the tax cuts and transfers. Through the end of July, the federal government had paid out more than $70 billion in Recovery Act funds, with a total of nearly $200 billion either already paid out or obligated to be paid out in the near future. The spending from these programs will provide an important boost to economic activity throughout the next several months and in 2010.
In sum, the available data suggest that the recession's grip on the economy is easing. The boost to activity from the Recovery Act, stabilizing and improving credit markets, and rising business and consumer confidence are building a foundation for the resumption of sustainable economic growth going forward.