The GDP data released on Friday showed that the economy was sinking at a 1.0 percent annual rate in the second quarter. This would not ordinarily be good news, except that the economy was contracting at a 6.4 percent rate in the first quarter of 2009 and at a 5.4 percent rate in the fourth quarter of 2008. The second quarter GDP numbers indicate that the economy is still contracting, but the free fall of the prior six months is over.
President Obama can take credit for ending this free fall with his stimulus package. The government sector directly added 1.1 percentage points to the growth rate in the second quarter. This was due partly to additional federal spending (much of it defense-related), but also due to a modest increase in state and local spending. In the prior two quarters, state and local government spending had been contracting, as state and local governments were forced to make cuts in response to budget deficits. The stimulus package allowed them to sustain existing programs and even expand them in some areas.
In addition to the direct contribution from government spending, the stimulus also spurred consumption by putting more money in people’s pockets. The extension and increase of unemployment insurance benefits gave money to people who were almost certain to spend it immediately. The same is true of the increase in food stamp benefits and a one-time payment to Social Security beneficiaries. In addition, his Making Work Pay tax credit also increased the take home pay of many moderate-income families.
As a result of these benefit increases and tax cuts, disposable income rose at a 4.6 percent annual rate in the quarter, even as wage income shrunk at more than a 5.0 percent rate. This increase in disposable income helped to sustain consumption. While consumption still fell at a 1.0 percent annual rate, the drop-off almost certainly would have been much more severe without the boost to income provided by the stimulus.
The stimulus probably added between 2.5 to 3.0 percentage points to the growth rate for the second quarter. This is the difference between the modest decline that we saw in the second quarter and the plunge in output the prior two quarters. Assuming the normal relationship between GDP and employment, the stimulus may have led to as many as 1 million additional jobs by the end of the second quarter.
That’s the good news. The bad news is that the economy is likely to continue to grow at a very slow rate, or possibly even shrink modestly for the foreseeable future. With households having lost close to $6 trillion in housing equity, there is little likelihood for any uptick in consumption any time soon.
Note, this is not a question of consumer attitudes, as is so often asserted. The problem is that consumers don’t have the money to spend now that they have lost so much wealth in their homes.
Other sectors look even worse. There was enormous over-building in most areas of non-residential real estate in the last few years. As a result, non-residential construction is likely to continue to contract over the next couple of years. While housing may have finally leveled off, with record vacancy rates, there is little possibility of any rebound in residential construction any time soon.
Equipment and software investment will remain weak as long as there is enormous idle capacity in most areas. And state and local governments are putting in place another round of cuts as a result of new recession-induced budget deficits.
In the long-run, an improvement in the trade balance will be needed to sustain healthy growth, but this will only happen when the dollar falls, making our products more competitive in world markets. But this will not happen any time soon.
The only way to prevent double-digit unemployment will be another, much bigger round of stimulus. The Obama stimulus threw out around $700 billion to counteract a $2.6 trillion two-year shortfall in demand.
The stimulus helped, but you can’t put out a forest fire with a few buckets of water. We need much more spending. The alternative is a much poorer country today and a poorer country for our children. If we could just teach Congress and the punditry a bit of economics, they would stop whining about the budget deficit and start thinking about how they can get 15 million people back to work.
In total, the stimulus probably added 2.5 to 3.0 percentage points to the growth rate for the quarter. This is the difference between the mild decline that we saw and the disastrous plunge of the prior two quarters. And, assuming normal relationships between output and employment, as many as one million people have jobs today, who would not otherwise, because of the stimulus.
But to say that the stimulus has made things better is not to say that it has made things good. We are looking at an unemployment rate that is virtually certain to cross 10 percent in the next few months and likely to remain above 10 percent into 2011, and possibly longer, without a further boost to the economy. While most of the stimulus has not yet been spent, we are already spending out the money at close to the maximum rate, and it is the rate of spending that matters.
To see this point, suppose a worker’s pay is increased by $500 a month. Mostly likely this worker will increase her monthly consumption in the fist few months after getting her raise. She may keep this raise for several years, but after her consumption originally increases, it remains fixed at the higher level as long as her pay stays at the new higher level.
In the same vein, the stimulus was already kicking an extra $30-$40 billion a month into the economy in the second quarter. There will be little additional boost from the stimulus in future quarters.
This is very bad news, because the economy has almost zero upward momentum. The continuing decline in jobs and hours, and falling real wages, will depress consumption. Investment is depressed by huge overcapacity. The same holds for housing, with the vacancy rate still at a record high. And, of course the stimulus was not large enough to fully stem off a massive round of budget cuts by state and local governments across the country.
The stimulus has eased the crisis, but voters will be expecting more, and it’s hard to see how they’ll get it without more government action to boost demand.
– This article was published on August 3, 2009 by Truthout.