The US Bureau of Economic Analysis (BEA) released the – Gross Domestic Product, Third Quarter 2019 (Advance Estimate) – data yesterday (October 30, 2019). It shows that the US economy “increased at an annual rate of 1.9 percent in the third quarter of 2019” which was slightly slow than the 2 per cent recorded in the June quarter. As this is only the “Advance estimate” (based on incomplete data) there is every likelihood that the figure will be revised when the “second estimate” is published on November 27, 2019. Underlying the headline figure, however, are shifting expenditure patterns in the US. Household consumption growth is declining and the contribution to growth was down from 3.03 points in une 2019 to 1.93 points. The personal saving rate rose from 8 per cent of disposable income to 8.1 per cent as households tightened up in the face of record levels of debt and sluggish wages growth. Total investment continued to be a negative drain on growth (-0.27 points compared to -1.16 points. Net exports also subtracted from growth (0.08 points compared to 0.68 points in the June-quarter). The increase in disposable personal income was lower (4.5 per cent) than in the June-quarter (4.8 per cent), although in real terms, the growth was 2.9 per cent compared to 2.4 per cent. Overall, and notwithstanding the continued growth, the question for the US growth prospects centre on what will happen to consumption expenditure growth. How much more will it decline and the saving rate rise?
The aggregate level
The US Bureau of Economic Analysis said that:
Real gross domestic product (GDP) increased at an annual rate of 1.9 percent in the third quarter of 2019 … In the second quarter of 2019, real GDP increased 2.0 percent.
Note that the BEA is using the annualised quarterly figure here (multiplying the third-quarter growth by 4) rather than the actual annual (year-on-year) growth rate which is the percentage shift from the September-quarter 2018 to the September-quarter 2019.
That growth figure was 2.03 per cent, down from 2.28 per cent in the June-quarter. The quarter-on-quarter growth outcome of 0.48 per cent was slightly lower than the June-quarter result of 0.5 per cent.
The following sequence of graphs captures the story.
The first graph shows the annual real GDP growth rate (year-to-year) from the peak of the last cycle (December-quarter 2007) to the September-quarter 2019 (grey bars) and the quarterly growth rate (blue line). Note the date line starts at March-quarter 2008.
The year-to-year growth calculation smooths out the considerable volatility in the quarterly data to help us see the trend.
The grey bars suggest there is declining momentum in US growth in terms of the annual growth rate (year-on-year).
The next graph shows the evolution of the Private Investment to GDP ratio from the December-quarter 2007 (real GDP peak prior to GFC downturn) to the September-quarter 2019. Note the date line starts at March-quarter 2008.
The decline in the investment ratio as a result of the crisis was substantial and endured for 2 years. As a result the potential productive capacity of the US contracted somewhat. There are various estimates available but the overall message is that potential GDP fell considerably as a result of the lack of productive investment in the period following the crisis.
In more recent times, the investment ratio has stalled and is now at 18 per cent of GDP, down from 18.4 per cent in the June-quarter, which was the highest levels since the current BEA data series began in the June-quarter 1947.
In this blog post – Common elements linking US and UK economic slowdowns (May 1, 2017) – I discussed estimates of potential GDP in the US and the shortcomings of traditional methods used by institutions such as the Congressional Budget Office.
So if you are interested please go back and review that discussion.
The latest CBO estimates, made available through – St Louis Federal Reserve Bank, show why we should be skeptical.
To get some idea of what has happened to potential real GDP growth in the US, the next graph shows the actual real GDP for the US (in $US billions) and two estimates of the potential GDP. There are many ways of estimating potential GDP given it is unobservable.
While I could have adopted a much more sophisticated technique to produce the red dotted series (potential GDP) in the graph, I decided to do some simple extrapolation instead to provide a base case.
The question is when to start the projection and at what rate. I chose to extrapolate from the most recent real GDP peak (December-quarter 2007). This is a fairly standard sort of exercise.
The projected rate of growth was the average quarterly growth rate between 2001Q4 and 2007Q4, which was a period (as you can see in the graph) where real GDP grew steadily (at 0.65 per cent per quarter) with no major shocks.
If the global financial crisis had not have occurred it would be reasonable to assume that the economy would have grown along the red dotted line (or thereabouts) for some period.
The gap between actual and potential GDP (red dotted version) in the September-quarter 2019 is around $US2,296.1 billion or around 10.7 per cent.
That gap rose steadily since late 2014 but then stabilised but has increased in the last two quarters.
The green dotted line is the estimate of potential output provided by the US Congressional Budget Office and suggests that the US economy is estimated to be operating at 0.8 per cent over its potential in the September-quarter 2019 and has been operating at over-full capacity since the March-quarter 2018.
It is hard to believe the estimate!
Especially in line with the US Federal Reserve cutting interest rates yesterday for the third consecutive time this year.
In its – FOMC Statement (October 30, 2019), the US Federal Reserve noted that:
On a 12-month basis, overall inflation and inflation for items other than food and energy are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed.
This was also supported by the BEA commentary:
The price index for gross domestic purchases increased 1.4 percent in the third quarter, compared with an increase of 2.2 percent in the second quarter … The PCE price index increased 1.5 percent, compared with an increase of 2.4 percent. Excluding food and energy prices, the PCE price index increased 2.2 percent, compared with an increase of 1.9 percent.
