The 2011 Q2 GDP Report

As we and other analysts have already mentioned, the GDP report released Friday indicates that growth was slower than we thought and inflation was higher than we thought during the 2007 to 2010 period.

2011 quarter 2 economic growth was 1.3 percent. Some details include:

• Consumption growth was essentially zero
• The BEA savings measure rate rose a bit (from 4.9 to 5.1 percent)
• Investment was reasonably strong with a 0.9% contribution
• Government spending and investment was a drag on the economy (by 0.23 percent)
• Trade boosted GDP by a 0.6% contribution
• Motor vehicle output dropped
• The Core PCE price measure of inflation rose from 1.6 percent in quarter 1 to 2.1 percent in quarter 2

I do not mind seeing the consumption growth rate decline, and the savings rate rise. I have been arguing for a while that high debt levels and depressed housing prices should imply that households rebuild their assets to liabilities.

I note that the late 2009/early 2010 drop in the savings rate was during a period of time when the government was providing incentives for consumption: Cash-for-Clunkers and Home-buyer incentive programs. Balance sheet rebuilding is a hard and lengthy process. Perhaps policymakers should consider incentives to save rather than consume at this point.

It will be tough for the government to stimulate the economy in the near term. Witness what happened in quarter 2:

• Federal defense spending grew 7.3 percent
• Federal non-defense spending was shrank by 7.3 percent
• State and local spending also shrank by 3.4 percent

Despite vigorous defense spending, government sector growth was negative. State and local spending is about two-thirds of the total government spending level, and these governments will not be able to increase spending anytime soon. They have experienced a large drop in revenues, and they are constitutionally required to run balanced-budgets.

I note that export growth exceeded import growth by 470 basis points in quarter 2. This could easily swing the other way next quarter, i.e. the trade contribution could easily evaporate in 2011 quarter 3 or even become negative. Without trade in quarter 2, growth would have been less than 1 percent.

Our June forecast of quarter 2 economic growth was 2.0 percent, against the Wall Street Journal consensus of 2.3 percent. The new consensus will be out in about 2 weeks. I expect a large downward revision compared to the June consensus growth rate, 3.3 percent, for quarters 3 and 4. Despite that, our updated forecast will likely still be lower than this new, lower consensus.

Our relatively pessimistic forecast would be supported if savings increased yet again. In the near term, it would restrain growth, but in the long term it would bring debt down to healthier levels, paving the way for greater future economic growth.

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