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Economic conditions continued to improve in the fourth quarter of 2009, with real GDP posting its fastest quarterly rise since the middle of 2003, although the job market remains a major concern. Housing markets showed additional signs of stabilization and business investment spending picked up. Labor market conditions improved marginally, but remained weak: The unemployment rate reached a 26-year high during the quarter, and job losses continued to mount, although at a slower pace. Conditions in financial and credit markets improved. Policies undertaken last year--including the Recovery Act, the Financial Stability Plan, and various housing programs--played a key role in arresting the economy's freefall and restoring an environment conducive to private sector economic growth. Yesterday, the Administration released the FY2011 Budget, which shows that, under realistic assumptions about economic growth, the federal budget deficit will decline sharply over the next two years. In addition, the budget proposes a mix of programs that will help put federal finances on a more sustainable path, while making necessary investments in education, research and development, clean energy, and infrastructure to support future growth.
The economy expanded in the fourth quarter, with real GDP rising at a strong 5.7 percent annual rate. The fourth-quarter gain followed a 2.2 percent rise in the third quarter; these gains in turn followed four consecutive quarters of decline. A key contributor to the acceleration in the fourth quarter was a sharp slowdown in the pace of inventory liquidation. Business inventories fell by just $33 billion (2005 chain-weighted dollars) in the fourth quarter, following a steep $139 billion drop in the third and an even larger drawdown in the second quarter. The inventory swing contributed 3.4 percentage points to fourth-quarter growth. Excluding inventories, final sales were up by a solid 2.2 percent in the fourth quarter, and growth was recorded in nearly every major component of GDP, another sign that recovery is taking hold. The trend in final sales has been positive for 3 quarters in a row.
Consumer spending rose by 2.0 percent in the fourth quarter, contributing 1.4 percentage points to real GDP growth, less than its 2 percentage point contribution in the third quarter. Outlays for durable goods fell, reflecting a decline in motor vehicle purchases after the successful Cash for Clunkers program ended in late August. However, consumer spending on nondurables and services picked up. For all of 2009, the personal saving rate averaged 4.6 percent, up 2 percentage points from 2008.
Business investment increased for the first time since 2008Q2. Purchases of equipment and software accelerated, rising at the fastest pace since early 2006, but spending on structures continued to fall. The net export deficit narrowed as exports posted a second straight quarter of growth in excess of 18 percent, boosting real GDP by half of a percentage point. Overall government spending edged down in the fourth quarter, with a small decline in state and local expenditures more than offsetting a 0.1 percent gain in federal outlays.
The housing market showed more signs of stabilizing in the fourth quarter. Residential investment--mostly homebuilding--increased for a second straight quarter but made only a marginal contribution to GDP growth. Housing starts and sales moved down at the end of the year, partly reflecting poor weather in December and, more importantly, the decline in sales following the surge related to the expected expiration of the first-time homebuyer tax credit (which was recently extended). Total existing home sales fell a record 16.7 percent to 5.5 million homes (annualized rate) in December, although the level of sales remained above August, the month before the acceleration from the tax incentive began in earnest. New single-family home sales fell 7.6 percent to 342,000 (annualized rate) in December. Home inventories are down substantially in absolute terms, but are still high relative to sales. For example, in December unsold new single-family homes were at an 8.1-month supply--the usual supply is between 4 and 6 months --while the number of unsold new single-family homes is at a 38-year low.
House prices continued to stabilize. In November, the Federal Housing Finance Agency purchase-only house price index rose 0.7 percent, and it posted a 0.5 percent year-over-year gain, the first 12-month increase in more than two years. The S&P/Case-Shiller 10-city composite home price index was down 4.5 percent in the year ending in November, the smallest decline in 2½ years.
Labor markets remained weak in the fourth quarter, but also showed signs of stabilizing. The unemployment rate reached a 26 year high of 10.1 percent in October, and remained at 10 percent for the rest of the fourth quarter. More than six workers are unemployed for each vacant job. The number of payroll jobs continued to fall in the fourth quarter. Jobs losses averaged nearly 70,000 per month during the quarter, down from about 200,000 in the third quarter, and well below the nearly 700,000 jobs lost per month on average during the first quarter. Altogether, 7.2 million jobs have been lost since the recession started in December 2007.
Inflation remained moderate throughout 2009. Headline consumer prices rose 2.7 percent over year ending in December, compared with a 0.1 percent rise during 2008, an acceleration that mostly reflected the rise in oil prices. The crude oil price--the nearby futures price for West Texas Intermediate crude--averaged just under $80 per barrel in January, up $37 from a year ago. Core consumer prices (which exclude food and energy) rose 1.8 percent during 2009, the same as in 2008. Excess capacity and labor market slack are keeping a lid on inflationary pressures.
