Fourth Quarter GDP Report

This morning, the government released its first estimate of economic growth for the fourth quarter of 2012.  The headline number reveals that economic growth was negative (-0.1%), the first contraction since the end of the Great Recession in the summer of 2009.  The number will be revised in about a month and then again in 2 months (and in the future) as more data become available, so it's possible that the economy actually actually grew a little (or for you pessimists, shrank even more).  When was the last time economic growth was negative when the economy wasn't in recession?  1959.  In fact, there were a few episodes of negative growth outside of recessions during the 1950s.  Are we in a recession now?  While the economy is sluggish, a recession is unlikely.  As noted elsewhere, the reasons for the decline in GDP includes businesses increasing their inventories at a slower rate, cuts in defesne spending (which spiked in the third quarter), and a decline in exports (due to weakness in the global economy).  Core business activity, as represented by business investment, residential investment, and consumption, actually accelerated in the fourth quarter.  After declining in the third quarter, business investment surged by 8.4% in the fourth quarter.  Consumption grew at a slightly quicker pace (2.2%) compared to about 1.5% in the middle 6 months of 2012.  Given that the negative aspects of the report are unlikely to be repeated in early 2013, most economists expect positve, but weak growth in the first quarter of 2013.

Is there a chance of back-to-back negative quarters of economic growth?  Though I don't think that will happen, here's the case for it.  The increase in payroll taxes in 2013 will hurt consumer spending; the question is how much?  Consumer confidence took a hit according to the latest report from the conference board, but weaker consumer confidence doesn't always result in weak consumer spending.  We'll get more information next month as reports covering retail sales and consumer spending for January are released.  A second factor is that businesses did not reduce inventories in the fourth quarter, they just increased them more slowly than the previous quarter.  The inventory to sales ratio remains slightly elevated, so weak consumer spending could lead to further efforts to control inventories.  Third, the global economy remains weak as Japan and the UK are on the verge of triple dip recessions, the German economy is slowing down, and several other countries in Europe are in recession.

What's the strongest sector in the US economy?  Housing!  Residential investment has grown at a double-digit rate in 4 of the last 5 quarters.  Residential investment tends to have spillover effects as people buy furniture and appliances for their new home.  So is a recession in the US imminent?  I think it's more likely that the economy will experience a couple of weak quarters rather than outright decline.

A few more observations on the report.  Disposable income surged in the fourth quarter - do you feel much richer?  The reason for the surge was a $123 billion increase in dividend income.  Many companies moved dividends from 2013 to December 2012 to avoid the anticipated increase in tax rates on dividend income.  There will be some give back in 2013 as disposable income will decline since the many of the dividends normally paid in 2013 have already been paid out in 2012.  The upcoming correction in disposable income will also reduce the savings rate, which rose to 4.7% in the fourth quarter.

What's the takeaway from the report?  The economy is sluggish, but a recession is unlikely.

Some Thoughts on the Fiscal Cliff Deal

As expected, Congress and the President reached a deal avoiding the worst of the fiscal cliff.  I won't get into the politics of the deal, but it's surprising that there were virtually no net reductions in spending as part of the deal ($15 billion over 10 years).  The response of both sides is that spending reductions will take place later, when there's no rush to meet a deadline.  Perhaps.  We'll find out soon as the next debate over the budget will take place in February as the US must raise the debt ceiling.

How does this affect the national debt over time?  It has some impact, but clearly falls considerably short of what's necessary and doesn't address the primary issue - increases in entitlement spending, particularly Medicare and Medicaid.  Any serious attempt to address future deficits and the national debt must reduce the growth of entitlements.  For more details, see my my earlier post on the fiscal cliff.

Back to the economics.  The good news is that the US didn't go off the fiscal cliff.  Also, the tax increases shouldn't cause much harm to the economy over time.  The tax on dividends and capital gains for upper-income earners rises to 20% from 15% and income tax rates rose modestly for the highest income earners.  One can argue that this is not the best policy, but it's hard to argue that this will result in significant harm to long-term economic growth.  In the near term, the increase in the payroll tax will be a drag on economic growth.  All working Americans will experienced a 2% cut in after-tax pay (for wages and salaries up to just over $110,000).  Clearly this will lead to some combination of less consumer spending and less personal savings.  On the flip sides, the fiscal cliff deal removes a lot of uncertainty about the tax code, which may help free up some spending.  Overall, the deal will be a drag on economic growth for the first half of 2013.  Given the economic weakness of the economy at the end of 2012 (weaker than expected Christmas sales along with an undesired buildup in inventories), economic growth should be quite weak as we begin the new year.

For more specifics, please check out my other website for various economic forecasts.