Third quarter growth was driven by private consumption and government defense consumption. Investment expenditures were weak, and trade was a small drag on third quarter growth. Business investment expenditures actually contracted, while residential real estate investment was strong at 14.4 percent.

The residential investment is welcome and appears to be a bounce off of the bottom for the residential real estate market. The recovery in housing will likely be bumpy, so we should not expect 14.4 percent residential investment growth rates in the next few quarters.

This report indicates a weak economy despite indicating third quarter’s growth was greater than second quarter growth of 1.3 percent. If we take out “computers” which was boosted by the release of a new I-phone and government expenditure growth, then economic growth would have been 1.1 percent rather than 2 percent.

As one might suspect with third quarter consumption expenditures of two percent, up from 1.5 percent in second quarter, the BEA measure of the personal savings rate fell from 4 percent in the second quarter to 3.7 percent in the third quarter. This report indicates that savings and investment was relatively low in the third quarter.

We have come to a point where short-run Macroeconomic stimulus policies are a waste of resources. The trough of the Second Great Contraction, 2009 Q2 as measured by the level of real GDP, was over three years ago. We are way past it, and we need to get over it. What is needed now are economic behavior and policies that will foster medium-term and long-run growth.

What is healthiest for U.S. medium and long-run economic growth is savings and investment. Households should continue rebuilding their balance sheets and governments should put policies in place for dealing with structural budget problems over time. These activities would provide the environment for private business to invest and grow the economy.

The post Third Quarter U.S. Economic Growth appeared first on Center for Economic Research and Forecasting.

Dan Hamilton
October 28, 2010

The first estimate of United States third quarter Gross Domestic Product came out today. The preliminary estimate of third quarter real GDP growth was 2.0 percent, which follows a 1.7 percent growth rate during the third quarter. This preliminary estimate of third quarter economic growth is not very different from the previous quarter’s growth rate. However, one aspect of the composition of growth changed dramatically from the previous quarter, which was residential real estate investment. This measure, which grew 26 percent during second quarter, fell 29 percent during the third quarter.

I have argued in this blog-space that the 26 percent second quarter growth was a temporary, stimulus driven result, and not a sustainable recovery in residential real estate. This data release supports that argument and is congruent with our September 27 United States Economic Forecast of a contraction in this investment segment.

I should say that with respect to the recently ended recession and the currently weak recovery that we are now experiencing, “it’s the residential real estate, stupid!”, and we see continued weakness for that sector for some time. There are too many homes yet to be foreclosed on and too many unemployed that cannot consider a home purchase at this time. The stock of ownership housing is too large for demand, and it will remain too large for demand this same time next year.
Other aspects of the data release are counter to my forecast, namely stronger consumption expenditures, stronger inventory investment, stronger government expenditures, and stronger commercial real estate expenditures. Stronger consumption expenditures boost GDP now, but given that household sector debt levels are still too high, I worry about the long-term consequences of such consumption. Continued consumption growth, if it occurs, will be accompanied by rapid inventory investment.

I continue to be surprised by the strength of government expenditures. The preliminary estimates show federal spending growing with such strength to offset state and local weakness. I continue to expect that state and local expenditure weakness will be a greater drag on growth during the next few quarters than the previous couple of quarters.

Third quarter GDP was reduced by trade as was the case in second quarter, although this effect was weaker this time, 200 basis points, versus 350 basis points during second quarter. These results are driven by extraordinary import strength, which most forecasters, as well as I, do not believe is sustainable. Once this import strength subsides, GDP growth will benefit.

I do not see many fundamental support factors for United States economic growth at this time other than trade, technology, and manufacturing. However, these are not large enough to create a strong economic recovery from the Great Recession. The next couple of quarters might see offsetting factors that create moderate growth for some time to come. The positive factors will likely be: federal government expenditures, equipment and software investment, and import growth reductions. The negative factors will likely be: state and local government expenditures and real estate.

A major difficulty with forecasting at this time is the question of how households will behave during the next couple of quarters. Will they save for the future or consume? There are economists on both sides of this question. We have been thinking that they would save, and we will probably continue to forecast this.

The post United States GDP appeared first on Center for Economic Research and Forecasting.

