The Recovery: Are We Being Suckered?
by John B. Hagens
John has been with IPR since 1990, with activity in all of IPR's businesses. Prior to joining IPR, John was senior vice president for the WEFA Group, with responsibility for the company's U.S. economic forecasting service. Before his ten-year stint with Chase Econometrics (and then WEFA), John had jobs as senior economist for the Carter Administration's Council on Wage and Price Stability and for the Social Security Administration, the latter under a Brookings Institution Economic Policy Fellowship awarded while he was an economics professor at Colby College. John holds an undergraduate degree in mathematics and economics from Occidental College and a Ph.D. in economics from Cornell University.
The Recovery: Are We Being Suckered?
In its advance release, the Commerce Department reported that GDP growth in the first quarter of this year was 3.2% compared with 5.6% in the fourth quarter of last year. Is this slowdown a cause for concern about the health of the current recovery? The GDP advance release is based on the very preliminary statistics and will be revised over the next two months, so we should not read too much into the slowdown. However, as we have pointed in previous notes, the economy is in a deep hole and we'll need much stronger average growth if we are to dig out and see significant declines in the jobless rate. We have now had three consecutive quarters of positive growth and it is useful to compare the broad composition of this recovery with previous ones in order to identify any telltale signs of concern.
Over the last nine months the U.S. economy has grown at an annual average rate of +3.7%, significantly faster than the first nine months of recovery after the shallow recessions in 1990-91 (+2.0%) and 2002 (+2.5%), but significantly slower than the recoveries after the deeper and more comparable recessions in 1973-75 (5.1%) and 1981-82 (7.5%). The relatively anemic current recovery is even more troubling because it has been disproportionately driven by a rebuilding of inventories. GDP growth can be decomposed in a variety of ways, but a particularly useful approach is to split it into final sales and inventory building. The more growth comes from inventory rebuilding, the more one needs to be concerned about the durability of the recovery. Final sales (or final demand) is the sum of consumer spending, business and residential fixed investment, government spending, and net exports. Over a long horizon, GDP growth is virtually identical to final demand growth. While there is some gradual building of inventories as the economy expands on a trend basis, by far changes in inventories are driven by anticipated and unanticipated deviations in final demand compared with trend. Typically, an unexpected drop in demand leads to unplanned inventory accumulation which is then subsequently run down. When demand picks up inventories are run down further, then followed by a period of stock rebuilding.
In each of the last three quarters final demand in the U.S. economy has increased by a modest 1.5-2.0%, contributing about 45% to GDP growth. The remaining 55% has been due to inventory rebuilding, which as we described above, is temporary. Our current dependence on inventory rebuilding for fueling growth is unusual for recoveries following deep recessions. Inventory dependence was 16% for the 1975 recovery and 22% for the 1983 recovery. Both of these two recoveries were fueled by a strong pickup in final demand. Inventory dependence was about 50% in the last two shallow recessions. As we have discussed in previous notes, these last two recoveries saw anemic job growth, while recoveries from the earlier more severe recessions saw much stronger job growth. Stronger job growth is much more likely to come about when the recovery of GDP is driven by strong growth in final demand and not inventories. Firms are unlikely to increase hiring significantly if a large percentage of production is going to a finite rebuilding of inventories.
