The Bureau of Economic Analysis announced here that real GDP increased by a seasonally adjusted annual rate of 2.5%. The increase was fueled largely by personal consumption expenditures (contributing 2.24 percentage points to the overall 2.5 percentage point increase).

What worked against the increase in real GDP growth was a large decline in government spending along with a big rise in imports.  Although this report represents yet another quarter of growth below the long run trend, it was positive growth in contrast to Europe which is sinking back into recession.

On the bright side, the economy continued to generate positive growth without the boost from Government spending.  Signs that housing markets contributed to the positive growth represent an encouraging phase in the recovery–historically, housing  has led the economy out of contractions.

The bar graph shows another way of looking at the recent behavior of real GDP. The bars in the graph show the quarter-to-quarter change (s.a.a.r.) in real GDP while the blue line indicates the year-over-year change (s.a.a.r.). The first thing that stands out is the very large decline in real GDP during the last recession. The recession in the earlier part of the decade hardly looks like a recession at all in comparison. And, while the quarterly change in Q1 was 2.5%, the year-over-year change between 2013Q1 and 2012Q1 was 1.8%. Moreover there appears to be somewhat of a decline in the average year-over-year change: the average pre-2001 recession year-over-year change was higher than that in the years between the 2001 recession and the recession beginning in 2007 and that is higher than the recovery phase starting in June, 2009 (according to the NBER business cycle dates).

An alternative way to think about long-term economic growth is to decompose real GDP into a trend component and movements around this trend, that is, the cyclical component of the business cycle.  Many economists use the Hodrick-Prescott (HP) filter to do this decomposition. The HP filter, however, has some issues that we have pointed out previously here about estimating the growth trend at the end of the data series.

If one believes we will eventually get back to 2% real growth, the trend line will be something like the dashed red line in the following two graphs. The green line represents the HP filter’s trend which equates to about 0.8% annual GDP growth.

The implication of this is that the recent recession and recovery will appear much worse if we believe that GDP will grow at 2% over the long term. The red dotted line in the graph below has shown no signs of returning to the historical trend, and won’t, as a long as the quarterly report consistently comes in below 2 percent. On the other hand, if you believe that the financial crises and Great Recession inherently altered the growth potential of the US economy and that the long-term growth trend has shifted down, as the green line shows, then the recovery doesn’t look nearly as anemic. In fact, with this view GDP has already recovered and is above trend.

Many may be aware of what has been called the Great Moderation, a period where the volatility of real GDP declined markedly–between the mid 1980′s and 2007. While some have mentioned that this may be the result of better policies, the recent episode may suggest that the great moderation was nothing but a series of smaller, or less consequential shocks.

If one believes that we will once again move to the sustained 2% growth path, then the graph above leaves plenty of room for concern in the short-term.

Data released by the Federal Reserve shows that household sector debt outstanding rose at a 2.5% annual pace in the last quarter of 2012. It was the first time since the beginning of the recovery that household debt didn’t fall as a percentage of GDP. Households had been steadily de-leveraging until the most recent quarter. Debt to GDP remains 15 percentage points below its level at the peak of the cycle and those levels will not likely be seen again soon. Total borrowing by the household sector also increased in the fourth quarter, indicating that the household sector is willing to take on additional debt in this very low interest rate environment.

In terms of net worth (assets minus liabilities), households’ balance sheets are slowly improving, aided by a recovery in the housing sector and rising equity prices. As a percentage of GDP, the fall in household net worth from the peak in 2007 was 4 times as severe as the fall caused by the dot-com bust that spurred the 2001 cycle. The difference, of course, was the collapse of the housing market. The total market value of real estate assets fell 40 percent more than the fall in GDP. This was combined with a similar fall in the value of household’s holdings of financial assets.

Non-financial business corporate debt rose at an even faster pace in Q4 (8.75% annually). A large portion of the increase was due to increased corporate bond issuance.

There has been a lot of talk (here is one example) about how corporations are hoarding cash and are reluctant to invest earnings. The figure below shows the amount of checkable deposits and currency held by the non-financial corporate sector (only one form of liquid assets corporations hold).

The total size of this cash hoard is now nearly twice as high as it was before the peak of the cycle and nearly $400 billion higher than at the trough. Before you make the call in favor of hoarding though, take a look at the evolution of total currency and deposits as a percentage of total assets.

As a percentage of total assets, the business corporate sector’s holding of currency and deposits is relatively low and is returning to the levels of the 1980′s. A similar picture can be shown looking at a broader category of liquid assets (including savings, time depots, mmmfs, etc.). There doesn’t seem to be any extraordinary behavior on the side of firms. Similarly, households appear to be carrying relatively low levels of cash and deposits relative to total assets.