However, the impact will be relatively modest. Notice that expensing merely accelerates deductions. Thus, the value to the firm depends on interest rates. With interest rates near zero, the impetus to investment is small. Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.

I like his final paragraph, where he endorses an investment tax credit, something we at CERF have been recommending for some time:

One can imagine more aggressive policies along similar lines, such as an investment tax credit together with expensing.  But let’s not make the best the enemy of the good.  This policy proposal is a step in the right direction.  I hope Congress passes it quickly and in a bipartisan fashion.

I hope so too.

The post Mankiw Speaks appeared first on Center for Economic Research and Forecasting.

Seeing a problem and knowing how to solve it are two different things.  So, we’re going to see lots of silly ideas proposed.  We’ll see demands for more government spending.  We’ll see demands for less government spending.  We’ll see demands for higher taxes.  We’ll see demands for lower taxes.  We’ll see demands for more consumer spending.  We’ll see demands for more consumer saving.

All of these recommendations can’t be correct.  In fact, they are all beside the point.  I’m not saying the proposals won’t have any impact.  They will, but the impacts will either be marginal or they will be some time in the future.  Our problem is immediate and very serious.  Here’s what we need to do to avoid a lost decade:

• Fix the financial sector
• Stop paying interest on deposits at the Fed
• Lower effective borrowing costs with an investment tax credit
• Reduce regulatory uncertainty and big-business bias
• Increase immigration

Any vigorous recovery needs a vigorous financial sector, and ours is not.  Fed policy has been ineffective, because the money multiplier has tanked, even as the monetary base soared.  There are two reasons for this: The Fed is paying banks to deposit at the Fed, and the banks–burdened with over-leveraged balance sheets, huge charge-offs, and bad assets–are in no shape to lend.  Fix the banks, and stop encouraging them to park money in Washington, and we’ll have a start on real recovery.

We have an investment problem; there isn’t any.  That’s because, even at zero, borrowing costs exceed expected returns on investments, and the future regulatory environment is extremely uncertain.  We can’t lower interest rates below zero, but an investment tax credit would effectively lower borrowing costs.  Do that and remove regulatory uncertainty, and our businesses will invest.  While we’re at it, let’s reduce big business’ regulatory advantage.

Finally, we don’t have any problems that couldn’t be fixed by a few million new immigrants.  We’d see an immediate increase in housing demand and construction.  Our inner cities would be renewed.  Our economy would see a burst of creativity, energy, and new business formation.

The post America's Lost Decade appeared first on Center for Economic Research and Forecasting.

The paper is clear, and that’s not what I’m confused about. I’m confused because Christina Romer is one of the administration’s top economists, and the insights in her research are not being reflected in policy.

Romer and Romer find that there is a large negative tax multiplier, perhaps over three percent. That is for one percentage-point change in taxes as a percentage of GDP, you get an opposite three percent change in output, GDP. So, a one percentage point increase in taxes, as a percentage of GDP, results in a GDP decrease of about three percent. Conversely, a one percentage point decrease in taxes generates about three percent GDP growth.

The size of the tax multiplier stands in stark contrast with the best estimates of the spending multiplier. For example, Valerie Ramey, in a very recent paper that is currently unpublished but will surely be published in a top journal, uses a methodology very similar to the Romers’ and finds the spending multiplier is positive and in the range of 0.6 to 1.2.

The implication of the research is clear. Tax policy is a far more powerful economic stimulus tool than is spending policy. Why isn’t this research reflected in current policy?

Beats me.

Given the popular belief that economic conditions are important to a party’s reelection, ignoring this research appears to be irrational.

The Romers’ paper has other insights. One is that the purpose of the tax change seems to matter. Tax increases intended to reduce deficits are less harmful than a random tax increase. The authors speculate that part of this phenomenon is that tax increases to reduce deficits are usually accompanied by complementary spending cuts.

The most fascinating result is that the multiplier works mostly through investment. A tax increase has a small negative effect on consumption, but a large negative effect on investment. Similarly, a tax cut’s stimulative effect is mostly through investment and not consumption.

These findings have important implications for today. A lack of investment is a key characteristic of this business cycle. If we are in a recovery, this is why it will be so weak. Obviously, raising taxes would be the opposite of a stimulus, and best avoided for now. Instead, we need the mother of all investment tax credits.

