The U.S. economy is expected to strengthen in the second half of 2004 and continue to grow in 2005, although at more moderate levels than in the third and fourth quarters of this year, an economist with the Federal Reserve Bank of Kansas City says.
That is, it will strengthen if the economy can weather a “soft spot” that has developed primarily due to slower consuming spending stemming from rising energy costs and growing consumer debt, says Jason Henderson, an economist with the Center for the Study of Rural America at the Kansas City bank.
“The jobless recovery is no longer jobless,” Henderson told economists attending the Southern Region Agricultural Outlook Conference in Atlanta. “But, while it is no longer jobless, we are going through a soft spot in the U.S. economy.
“The question is how soft is the soft spot?”
Henderson said the nation finally left the jobless recovery area last year when job creation moved into positive numbers some 27 months after the beginning of the recession in 2001.
In contrast, the economy began creating more jobs than it was losing 12 months after the trough in unemployment in 1991, said Henderson. “The big difference was the dip that occurred in March 2003, which marked the start of the Iraq War.
“The growth rate was very strong in the last half of 2003 with GDP rising 4 to 5 percent over the previous quarter,” he said. “The concern that some people have is that we appear to have hit a soft spot in the April-June quarter when the growth rate was down to about 2.8 percent.” (Note: Since Henderson spoke in Atlanta, the Commerce Department has reported growth was stronger that previously thought. The department said GDP for the April-June quarter expanded at a revised 3.3 percent annual rate, still the most sluggish rate of GDP growth since the first quarter of 2003.)
Much of the earlier growth occurred because of rising productivity, which, in recent months, has far outstripped that of the previous economic recovery in the 1990s,” said Henderson.
“What's happening is that all these companies invested in new information technology,” he noted. “But it took them two years to learn how to make full use of that new technology. Not only that, but it took them some time to learn how to use it efficiently.”
The forecast for more strengthening in the last two quarters of 2004 is based on a Blue Chip Economic Indicators survey conducted in September. The Blue Chip is a survey of the country's general economists. The top 10 percent of respondents believe growth will be above 4 percent and the bottom 10 percent below 3 percent in the last six months of 2004.
After Jan. 1, the majority of the respondents believe Gross Domestic Product or GDP growth will return to its long-term potential trend.
While consumer spending has been credited with helping prop up the weak economy since the recession began in 2001, figures show consumer purchases have fallen in recent months, he noted.
Consumer spending dropped by 2.5 percent between the first and second quarters of this year, according to figures compiled by the Bureau of Economic Analysis. Government spending was down 0.1 percent, exports down 1.2 percent and imports up 2.5 percent.
Business investment was up 7.9 percent and residential investment up 9.7 percent, but the strength in those categories was not enough to offset the downturn in consumer spending.
“Depending on the timing, consumer spending accounts for at least two-thirds if not three-quarters of GDP slowing in the second quarter,” Henderson notes. “The encouraging side is that while consumers were retracting in spending, business and residential investment continued to surge.”
Breaking down the consumer area, the Bureau of Economic Analysis said second quarter spending for durable goods was unchanged from the first quarter and down 0.1 percent and 0.3 percent for nondurable goods categories such as clothing and gasoline and energy. Spending was also reduced for household operations and other services.
Most analysts attribute the softening to rising energy prices. “Consumers need gasoline whether it's $1.50 or $2 per gallon,” he said. “They can cut back a little, but not much. Oil prices are now hovering around $50 per barrel, and that is having a huge impact on consumer spending.
“Economists we've talked to who study the oil market say that gasoline prices at this level have already knocked off 1 percent from our Gross Domestic Product. We're expecting 3.5, but if we had energy prices back in that $30-per-barrel range, we would have GDP growth at 4.5 percent.”
Henderson says another concern about the outlook for the remainder of 2004 is whether consumers can increase their spending given the amount of debt they hold.
With low interest rates, many consumers have refinanced their mortgages and used the money left from lower payments to pay down credit card debt, he noted. Even so, household debt service levels are at historical highs.
“It's now taking about 13.5 percent of income to service the debt,” Henderson said. “One thing that is encouraging is that it appears to have plateaued. But it would be nice if that would start to decrease. For now, it may limit the ability of consumers to expand their contributions to GDP.”
Despite the high debt levels and weak labor markets, consumer confidence remains relatively high, according to the Conference Board, whose surveys have become the leading indicators of how consumers view their economic futures.
“Both the University of Michigan and Conference Board numbers indicate that consumer confidence is about at the level it was in 1996, prior to the start of the economic boom,” Henderson said.
Increases in corporate profits and improvements in the stock markets are also bolstering business confidence and underpinning the prospects for stronger growth in the latter half of 2004. Federal government deficit spending, which is expected to reach $550 billion by the end of fiscal 2004, is also stimulating the economy, he said.
The combination of those factors is also forcing Federal Reserve Board governors to take a new look at an issue that hasn't been much of a concern for several years — inflation.
“Commodity prices have risen sharply in 2004, which, along with factors such as industrial capacity constraints and rising benefit costs, are expected to increase the risk of inflation,” Henderson said.
“But most analysts expect inflation increases to moderate with a return to more normal economic growth in 2005.”
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