The advance estimate of Q4 Real GDP released on Wednesday showed that US output contracted by 0.1 percent in the final quarter of 2012. The effect of fiscal policies as well as weakness of the European economy and the rest of the world can clearly be seen in the negative aspects of the report.  The overall decline was due to a reduction in  exports (-5.7%) and a rundown in inventories as well as a large decline in government spending (-6.6%) caused by a 22.2% cut in defense.

The negative headline number hides overall positive growth in domestic fundamentals. Consumption expenditures on durables increased at a faster pace than in Q3, and both residential and non-residential fixed investment recorded the highest combined growth since the second quarter of 2010. There are signs that spending on services and non-durables are slowing down, which will be a cause of concern if the trend continues into 2013.

Fiscal policies matter. The expected end of the payroll tax holiday had a large effect on personal income and savings toward the end of the year. In the final two months of 2012, real disposable personal income increased by 1.3% and 2.8% in November and December. This is in stark comparison to the .14% growth in the first 10 months of the year. The run-up in income can almost entirely be attributed to companies shifting dividend payments forward. The result lead to a jump in the savings rate, up to 6.5%, but no apparent change in personal consumption expenditures.

                           Aug.     Sept.    Oct.     Nov.     Dec.
                           (Percent change from preceding month)
Disposable personal income:
  Chained (2005) dollars  -0.3      0.1     -0.1      1.3      2.8
Personal consumption expenditures:
  Chained (2005) dollars   0.0      0.5     -0.2      0.6      0.2

Personal Savings Rate      3.6      3.3      3.4      4.1      6.5

Inventory Changes

Interpretation of the downward change in business inventories is difficult. The negative view is that businesses are cutting back on production for fear of weak demand in the future perhaps in anticipation of tax and spending cuts in the New Year. The positive view is that sales in the fourth quarter were unexpectedly high. So the question that really should be asked is when are negative inventory changes indicative of a slowdown in output?

A first step is to see how inventories are related to the business cycle. The graph below shows the real change in private inventories adjusted for the level of output (in red) and the business cycle component of real GDP (in blue) since 1970. Inventories are positively correlated with output and tend to lead the business cycle, meaning that generally inventories decline before output. However, the change in inventories is noisy. A quarter decline is much less informative than a prolonged period of inventory depletion. The implication is that we will have to wait a bit longer  to understand the full importance of the recent decline.

As always, we show the components of GDP measured from the peak of the business cycle.

There was little news in an altogether moderate  jobs report for December. Non-farm payrolls added 155,000 jobs in December, coming close to the average monthly net change in 2012 of 153,000. The gains largely came from health care (+45K) and food services and drinking places (+38K). Retail trade and temporary help services both contracted (-11K and -.6K respectively).

61 months after the start of the recessions and most labor market indicators are still well below their peak level. Non-farm employment remains close to 3% below while hours remains 5.4% below and showing signs of slowing down. 
The unemployment rate remained at 7.8% showing that the labor market has made little progress since the end of the summer.  Participation also remained steady at 63.9% as well as the employment population ratio at 58.6%. There are a few positive signs in the report that suggest improvements in the labor market may be ahead for 2013. The mean duration of unemployment fell from 39.7 weeks to 38.1, marking the biggest monthly decline since the recession began. It is still a far cry from an average of 16.6 weeks at the peak of the cycle, but it is the first signs that the whole distribution of unemployment duration is shifting lower.

The second estimate of Q3 Real GDP, released today indicates that output grew slightly faster at 2.7% than previously estimated at 2%. On the face of it this seems like good news because it implies a more robust recovery than the earlier estimate. Unfortunately there are reasons to temper that optimism.  Much of the increase was due to an upward revision in the Q3  change in inventories which increased from$34 billion to $61 billion.  Unfortunately, these inventories could dampen growth in the fourth Quarter as firms work them off.  Net Exports were also revised upwards and added significantly to the increase in estimated GDP growth.

The fundamentals that we look to  for evidence of a robust recovery were not encouraging. Real consumption growth was revised downwards from 2% to 1.4% and real private non-residential investment declined 2.2% in the third quarter in contrast to the 3.6% increase in the second. There has been a lot of concern about the drop off in capital spending and many observers attribute it uncertainty about Europe and fiscal policy.  Whatever the reason, the consequences for future output growth cause for concern.

In a departure from our usual format we present many of the series in both per-capita terms and levels in the following graphs.

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