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Economic Insights

What do data on inventories and consumer spending suggest for the pace of recovery?

With economic indicators swinging widely from one month to the next, it is harder than ever to get a fix on the underlying trends. At least it looks that way in the headlines. Fortunately, a little detail makes patterns clearer. The most information comes from a look at two subcategories of the gross domestic product (GDP): inventories and consumer spending. The picture that emerges points to likelihoods of continued sluggish growth that is broadly consistent with the pace of the recovery so far.

Inventories and Weather   
The broad GDP figures give a good idea of the statistical confusion and how that has created swings in consensus sentiment. The top line of Table 1 tells the story. When, in the last quarter of 2012, the Commerce Department reported almost no growth in real GDP,1 concerns immediately arose that a recessionary dip was in prospect. A resumption in the expansion during the first quarter of 2013 dissipated some of that fear, but it returned as the pace of economic advance slowed again in the spring quarter. Stronger growth in the second half of the year entirely dispelled recession fears and drove consensus thinking to look for an economic acceleration in 2014. But then an unseasonably severe winter depressed the first quarter. Though the reasons for the decline were obvious and clearly temporary, consensus thinking about fundamentals dipped along with the headline figures. A spring and slightly less pronounced summer surge in growth, though a predictable one-time catch up from weather-induced setbacks, seems nonetheless to have brought back renewed expectations for a fundamentally stronger economy.

If consensus thinking seems prone, as ever, to build on the most recent release, however obviously misleading, a look at some of the subcategories of the GDP can offer perspective, one that consensus thinkers might use, if, that is, they bothered to read more than headlines. The rest of Table 1 shows the relevant growth rates. Table 2 helps the analysis by showing the percentage-point contribution to overall real growth made within each major GDP subcategory. 

Inventory movements are especially revealing. In the first quarter of 2012, a temporary surge in housing and business spending caught suppliers off guard. The depletion of their inventories shaved 0.2 percentage points off the overall pace of real growth and moderated the overall impact of the surge.  When, predictably, these suppliers rebuilt their inventory stocks in the spring quarter, they added some 0.3 percentage points to overall growth. Since, however, housing and capital spending returned to their slower trends during that quarter, business needed to adjust inventory levels again. In the third and especially fourth quarter, they trimmed the inventories that they had mistakenly built up in spring. In the fourth quarter, these efforts alone cut 1.8 percentage points of overall growth, which, combined with a short-lived drop in government spending, created what was clearly a temporary interruption in growth though consensus thinking took it as more fundamental.  

 

Table 1. Quarter-to-Quarter Growth, Selected Measures
Seasonally adjusted % change annualized rate

 

 

 

 

 

 

 

2012

 

2013

 

2014

 

1

2

3

4

 

1

2

3

4

 

1

2

3

Real GDP

2.3

1.6

2.5

0.1

 

2.7

1.8

4.5

3.5

 

-2.1

4.6

3.5

Consumer Spending

2.8

1.3

1.9

1.9

 

3.6

1.8

2.0

3.7

 

1.2

2.5

1.8

Capital Spending

5.8

4.4

0.8

3.6

 

1.5

1.6

5.5

10.4

 

1.6

9.7

5.5

Housing

25.5

4.3

14.1

20.4

 

7.8

19.0

11.2

-8.5

 

-5.3

8.8

1.8

Government

-2.7

-0.4

2.7

-6.0

 

-3.9

0.2

0.2

-3.8

 

-0.8

1.7

4.6

Final Sales

2.5

1.3

2.7

1.9

 

2.0

1.5

3.0

3.8

 

-0.9

3.2

4.1

Source:  Department of Commerce.

 

Table 2. Contributions to Real GDP Growth
Percentage points of the annualized figure

 

 

 

 

 

 

 

2012

 

2013

 

2014

 

1

2

3

4

 

1

2

3

4

 

1

2

3

Consumer

1.9

0.9

1.3

1.3

 

2.5

1.2

1.4

2.5

 

0.8

1.8

1.2

Capital Spending

0.7

0.5

0.1

0.4

 

0.2

0.2

0.7

1.2

 

0.2

1.2

0.7

Housing

0.6

0.1

0.4

0.5

 

0.2

0.5

0.3

-0.3

 

-0.2

0.3

0.1

Government

-0.6

-0.1

0.5

-1.2

 

-0.8

0

0

-0.7

 

-0.2

0.3

0.8

Inventories

-0.2

0.3

-0.2

-1.8

 

0.7

0.3

1.5

-0.3

 

-1.2

1.4

-.6

Source: Department of Commerce.

