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Stimulus Means Slow Growth

August 3, 2012 5 minute Read by David Malpass

Second-quarter GDP data released July 27 continued to show a very weak and disappointing economic recovery. Economic growth slowed to 1.5% in the second quarter from a weak 2% in the first quarter. The downtrend is especially worrisome because government spending is pushing the national debt over $16 trillion while the Federal Reserve’s liabilities are rising toward $3 trillion. The Administration claims these are stimulative policies, yet economic growth keeps slowing — from an average 2.4% rate in 2010 to 1.8% in 2011 to only 1.75% so far in 2012. An important revision brought 2010 growth data down substantially, undercutting the perceived value of the government’s 2009 “shovel-ready” stimulus spending. First quarter 2010 GDP growth was lowered to 2.3% from 3.9%, and second quarter 2010 to 2.2% from 3.8%. For full-year 2010, average growth was brought down to 2.4% from 3.0%. The downward revision was largely due to lower assumptions for the change in inventory, meaning factories produced less during 2010 than the government had previously assumed. Also contributing to the 2010 downward revision was a reduction in the growth of business equipment and software. In the latest data, real GDP took longer to rise above the 2007 peak than previously thought. Earlier data had it topping 2007 in the third quarter of 2011, but the latest data show the cross-over in the fourth quarter of 2011. Another important revision hurts the growth outlook. First-quarter corporate profits (the latest available) were revised down and now show a pronounced decline from the fourth-quarter peak. Corporate profits are an important leading indicator of economic and job growth, with a decline in profits often signaling weaker growth or a recession ahead. The data now show $1.9 trillion in corporate profits in the first quarter (annual rate), a $53 billion decline (was a $6 billion decline before the revision) from the fourth quarter peak. Consumer durable purchases (autos, appliances, etc) shrank 1% in the second quarter from the first quarter. This was partly due to the weakening labor environment, which reduces personal income and makes consumers more cautious. Another factor was a letdown from strong first-quarter auto sales, which were aided by good weather and faster job growth. On the positive side, residential construction rose 7.4% in the second quarter (annual rate) after growing 5.2% in the first quarter. With housing starts finally growing, we expect this part of the economy to add to GDP in coming quarters after sizeable subtractions in 2006-2010. We expect continued economic weakness in the second half of 2012. Growth is being hurt by business caution due to uncertainty over their tax and health insurance costs, Europe’s deepening recession, and the weaker euro’s negative impact on U.S. corporate earnings. Why is the economy so weak? Some argue that it was inevitable given the financial crisis and the reduction in consumer debt. We’re not so fatalistic. We think several bad policy developments occurred earlier in the year, helping explain 2012’s weak growth, hiring, and investment.

  • The President's State of the Union speech in January explicitly pitted billionaires against teachers.
  • The February OMB budget provided no useable guidance on the U.S. fiscal crisis and got no support in either the Senate or the House.
  • The Washington decision to block the Keystone pipeline further soured business confidence in the government’s decision-making process.
  • And the Federal Reserve's stubborn efforts to push even longer-term yields toward zero is severely damaging savers, pension funds, small businesses, and the vital market-based capital allocation process.

Also holding down the second half growth outlook, the U.S. has no process to address the fiscal cliff — the combination of an enormous year-end tax increase, the exhaustion of the $16.4 trillion debt limit early in 2013, and automatic cuts in defense and Medicare spending. We think confidence-building steps like a cabinet meeting on the budget or a blanket delay in the year-end tax increase deadline would help. We’ve advocated rewriting the debt limit so that it would restrain spending but not cause the periodic financial panics caused by the current debt limit law.


Author

David Malpass

2012 Economic Growth Fellow

David Malpass is president of Encima Global, and chairman of GrowPac. He writes a regular Current Events column in Forbes magazine, and his opinion pieces appear regularly in the Wall Street Journal. He sits on the boards of the Economic Club of New York and the National Committee on U.S.-China Relations. Formerly, Mr. Malpass was chief economist of Bear Stearns. Between February 1984 and January 1993, he held economic appointments during the Reagan and Bush Administrations. He was Deputy Assistant Treasury Secretary for Developing Nations, a Deputy Assistant Secretary of State, Republican Staff Director of Congress’s Joint Economic Committee, and Senior Analyst for Taxes and Trade at the Senate Budget Committee.

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