GDP: Modest Growth Continues – Sustained Expansion Ahead

Real GDP rose 2.8 percent with gains in consumer spending, business equipment investment and housing. The negatives were the restructuring in local government and federal defense cuts. Inflation is slowing.

Growth: Continued Momentum at a Modest Pace

Sustained growth – either boom nor bust – remains the theme for this economy and has been our outlook now for some time. Real GDP rose at a 2.8 percent pace in the fourth quarter and is up 1.6 percent from a year ago. The gains in the fourth quarter reflected modest underlying growth in real domestic final sales, up 0.8 percent (top graph), with improvement in consumer spending, business investment – equipment and residential – yet weakness in government spending.

Consumer spending rose 2.0 percent in the fourth quarter with improvement in spending on durables and nondurables, and yet weak service spending. This is in contrast to the prior two quarters when weaker spending reflected higher prices, specifically for gasoline and groceries. Yet, the case for a full-fledged expansion at the pace of post-WWII history remains elusive as employment and income gains remain limited and housing and state and local government continue to restructure.

Consumer Spending: Positive, But Not Exuberant

Consumer spending continues to increase at a 2 percent pace (middle graph) and yet it is obvious from the graph that this pace is much slower than that experienced in the prior two expansions.

Income, wealth, credit and consumer confidence all play a role in explaining this slower pace of consumer spending. As for income, slower job and wage gains limit the growth of earned income. Meanwhile, very low interest rates limit the gains in interest income for many investors. Gains in housing wealth remain constrained for many and nonexistent, even negative, for many others. Credit, especially home equity loans, remains limited compared to its popularity in the past and this has limited consumer purchases of nondurables. Finally, all of these factors, plus the steady drumbeat of pessimistic rhetoric, has meant very low levels of consumer confidence at this point in the economic recovery.

Inflation: Above Perceived Fed Target, Definitely Not Deflation

With Chairman Bernanke’s comments earlier this week that the overall PCE deflator, not the core, will be targeted at 2 percent over time, it is useful to examine the details of this release. The fourth-quarter gain in the PCE of 0.7 percent reflected an outright decline in the prices of durable goods and below recent trend increases in nondurables and services (bottom graph). These patterns suggest that moderate economic growth will support the view that PCE measured inflation will continue to moderate on a year-over-year basis and thereby support the Federal Reserve’s continued easy monetary policy.

It is interesting that both export and import prices, and both services and goods, came in negative. This hints that global competitiveness to fight for market share in a moderate growth global economy is alive and well.


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