The great recession ended over two years and yet, economic growth remains sluggish, labor market is still moribund, and consumer confidence has barely budged since June of 2009. So, what’s missing?.
Economics and central bank policy will most likely play second fiddle to the ongoing debt ceiling debate in the United States, the fiscal woes in Europe and the heart of the second quarter earnings reporting season for the S&P 500 companies. Housing data (home-builder’s sentiment, housing starts, building permits, existing and pending home sales) will also be under the microscope. But the key report will be the July reading of the Philadelphia Fed manufacturing index. Overseas data on June consumer spending in Japan and July manufacturing in China will draw the most attention from market participants. Meanwhile, the Central Bank in Brazil, Canada, India, and South Africa are meeting and it appears Brazil is poised to raise rates. Indeed, many overseas Central Banks may now be much closer to the end of their tightening cycles than they were in the early part of 2011.
The great recession ended over two years and yet, economic growth remains sluggish, labor market is still moribund, and consumer confidence has barely budged since June of 2009. So, what’s missing? The answer, of course, is in the question: the recovery is missing growth, and jobs and confidence, but why? Below we briefly examine how we got here (two years into the recovery) and what makes this recovery different from prior economic recoveries. Our answers may surprise you.
In testimony to Congress in mid-July, Federal Reserve Chairman Ben Bernanke noted that although the economy was growing, and expected to continue to grow in the coming quarters, headwinds to growth were prevalent. The headwinds noted by Bernanke included the following:
- Slow growth in consumer spending, even after accounting for the effects of higher food and energy prices
- A continued depressed condition of the housing sector
- Limited access to credit for some household and businesses
- Fiscal tightening at all levels of government
Consumer Spending In prior public appearances over the past few months, Bernanke, in addition to mentioning contemporary factors — the earthquake and tsunami in Japan and its impact on the global supply chains, severe weather and higher energy prices –has cited as “weakness in the financial sector” and “balance sheet and deleveraging issues” as longer-term issues that may be impacting the recovery. All along, consumers have hung in there. At the beginning of 2011, the slow labor market and ongoing repair of consumer balance sheets (i.e. consumers are paying down debt and saving, along with doing a little spending) has clearly limited the consumers influence on the recovery. For the first seven quarters of the recovery(the second quarter of 2009 to the first quarter of 2011) consumer spending contribution to overall real domestic product, (GDP) growth has been 11 percentage points. While this may sound great, considering that consumer spending accounts were two thirds of GDP, the consumer’s contribution to GDP growth in this recovery pales when compared to the recoveries following the mid-1990-1991 and 2001 recessions, and is not even in the same league with the performance of consumer following the severe 1973-1975 and 1981-1982 recessions.
On average, during the first seven quarters of the economic recovery following the two mild recessions (1990-1991 and 2001), consumer spending contributed around 14 percentage points to growth. In a similar period following the severe recessions of 1973-1975 and 1981-1982, consumer spending contributed around 22 percentage points to growth.
Tepid real income growth, which, in turn, is a result of tepid job growth, takes most of the blame here during the current recovery, along with the aforementioned balance sheet repair. Looking ahead, the consumer-related headwinds are likely to persist, keeping a lid on spending and consumer confidence. Our outlook remains that the consumer will continue to try to hang in there, but will not be the driver of the economic growth as it was during similar stages of prior recoveries.
Housing and Credit Over the first seven quarters of the current recovery, housing has been a net drag on overall GDP growth, marking for the first time in post-World War II era that housing has not made a contribution to overall economic growth this far into a recovery. On average, during the economic recoveries following mild recessions, housing continues three (3) percentage points to GDP growth, and that figure is closer to seven (7) percentage points in recoveries from severe recessions. As one might expect, the weakness in housing in this recovery had a major impact on employment in the construction industry.
Construction employment has declined at a 3.7% annualized pay since June of 2009, while in the recoveries from the severe recessions in the ’70s and ’80s, construction employment at this point in the cycle has increased by 4%. Looking ahead, housing is likely to continue to bounce along the bottom, not getting any worse, but not getting any better anytime soon.
A large overhang of unsold existing homes – officially around 4M, but there are another 2M or so existing homes in so-called “shadow inventory” (bank owned houses mirrored in the foreclosure pipeline) – continues to be the largest impediment to an improved housing market. Additionally, tighter lending standards are in play as compared to the 2002-2006 boom years, and tepid labor markets are also helping to restrain people from buying homes.
The only plus side we see is that housing affordability and the ability of a family with medium income to afford the payment on a medium priced home is at an all-time high. Banks are just becoming more willing to lend in this sector.
Fiscal Tightening Since World War II, state and local government spending and employment has been a reliable source of economic growth at virtually all points of the business cycle. In mid-July, Fed Chairman Bernanke stated that state and local governments have been an unprecedented impediment to growth and employment in this recovery.
For the first time since World War II, state and local government spending has not added to the growth over the first seven quarters of the economic recovery. In fact, state and local government spending have subtracted 1.5 percentage points from growth over the past two years, and the state and local government employment has contracted at a 1.5% annualized rate over that time. In contrast, state and local government spending has added around one full percentage point to growth over the first seven quarters of the prior four economic recoveries, while adding jobs at 1.5 annualized rate.
Looking ahead, the best case would be that state and local government’s contribution to GDP growth stabilizes, and that job losses seen in the sector continue at the current pace (around 15,000 to 20,000 per month) for the foreseeable future, as states and municipalities of all sizes continue to struggle with too much spending and not enough revenue.
Of course, the lack of contribution with state and local government and housing, along with historically low contribution from consumers at this stage of the recovery, has left the heavy lifting to the export sector, inventory accumulation, business spending and, of course, federal government spending. Three of the four drivers of growth thus far in the recovery –business capital spending, exports, and inventory accumulation–appear likely to continue, while federal government spending will likely fade as budget cuts at the federal level loom on the horizon.