 

Having gone too far with inventory reductions in 2012, business in 2013 returned to rebuilding. Their efforts added to overall growth, making the economy look much stronger than it in fact was. Final sales do a better job of capturing the fundamental, more moderate trend and show why, even as business added to inventories, the stage was set for a subsequent downward adjustment. Matters reached extremes during 2013’s third quarter. Then, inventory accumulations added 1.5 percentage points to the overall growth measure and made a slight uptick in final sales, to a 3.0% annualized rate of expansion, otherwise look like a boom. Then, in this year’s first quarter, unseasonably severe winter weather started the whipsaw again. It affected almost all sectors in the economy, but problems with shipping made for an especially sharp downward adjustment in inventories that turned a modest dip in final sales into a frighteningly sharp decline in overall GDP. The subsequent efforts of business to rebuild those inventories exaggerated an understandable, but relatively contained and short-lived, spring catch up from weather-related interruptions in construction and business spending. In the third quarter, an effort at moderation returned. Though seen this way, and it is clear that almost all was temporary, the economy, to those who just looked at the headlines, appeared to have surged.

Behind all this confusion and the swings in consensus opinion, final sales offered a much less volatile and more reliable picture of still moderate growth. The final sales figures, to be sure, are still highly variable quarter to quarter, but, as is also evident, they are much less wild and misleading than the overall real growth measure on the top line. What these figures show, in fact, is an economy that has tracked a modest expansion path since this recovery began in 2009, growing steadily but slower than usually. All but one quarter recorded growth below the long-term 3.5% historical annual real pace. There is, of course, a chance of an acceleration going forward. It could come from many directions, but, with the consumer still amounting to 70% of the economy, much will depend on how willing he and she are to depart from the cautious pattern they have pretty consistently held throughout this recovery.     

The Consumer       
What this recovery has shown thus far is a consumer constrained by three factors. First, the slow rate of expansion in the jobs market has held back income growth and with it the wherewithal to spend. Second, the slow rate of jobs and income growth has made consumers shy of resuming past, more aggressive spending patterns. Historically, they have increased spending ahead of income growth on the assumption that an improving economy will catch them up to higher spending levels. Third, the scars left by the 2008–09 Great Recession and the attendant financial crisis have greatly exaggerated this caution.

Substandard jobs growth constitutes one root of this atypical caution. To be sure, the jobs picture has brightened some this year. Payrolls in 2014 have increased on average by 218,000 a month, compared with 194,000 in 2013 and 186,000 in 2012. This pace, however, is still historically disappointing. Past recoveries have done much better. Still, the modest 2014 acceleration in payrolls growth and very modest wage increase, due mostly to a greater use of overtime, have accelerated income growth modestly. Total employee compensation is up in nominal terms at an annualized pace of 5.2% so far this year, faster than the 4.1% recorded last year. That pickup should allow some acceleration in consumer spending, but even if households follow the relative income gains in lock step, they would still pick up consumption to slightly more than a 3.0% real growth, enough to accelerate the overall economy slightly, but not enough to change its still sluggish underlying character.

Then there is the added, critical question of caution. As already indicated, households have remained reluctant to follow their historical pattern of running ahead of income, foregoing saving and stepping up borrowing. Instead, they have saved more than in the past. Where once savings rates ran at 3.0–3.5% of aftertax income, they have in this recovery averaged 5.5–6.0%. During those few times when household spending has run ahead of income gains, such as the first and last quarters of 2013, and savings flows have fallen below 5.0% of aftertax income, households always have checked themselves in subsequent quarters, sharply slowed their rate of spending growth, and brought their savings flows back up toward 5.5%.

The greatest chance of an economic acceleration would emerge if households were to break this pattern, shed some of this caution, and return to past patterns. Clear improvements in their balance sheets certainly could support such a change in sentiment. Household net worth has gained 8.3% a year during the past two years. The value of household financial assets has risen 7.4% a year. Real estate values have risen 7.5% a year during this time. Owner equity in homes has jumped from 45.7% in 2012 to 53.6% presently.     

But while this balance sheet improvement could foster more aggressive spending and certainly argues against the possibility of a downturn, households do not seem likely to shed their caution just yet. Not only does their unusual preference for savings speak to ongoing caution but also so does their evident reluctance to expand liabilities of any kind, which, despite gains in assets, have only grown 1.1% a year during these last two years. With memories of the last recession lingering and a still-sluggish jobs market constraining income growth, people likely will remain reluctant to get too far ahead of themselves, making it therefore less than likely that the economy will accelerate substantially from the slow pace already set in this recovery.

 

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