Credit market conditions were relatively stable in the fourth quarter, with many key measures having reached pre-crisis levels in the third quarter. In January, t he 3‑month U.S. dollar LIBOR-OIS spread --a measure of what banks perceive as the credit risk in lending to one another --remained just above 10 basis points, roughly back to its pre-crisis norm and down from an all-time high of 365 basis points in early October 2008. Corporate bond spreads have also narrowed, pointing to a rising tolerance for risk. In January, the spread between Baa-rated corporate bonds and the 10-year Treasury note averaged about 260 basis points. Though still elevated, this measure is far below its December 2008 peak of 616 basis points. Mortgage rates remain at historically low levels. The average interest rate on a 30-year conventional fixed-rate mortgage is currently around 5.0 percent, which is providing support to housing markets.
Yesterday the Administration released its proposed budget for FY2011. Receipts in FY2010 are expected to be $2.2 trillion, up $60 billion (almost 3 percent) from FY2009. Receipts are projected to grow nearly 20 percent from FY2010 to FY2011, reflecting an improvement in the economy, although the rise brings the receipts share of GDP only back to 16.8 percent in FY2011, still well below the long-term average of just above 18 percent. Outlays in FY2010 are expected to be $3.7 trillion, up $203 billion (5.8 percent) from FY2009. Outlays are projected to rise 3 percent from FY2010 to FY2011. As a share of GDP, outlays are projected to be 25.1 percent in FY2011, down from 25.4 percent in 2010. The unusually high level of spending reflects effects of the recession and policies that are aimed at countering its impact, including automatic stabilizers and the Recovery Act.
The budget shows that considerable progress is expected in bringing down the budget deficit, although more work is needed to make federal finances sustainable in the longer term. The budget projects the deficit will decline from 10.6 percent of GDP in FY2010 to 4.2 percent in FY2013, and that the deficit will average just under 4 percent through 2020. The primary deficit, (receipts less spending other than interest on the federal debt) shows even more improvement, falling from 9.4 percent of GDP in FY2010 to under 2 percent of GDP in FY2013, and averaging less than 1 percent through the rest of the budget window. The relatively small primary deficit in the second half of the budget window highlights the importance of rising interest costs on the federal debt. Most of this debt is the result of policy actions taken before the Obama Administration took office. For example, from FY2000 to 2009, total debt held by the public excluding financial assets rose about $3.2 trillion; if the interest rate on the debt were to average 5 percent, that increase in the debt alone would add about $160 billion each year to spending. Interest costs become a dominant part of the deficit; more than 80 percent of the deficit in FY2020 is interest payments--the lion's share of which is on debt created by policies of previous Administrations.
To reduce annual deficits to a stable and manageable level, the Administration is proposing a number of policies, including rolling back the 2001 and 2003 tax cuts on the wealthiest Americans, freezing non-security discretionary spending for three years, and forming a fiscal commission to address the deficit in the intermediate and longer term. The Administration is committed to bringing the budget deficit down to 3 percent of GDP.
The economic assumptions on which receipts and spending forecasts in the budget are based are largely in line with the current expectation of private forecasters. The Administration projects real GDP will grow 2.7 percent between 2009 and 2010, while the Blue Chip consensus of private forecasters is projecting a slightly larger increase of 2.8 percent. In 2011, the Administration projects real GDP will grow by 3.8 percent, picking up speed as the economy recovers, while the Blue Chip expects 3.1 percent. The Administration forecast for unemployment is 10.0 percent in 2010 and 9.2 percent in 2011; the Blue Chip forecast is identical. With its current high unemployment rate, the economy is producing well below its potential. The economic projection in the budget assumes that the economy will return to its potential gradually. The Administration's economic projection for GDP growth through the end of 2010 is for a recovery that is about half the size of the typical recovery in the post-WWII period, largely reflecting the lingering aftereffects of the financial crisis.
In sum, the economy is continuing to recover from the most severe recession of the post-war period. Evidence at the close of the year suggested the recovery was beginning to pick up steam. It will take time for the pickup in economic activity to translate into renewed hiring, but labor market conditions should improve with sustained and solid economic growth. In addition, the President has proposed measures to spur job growth in the near term, including the newly announced Small Business Jobs and Wages Tax Credit. Administration policies have played an important role in jumpstarting economic activity and restoring stability to markets and will continue to provide support in the months ahead. The most recent reading on economic growth has exceeded expectations, another illustration that recoveries do not proceed along straight lines. Ultimately, we should expect some volatility around an overall upward trend this year.