Popular Economics Weekly
Part of the debate over whether the Fed’s QE3 purchases of securities should end is based on economic growth. I.e., why isn’t U.S. Gross Domestic Product growing faster than the average annual 2.2 percent rate? Actually, Q1 and Q2 2013 growth is even lower—1 and 1.7 percent, consecutively.
Part of the problem is that the unemployment rate is still 7.4 percent, of course, whereas the historical full employment rate is below 5 percent, which means at least another 2 million need to be employed. Also current consumer spending seems to be maxed out, with household incomes rising less than inflation, as Fed Chairman Bernanke has been pointing out. And so hopes are pinned on a housing recovery this year, which is still tentative.
For instance, existing-home sales finally reached its more normal 5 million unit annual rate the past 2 months, and new-home sales are some 500,000 annually, vs. 1.2 million at the height of the housing bubble. So the debate ought to be comparing current GDP growth to its full employment potential output. In fact, the U.S. economy has lost more than $4 trillion in output from the Great Recession.
The Congressional Budget Office recently released its updated Budget and Economic Outlook, which highlighted a key theme that recurs in many economic policy discussions: a rapid recovery is projected to begin relatively soon and to reliably deliver the economy back to full health in about four years. The problem is that this full recovery has generally been forecast to be four years away since the Great Recession began five years ago, says the Economic Policy Institute.
The output gap for 2012 was $995 billion, or roughly 5.9 percent of potential output. CBO’s latest economic forecast shows a rapid recovery starting in late 2013 and the full output gap now closing by 2017. So it seems no one really has an idea when the economy can return to historical growth and employment. That is a measure of just how ‘great’ was the Great Recession and its aftermath.
The latest economic data show a possibility of pickup in the fall, which is what the Fed’s deficit hawks are counting on to justify their call for an early end to QE3. Specifically, both the Institute of Supply Management’s service and manufacturing surveys rose sharply in July. The ISM's non-manufacturing report showed the largest surge that drove the composite index up a very substantial 3.8 points to 56.0 for the best reading since February. New orders, the key component in the report, rose nearly 7 points to 57.7 for its best reading since December. And overall business activity really took off, up more than 7-1/2 points to 60.4, also the best reading since December.
But from what level? It would have to remain above 50, which signals growth, for a considerable period before it is a reliable trend after last month’s dip to no growth in activity. Retail sales also remain healthy. July’s numbers show an almost 6 percent annual growth rate, close to pre-recession levels. Within the core, excluding more volatile auto and gasoline sales, gains were widespread with increases in food & beverage stores, health & personal care, clothing, sporting goods & hobbies & music, and general merchandise. But furniture & furnishings, electronics & appliances, and building materials & garden equipment purchases.
So bottom line seems to be that economic conditions are still very uncertain; especially with the debt ceiling debate about to be repeated in the fall and many of the sequester spending cuts yet to take effect. There should be no rush to end the Fed’s low interest rate program with such high unemployment levels and congressional gridlock that could even contribute to a further downgrade of federal debt.
Harlan Green © 2013
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