Orlando's Outlook: Fiscal policy decisions still matter to GDP growth
Bottom Line The Commerce Department reported last week that U.S. economic growth in the second quarter was stronger than overly pessimistic consensus estimates, as improvements in housing, inventory restocking and business cap-ex spending offset weaker trends in consumer and government spending and net exports. The advanced report for second-quarter Gross Domestic Product (GDP) of 1.7% was much better than dour consensus Bloomberg estimates for only 1.0% growth and even lower whisper estimates of 0.5%, although it was only slightly higher than our own 1.5% estimate here at Federated.
In addition, the government typically revises its historical data with the second-quarter flash, and this year the Bureau of Economic Analysis (BEA) went back to 1929, shifting the reference year for chain-weighted GDP from 2005 to 2009, and adding new benchmarks, seasonal adjustments, and methodological changes. This comprehensive exercise ticked up the average annual growth rate of real GDP between 1929 and 2012 from a trend-line of 3.2% to 3.3%, and the nominal level of GDP for the U.S. economy now stands at $16.6 trillion, up $600 billion (3.75%) from previous estimates.
Near term, however, GDP was revised lower for the previous four quarters, in part because of fiscal-policy drag, which we define as lower business and consumer spending in response to Washington's higher tax rates and the automatic spending sequester. The fourth quarter of 2012 slipped from GDP growth of 0.4% to 0.1%, and the first quarter of 2013 growth was chopped from 1.8% to 1.1%. But the good news is that we expect the deleterious economic impact from fiscal drag to fade in this year's second half, replaced by a positive "Wealth Effect," as higher stock and real estate prices — in conjunction with elevated savings rates and stronger consumer confidence — will spark more robust GDP growth.
GDP revisions Although the Commerce Department's comprehensive revisions date back to 1929, the following table reflects the more recent quarterly and full-year GDP changes entering and exiting the Great Recession:
|Quarter||Previous GDP||Newly Revised GDP|
|Full Year 2007||1.9%||1.8%|
|Full Year 2008||(0.3%)||(0.3%)|
|Full Year 2009||(3.1%)||(2.8%)|
|Full Year 2010||2.4%||2.5%|
|Full Year 2011||1.8%||1.8%|
|Full Year 2012||2.2%||2.8%|
Here are the key details regarding the recent second-quarter GDP flash report:
Consumer spending softened temporarily Personal consumption expenditures, which account for 70% of GDP, rose by 1.8% in the second quarter — slower than the downwardly revised first-quarter pace of 2.3% — and contributed 1.20 percentage points to quarterly growth. This second-quarter weakness was not unexpected, due to the increase in tax rates at the beginning of this year and the imposition of the automatic spending sequester in March. But with the labor market strengthening, the savings rate rising in the second quarter to 4.5%, consumer confidence at a five-to-six year high, and a growing Wealth Effect due to sharply rising real estate and stock prices, we expect that consumers will spend some of their dry powder during the important Back-to-School and Christmas retail seasons, sparking stronger second-half spending and boosting GDP above muted first-half levels.
Housing strengthens Residential investment rose by 13.4% in the second quarter (contributing 0.40 percentage points to quarterly growth), compared with a downwardly revised gain of 12.5% in the first quarter. We continue to believe that the housing industry, which is now two years off its trough, is one of the U.S. economy's true growth engines, with a sustainable multi-year recovery still on the horizon.
Huge capex bounce Real business fixed investment rose by 4.6% in the second quarter, which was a sizable rebound from the downwardly-revised 4.6% decline in the first quarter. Business equipment and software spending rose by 4.1% in the second quarter, compared with a downwardly revised first-quarter gain of 1.6%. Business structure investment — such as factories and office buildings — was the biggest delta, rising by 6.8% in the second quarter, compared with a downwardly-revised collapse of 25.7% in the first quarter. As part of the BEA's historic revision and change in methodology, intellectual property was added to this category, gaining 3.9% in the second quarter, essentially flat with a 3.8% first-quarter increase.
Inventory rebuild starts The inventory liquidation and restocking cycle that we had thought would commence in this year's second half apparently already started in the first half, adding 0.40 basis points to the second-quarter’s GDP growth. The pace of inventory restocking rose to $56.7 billion in the second quarter, compared with an upwardly revised $42.2 billion in the first quarter and a downwardly-revised $7.3 billion in last year's fourth quarter. Businesses started to see stronger end-market demand at a time when they were intentionally liquidating their inventories, and it was inevitable that inventories would eventually need to be rebuilt.
Trade deficit widens The stronger U.S. dollar versus the euro, yen and pound, in conjunction with weaker overseas economies, combined to subtract 0.80 percentage points from second-quarter growth due to a wider trade gap. Exports increased by a solid 5.4% in the second quarter, compared with a first-quarter decline of 1.1%. But import gains solidly outstripped the rise in exports, with a strong increase of 9.5% in the second quarter, compared with a muted 0.6% first-quarter bump.
Decline in government spending slows While total government spending, which accounts for about 17% of total U.S. GDP, fell for the eleventh time in the past 12 quarters, it is declining at a decelerating annual pace of only 0.4% in the second quarter, compared with sharper declines of 4.2% in the first quarter and 6.5% in last year’s fourth quarter. But state and local spending actually increased at a modest 0.3% rate in the second quarter, as municipal budgets (with the exception of Detroit) now find themselves in much better fiscal shape today than just a few years ago, and states and cities are finally starting to re-hire teachers, police, fire fighters and nurses with their newly balanced and flush budget outlooks. Federal government spending, however, dropped by 1.5% in the second quarter, as the automatic across-the-board spending sequester is continuing to cut defense outlays.