In their second estimate, the Bureau of Economic Analysis (BEA) revised Q1 2014 Real GDP down 1.1%, which means that Real GDP contracted by a seasonally adjusted annual rate of 1% in the first quarter of this year. In comparison, Real GDP grew at 2.6% in the fourth quarter of 2013. A substantial decline in inventory investment is responsible for much of the decline; in fact, if we leave inventory investment out of the GDP calculation, Real GDP actually rose by 0.6% over the period from Q4 2013 to Q1 2014.
Despite disappointing metrics, the IMF stood behind previous assertions that U.S. growth will pick up in the medium term, but extended the forecasted period of subdued growth by lowering Real GDP in 2014 to 2% from 2.8%. However, the forecast remained unchanged for years 2015 and beyond (3% in 2015 and a LT rate of 2% thereafter), suggesting that the downward revision in Real GDP isn’t indicative of any economic issues ahead.
The U.S. economy is expected to grow above trend into 2015. Why? Fiscally speaking, consolidation (i.e. efforts to reign in the deficit) will be less severe than last year. Monetary policy in the U.S. is still very accommodative, which should help the economy pick up some slack until about mid 2015 when the policy rate is expected to increase. Household wealth in the U.S. has also increased, thanks in part to the Fed propping up the stock market. The ‘Wealth Effect’ seems to be working via the stock market, encouraging financial asset-holding consumers to consume more. Keep in mind, though, that stock market gains disproportionately benefit wealthy consumers, limiting the wealth effect’s impact. As for credit markets, lending conditions depend on the customer in question. Business and industrial lending is easy, as is lending to the most credit-worthy customers. However, credit has been tightening for risky borrowers, even as demand for credit has surged and banks have tons of cash reserves. So, while total lending activity in dollar terms is increasing, and thus households are incurring more debt in aggregate, it doesn’t follow that banks are willing to take on more risk and lend to consumers who are dependent upon credit. Wage growth is also slow, further constraining the majority of consumers’ ability to consume. Personal consumption is 70% of the U.S. GDP, so to see broad-based and sustainable gains in GDP, wages will have to grow and/or credit will have to become more available.
Inflation declined in 2013 which was presumably helped by lower commodity prices (like energy and food). The issue is (mostly) in what low inflation tells us about where the economy is operating relative to its potential. The widespread decline in inflation reminds us that the output gap in the US economy persists and is closing only gradually. Additionally, there are some prices that we want to see increase – like wages! Unfortunately, that’s happening only very modestly (as shown above). Wage growth will need to pick up in order to grow consumption, especially given credit conditions for middle and low income consumers. If you’re looking at unemployment figures and thinking that the labor market looks strong, I’d invite you to take a look at the labor force participation rate as well, as the labor force is at a 35-year low. The picture isn’t all that good, and unemployment is still high relative to the long term trend. To see a healthy ish labor market, look at Germany.
To summarize the summary, the good news outweighs the bad news – but remember two things: 1) better economic conditions aren’t necessarily good economic conditions, and 2) the U.S. economy, like all advanced economies, is heavily integrated with the global economy, whose recovery remains patchy, uneven and fragile in some areas. I suppose you could say cautious optimism about the U.S. economy as a whole in 2014 and 2015 is warranted given the current state of demand and prices.
Sources: IMF World Economic Outlook, BEA, and WSJ