Alan B. Krueger
Economic conditions improved in the third quarter of 2009. GDP growth resumed following a year of steady contraction. The third-quarter rise reflected a jump in consumer spending but activity also picked up in a number of other sectors, including housing. While many third-quarter measures improved, the labor market remained weak, even as the pace of job losses slowed. Conditions in financial and credit markets continued to improve. The economy's recent improvement is partly due to the broad array of measures taken by the Administration and Congress to encourage growth and restore stability in credit and financial markets; at the same time, there are encouraging signs that the private sector is starting to expand again on its own.
Real GDP rose 3.5 percent at an annual rate in the third quarter. Growth in the summer was the strongest in two years and followed a record four quarters of steep decline, during which real GDP fell by nearly 4 percent. Federal outlays provided crucial support to the economy during the June-to-September period, but private expenditures rose for the first time since the spring of 2008.
Consumer spending, which accounts for 70 percent of GDP, posted a solid 3.4 percent gain (annual rate) in the third quarter. A surge in motor vehicle purchases spurred by the Cash for Clunkers program accounted for a substantial portion of the jump in consumption, but even excluding the pickup in autos, consumer demand strengthened notably in the third quarter. For example, spending on services and non-durable goods posted their largest quarterly gain since the third quarter of 2007.
Residential investment, which had been a drag on growth since the housing downturn began more than 3 years ago, turned up for the first time since late 2005, contributing about 1/2 percentage point to real GDP growth during the third quarter. Housing starts, building permits, home sales, and housing prices have generally turned higher since the spring. The inventory of homes on the market has come down, and homebuilder sentiment has improved slightly. Despite these recent welcome improvements, the housing sector remains weak, with the real value of homebuilding activity in the third quarter less than half of the level in 2005.
Overall business investment fell in the third quarter but the pace of decline slowed sharply. Business spending on equipment and software edged up, growing for the first time in nearly two years. Outlays for structures continued to fall but the rate of decline eased considerably. Although businesses continued to liquidate inventories, the inventory drawdown in the third quarter slowed. As a result, inventory investment made a sizable contribution to real GDP growth in the third quarter after providing a substantial drag on the economy in each of the previous three quarters.
Exports grew in the third quarter, providing some evidence that the international economy also began to recover. At the same time, the improvement in the U.S. economy boosted imports, and the net export deficit widened, producing a small drag on real GDP growth. Net exports had been providing support to the economy in the previous three quarters, when imports--reflecting the steep declines in the U.S. economy--were falling faster than exports.
Administration policies, including fiscal stimulus and efforts to stabilize the financial sector, have played a key role in the third quarter economic improvement. The Car Allowance Rebate System--the "Cash for Clunkers" program--provided a much needed boost to motor vehicle sales this summer, helping consumers who turned in their gas guzzlers purchase nearly 700,000 new, more fuel-efficient vehicles. These purchases were an important driver of consumer spending in the third quarter. The first-time homebuyer tax credit may have contributed to a pickup in home sales, helping to stabilize the housing sector following a prolonged slump. As of September, combined sales of new and existing homes had risen more than 20 percent from the 14-year low recorded in January.
The American Recovery and Reinvestment Act (ARRA) has also stimulated private demand, with an array of tax cuts, one-time payments, and infrastructure outlays amounting to nearly $800 billion. Through October 30, tax cuts associated with the Recovery Act pumped nearly $85 billion into the economy, while contracts and entitlement payments contributed roughly another $120 billion. Administration estimates along with analysis by a wide range of private-sector forecasters suggest that the ARRA contributed between 3 and 4 percentage points to real GDP growth in the third quarter. New data released last week by the Recovery Board show that recipients of Recovery Act contracts, grants, and loans have reported that nearly 650,000 jobs were either created or saved as a direct result of the ARRA. This jobs figure excludes the effects of tax cuts, and does not include any jobs created or saved indirectly--like jobs created in businesses that provide goods and services to those directly receiving government contracts. Taking account of those effects, estimates are that more than 1 million jobs were created or saved.
Although there has been noticeable improvement in many sectors of the economy, the labor market remains very weak. In September, the unemployment rate reached a 26-year high of 9.8 percent, and payrolls declined for the 21st straight month. Altogether, 7.2 million jobs have been lost since the recession started in December 2007. Although businesses continue to trim their payrolls, the pace of job loss has slowed considerably. In the third quarter, the average monthly decrease in nonfarm payroll employment was 256,000, well below the second-quarter average of 428,000. More recently, weekly data on new claims for Unemployment Insurance have trended down, and, though at levels consistent with further large job losses, also point to slowing declines.
The headline Consumer Price Index fell 1.3 percent over the year ending in September, in stark contrast to the 4.9 percent jump recorded in the same period a year ago. Steep declines in energy prices in late 2008 are largely responsible for the drop in headline inflation. Over the year ending in September, consumer energy prices plunged 22 percent, a sharp reversal from the 23 percent surge recorded in the year-earlier period. Energy prices started to rise again recently, however, and so far this year are up 17 percent at an annual rate. Still, headline inflation through the first nine months of 2009 was a moderate 2.7 percent. In addition, the high unemployment rate and low business capacity utilization rate are helping to keep inflation pressures contained. Core consumer inflation (a measure that excludes energy and food prices) was 1.5 percent over the year ending in September, down from 2.5 percent a year ago. So far this year, core inflation is around 2 percent.
Credit market conditions improved further in the third quarter. The 3-month U.S. dollar LIBOR-OIS spread – a measure of what banks perceive as the credit risk in lending to one another – has narrowed to around 13 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. The spread between Baa-rated corporate bonds and the 10-year Treasury note is currently around 280 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.
Financial markets have stabilized. The S&P stock market volatility index (VIX), often used as a measure of financial market uncertainty, has retreated from the all-time high of almost 81 percent posted on November 20, 2008 and at roughly 25 percent is approaching readings near the 20 percent recorded in late August 2008. Equity markets have turned sharply higher. The S&P500 has risen almost 60 percent from its March 9, 12½-year low and is up nearly 20 percent for the year.
Many private forecasters believe the economy has turned a corner. Most expect to see another solid increase in real GDP in the fourth quarter, and are currently looking for real GDP to grow about 2½ percent in 2010. Recovery in the labor market is expected to lag behind GDP growth. The consensus forecast expects the unemployment rate to climb to 10 percent by the end of this year and remain near that level through at least the first half of 2010.
In sum, the economy is starting to recover from what has been the most severe recession of the post-war period. 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. 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. Recoveries do not proceed along straight lines, and while we can expect some volatility on the road to recovery, the overall trend is expected to be upward.