The post I’m Confused appeared first on Center for Economic Research and Forecasting.

I’ll stipulate his second point, but his first point is all wrong.

The data make it pretty clear that unemployment insurance increases unemployment in good times.  An amazing percentage of unemployed find jobs the last week of eligibility.   Of course, these aren’t ordinary times. Given the difficulties in finding a job in this market, and given the average duration of unemployment, it is easy to believe that there are very few people who are unemployed because of unemployment benefits.

Laffer presents the following chart, and he claims that is proves his point that unemployment benefits cause unemployment.

He says:

“As the chart nearby clearly shows, since the 1970s there’s been a close correlation between increased unemployment benefits and an increase in the unemployment rate. Those who argue that things are different today don’t have the data to back up their claims.”

There is a correlation, no doubt about that, but as Mr. Laffer has surely heard countless times, correlation does not imply causation.  It looks to me that the unemployment insurance lags unemployment.  That would imply that unemployment causes unemployment benefits.

Of course, that’s the way it seems to work in practice.  When unemployment becomes extraordinarily high and its duration long, governments extend benefits.  That seems like the right thing to do.  It’s not stimulus, and people who claim it is stimulus are uninformed or dissembling.  It’s just one of those humanitarian things we do to share the costs of a deep recession.  Think of it as mutual insurance.

The post No Mr. Laffer, The Data Don't Back Up Your Claim appeared first on Center for Economic Research and Forecasting.

New unemployment claims also rose to 444,000, again exceeding “consensus expectations.”

There was also a report that will receive much less attention, but it is important. Inventories increased in November, the most recent month for which data are available. If inventories were increasing over the Christmas shopping season, and sales were declining, retailers ended the year with excessive inventory. That means reduced production in the first and second quarters of 2010.

2009’s third quarter output (GDP) growth was positive, and many expect a very impressive positive number for the fourth quarter, some as high as five percent. If the fourth quarter does come in with a strong GDP growth rate, it will be hailed as the harbinger of a soon-to-be-realized vigorous recovery.

Don’t buy that, and you won’t be disappointed.

That vigorous recovery may eventually come, but it is unlikely to come in 2010. Whatever growth generated in second-half of 2009 was government-supported consumption, ephemeral, not a solid foundation for economic growth, certainly not the basis for sustained vigorous job growth.

A vigorous recovery will be a result of investment, technological growth, and improved productivity. Recent productivity numbers have been encouraging, but in large part, they are probably the result of firms downsizing. Technological growth and solid job growth require investment, and that is the problem.

Our banks are in no condition to fund any vigorous expansion. Indeed, bank loans have been declining since October 2008. Businesses and consumers remain over-leveraged, unable to increase spending on consumption, unable to invest, desperately trying to reduce debt.

We won’t see a vigorous recovery until balance sheets are improved and banks can lend.

Government programs haven’t helped. Most of the spending programs have been consumption based instead of investment based. Some have been outright counterproductive, programs such as foreclosure-delay, paying interest on bank deposits at the Fed, and cash for clunkers. Even worse, the banking problem has been ignored, and now new taxes on banks are being discussed. That is as bad an idea as I’ve heard in a long time.

The post How’s That Recovery Going? appeared first on Center for Economic Research and Forecasting.

I’m as concerned as anyone about total government spending and the deficit. I’m probably more concerned than most about bank lending to business. But, conspiracy isn’t the problem.

Part one of Melloan’s theory is that the Fed is causing banks to be excessively risk averse. He says “The Federal Reserve, which supervises some 7,000 banks, has been telling bankers that they must cut risk.”

The FDIC reported today that there are 552 banks on their problem list. Banks have been charging off $40 to $50 billion per quarter in loans for a year now. Capital has been eroded, and banks are way overleveraged, in part because of excessive risk taking. You think that maybe banks should be more risk averse today? You think that maybe there is a rational reason for banks to lend less to business and purchase more government securities?

The real problem is not some government conspiracy. The real problem is the government’s quiescence.

Too many of our banks are zombies, and we face something like Japan’s lost decade if we don’t fix them. This is the single most serious United States problem today. It drives me crazy that we are wasting huge amounts of resources and political capital on second-order problems while ignoring the bank problem.

