Tue, Jul 05, 2011 - Page 9 News List

Weakness of US economy unlikely to improve soon

By Martin Feldstein

The US economy has recently slowed dramatically and the probability of another economic downturn increases with each new round of data. This is a sharp change from the economic situation at the end of last year — and represents a return to the very weak pace of expansion since the recovery began in the summer of 2009.

Economic growth in the US during the first three quarters of last year was not only slow, but it was also dominated by inventory accumulation rather than sales to consumers or other forms of final sales. The last quarter of last year brought a welcome change, with consumer spending rising at a 4 percent annual rate, enough to increase total real GDP by 3.1 percent from the third quarter to the fourth. The economy seemed to have escaped its dependence on inventory accumulation.

This favorable performance led private forecasters and government officials to predict continued strong growth for this year, with higher production, employment and incomes leading to further increases in consumer spending and a self-sustaining recovery. A one-year cut of the payroll tax rate by 2 percentage points was enacted in order to lock in this favorable outlook.

Unfortunately, the projected recovery in consumer spending did not occur. The rise in food and energy prices outpaced the gain in nominal wages, causing real average weekly earnings to decline in January, while the continued fall in home prices reduced wealth for the majority of households. As a result, real personal consumer expenditures rose at an annual rate of just about 1 percent in January, down from the previous quarter’s 4 percent increase.

That pattern of rising prices and declining real earnings repeated itself in February and March, with a sharp rise in the consumer price index causing real average weekly earnings to decline at an annual rate of more than 5 percent. Not surprisingly, survey measures of consumer sentiment fell sharply and consumer spending remained almost flat from month to month.

The fall in house prices pushed down sales of both new and existing homes. That, in turn, caused a dramatic decline in the volume of housing starts and housing construction. That decline is likely to continue, because nearly 30 percent of homes with mortgages are worth less than the value of the mortgage. This creates a strong incentive to default, because mortgages in the US are effectively non-recourse loans: The creditor may take the property if the borrower does not pay, but cannot take other assets or a portion of wage income. As a result, 10 percent of mortgages are now in default or foreclosure, creating an overhang of properties that will have to be sold at declining prices.

Businesses have responded negatively to the weakness of household demand, with indices maintained by the Institute of Supply Management falling for both manufacturing and service firms. Although large firms continue to have very substantial cash on their balance sheets, their cash flow from current operations fell in the first quarter. The most recent measure of orders for nondefense capital goods signaled a decline in business investment.

The pattern of weakness accelerated in April and May. The relatively rapid rise in payroll employment that occurred in the first four months of the year came to a halt in May, when only 54,000 new jobs were created, less than one-third of the average for employment growth in the first four months. As a result, the unemployment rate rose to 9.1 percent of the labor force.

This story has been viewed 4603 times.

Comments will be moderated. Keep comments relevant to the article. Remarks containing abusive and obscene language, personal attacks of any kind or promotion will be removed and the user banned. Final decision will be at the discretion of the Taipei Times.

TOP top