That is, price pressures declined, hardly symptomatic of an economy that is operating at 0.8 per cent over its capacity.
Further, wages growth is contained and broader measures of labour underutilisation indicate there is still considerable slack.
Which suggests that the CBO estimates are inaccurate – probably by several percentage points.
We know (and I explain this in more detail in the blog post mentioned above), the CBO base their estimate of Potential GDP on their estimate of the NAIRU – the (unobservable) Non-accelerating Inflation Rate of Unemployment.
This is a conceptual unemployment rate that is consistent with a stable rate of inflation.
The literature demonstrates that the history of NAIRU estimation is far from precise. Studies have provided estimates of this so-called ‘full employment’ unemployment rate as high as 8 per cent or as low as 3 per cent all at the same time, given how imprecise the methodology is.
The former estimate would hardly be considered ”high rate of resource use”. Similarly, underemployment is not factored into these estimates.
The continued slack in the labour market (bias towards low-pay and high underemployment) would lead to the conclusion that the output gap is likely to be somewhat closer to the extrapolated estimate than the CBO estimate.
The question to ask is this: How much lower would the unemployment rate and the broader underutilisation rate go if the US federal government offered a Job Guarantee on an unconditional basis?
I would bet the answer would be much lower without any inflation acceleration emerging.
Contributions to growth
The accompanying BEA Press Release said that:
The increase in real GDP in the third quarter reflected positive contributions from personal consumption expenditures (PCE), federal government spending, residential fixed investment, state and local government spending, and exports that were partly offset by negative contributions from nonresidential fixed investment and private inventory investment. Imports, which are a subtraction in the calculation of GDP, increased …
The deceleration in real GDP in the third quarter reflected decelerations in PCE, federal government spending, and state and local government spending, and a larger decrease in nonresidential fixed investment. These movements were partly offset by a smaller decrease in private inventory investment, and upturns in exports and in residential fixed investment.
The next graph compares the September-quarter 2019 (blue bars) contributions to real GDP growth at the level of the broad spending aggregates with the June-quarter 2019 (gray bars).
The positive overall growth outlook masks a distinct softening in the contribution of private consumption spending. In the June-quarter 2019, it contributed 3.03 points to the overall growth of 2 per cent, more than offsetting the negative contributions o investment and net exports.
By the September-quarter 2019, this contribution had fallen significantly to 1.93 points.
It was always a question of when not if that private consumption spending would start to wane, given the household debt remaining high (see below) and the sluggish real wages situation.
Most of the consumption growth has occurred because more people are getting jobs even though wages growth is flat. This cannot persist obviously.
In line with the slight decline in the investment ratio, gross private domestic investment subtracted from overall growth by 0.27 points.
The Government sector added 0.35 points to the September-quarter 2019 growth, down from 0.82 points in the previous quarter.
While earlier in the year, it was the contribution of the State and Local governments that drove the government contribution, in the last two quarters, it has been the federal government contributing most.
The next graph decomposes the government sector and shows that all levels of government contributed significantly to growth in the current-quarter but decreased their contributions relative to the previous-quarter.
The next graph breaks down the contributions to real GDP growth of the various components of investment.
The decline in most categories of investment is a worrying sign.
Household consumption and debt
… total household debt increased by $192 billion (1.4 percent) to $13.86 trillion in the second quarter of 2019. It was the twentieth consecutive quarter with an increase, and the total is now $1.2 trillion higher, in nominal terms, than the previous peak of $12.68 trillion in the third quarter of 2008. …
Mortgage balances—the largest component of household debt—rose by $162 billion in the second quarter to $9.4 trillion, just higher than the previous high of $9.3 trillion from the third quarter of 2008. Non-housing balances increased by $37 billion in the second quarter, with a $17 billion increase in auto loan balances and a $20 billion increase in credit card balances offsetting an $8 billion decline in student loan balances.
The rise in non-housing debt (for example, credit card balances) is particularly worrying. It is a sign that household income growth is not sufficient to finance basic needs.
The decline in US household consumption spending growth is now clear and is probably a response to the pressures that the rising household debt levels are placing on household solvency.
The Data shows that:
About 232,000 consumers had a bankruptcy notation added to their credit reports in 2019Q2, an increase from the 225,000 in 2018Q2.
The following graph is taken from the FRBNY publication. Clearly the gap between mortgage and non-mortgage debt is rising as total household indebtedness rises.
This looks to be an unsustainable situation and will require either significant non-government spending boosts in investment or net exports or government spending increases to offset the likely slowdown in household consumption spending.
The US economy continues to growth, albeit at a slightly slower rate.
Household consumption growth is declining and the contribution to growth was down from 3.03 points in une 2019 to 1.93 points.
The personal saving rate rose from 8 per cent of disposable income to 8.1 per cent as households tightened up in the face of record levels of debt and sluggish wages growth.
Total investment continued to be a negative drain on growth (-0.27 points compared to -1.16 points. Net exports also subtracted from growth (0.08 points compared to 0.68 points in the June-quarter).
The increase in disposable personal income was lower (4.5 per cent) than in the June-quarter (4.8 per cent), although in real terms, the growth was 2.9 per cent compared to 2.4 per cent.
Overall, and notwithstanding the continued growth, the question for the US growth prospects centre on what will happen to consumption expenditure growth.
How much more will it decline and the saving rate rise?
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.