Robust recovery requires banks lending to businesses. Banks can’t lend to businesses until they are adequately capitalized, and the bad assets are off the books. We will not have a robust recovery and put people back to work until our banks are fixed.

Bankruptcy is one way to clean up our banks. Since the FDIC fund is currently upside down, -8.2 billion, this would require external funds to the FDIC. The other option is the one successfully used by Sweden. They nationalized the banks, cleaned them up, and resold them. This would also require an investment.

Either way, fixing the banks is a far better use of money than some Stimulus 2 program or even the unspent portion of the current stimulus program.

The post It is Not a Conspiracy appeared first on Center for Economic Research and Forecasting.

I think Fed policy has been too tight. Instead of paying interest on excess deposit, they should be charging a fee. Of course, many disagree and worry about inflation, and that is what I thought I was reading as Shelton proceeds with her thesis that the Fed’s policy may be fueling a new asset bubble. This is pretty standard stuff, boringly standard in fact. I was about to quit reading and go on to something else when I came to a paragraph that stopped me cold:

“Deflation is seen as the bugaboo of Keynesian economics. But it can actually serve to spur economic activity as lower prices enable struggling consumers to get back in the game, and enterprising individuals can build businesses using tangible assets that yield valid profits.”

That paragraph is breathtaking, so wrong on so many levels, so counter to what we know to be true. I couldn’t believe that an economist would say that. So, I looked for her tag line. Sure enough, it says she’s an economist. I did a web search. She’s got at least one book out. She’s in the WSJ frequently. She’s all for a gold standard.

Shelton received her Ph.D. in Business Administration at the University of Utah, and she’s a professor at the Duxx Graduate School of Business at Monterrey, Mexico. One observer—goes by Federalist on the web, but I couldn’t find a name—described her as having few credentials. I don’t think that is exactly true. She has impressive credentials, just not as an economist.

Let’s correct her paragraph:

No one is going to mistake me for a Keynesian, but I’m certain that deflation is bad. Economists in general, not just Keynesian, know deflation is bad. I don’t know of one credible economist, from a top 50 school, with a Ph.D. in economics, who believes that deflation is not bad.

Shelton goes beyond saying deflation is not bad. She claims deflation is good, stimulative, spurring economic activity, “enabling struggling consumers to get back in the game.” Amazing.

Here’s the story on deflation: As prices fall, no one has an incentive to purchase anything, the cost will be less tomorrow; consumption and investment decline. Borrowers pay with deflated dollars, making real interest rates very high, again leading to less investment and consumption. Wages don’t adjust quickly, leading to unemployment, 25 percent in the depression. Asset values decline, but debts become more burdensome, leading to credit defaults and over-leveraged banks, businesses, and consumers. Lending, borrowing, consumption, investment, and economic activity decline.

One problem of smart people pontificating outside their field is that they come up with ideas that sound good, don’t hold up to serious analysis. Economists have performed a huge amount of research on inflation and deflation, empirical research and theoretical research. The profession has rejected the thesis that deflation is good. The risk is that someone with authority listens to someone like Shelton and tries to implement her recommendations. That would be tragic. Bad policy leads to a bad economy, and the costs of a bad economy are immense and not just financial. Serious recessions change lives, usually for the worse. Careers, families, and lives are destroyed. It is a shame that Shelton has a mouthpiece as big as the Wall Street Journal.

The post Deflation is Always Bad appeared first on Center for Economic Research and Forecasting.

Their piece is titled “The Stimulus Didn’t Work.” They provide data and cite the work of two economic gods: Friedman and Modigliani. I think the argument is convincing, but then I never expected the stimulus to work.

The piece is well worth reading.

Paul Krugman will claim it didn’t work because it was too small. Of course you can always say that. After the inevitable recovery, less intellectually honest politicians will claim it worked. Heck, some are already claiming it worked.

There is a problem with this. There will be another recession some day, and there will be another stimulus, even if it is counterproductive. It doesn’t matter which party will be in office. Every administration going back to and including at least the first Bush has engaged in some sort of stimulus-type programs when faced with a recession. Clinton was lucky enough to not have a recession in his tenure.

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