Friday, July 27, 2012

The economy continues to avoid another recession

Second quarter GDP was undeniably weak (1.5% at an annualized pace), but the more important news is that the economy continues to grow. With the market priced to dismal expectations (e.g., 10-yr Treasury yields at 1.4%, PE ratios below average despite record-setting profits, real yields on TIPS deep in negative territory) all it takes to cheer the market is evidence that the economy continues to grow and continues to avoid a recession.

GDP was upwardly revised a bit over the past three and a half years, but as the chart above shows, the economy is still about 12% smaller than it could have been if we extrapolate from the growth trend over the past 50 years. That 12% "output gap" translates into roughly a $2 trillion shortfall in national income—that's an awful lot of money and jobs that have gone missing. This is a real national tragedy, that we have experienced such a weak recovery. If there is a silver lining to this dark cloud, it is that we now know that running up annual deficits of well over $1 trillion per year (equivalent to a whopping 9% of GDP each year on average) for the past three years hasn't managed to help the economy at all. Indeed, it's likely that the deficits are to blame for most of the underperformance, because they served mainly to redistribute income and finance a lot of wasteful and unproductive spending (e.g., Solyndra et. al.). In other words, the government spending multiplier is probably negative; we would have been much better off without all that "spending."

One other important piece of news is that despite the economy's unprecedented (in modern times) output gap, inflation remains positive, and still close to the upper bound of the Fed's target range. Keynesian theory has thus suffered a double body blow in this recovery: government spending is not necessarily stimulative, and weak growth is not necessarily deflationary.

Indeed, even as economic growth has slowed this year, from a 4.1% annualized rate in Q4/11 to 1.5% in  Q2/12, forward-looking inflation expectations (as shown in the chart above, which plots the implied 5-yr, 5-yr forward inflation expectations embedded in TIPS and Treasury prices) have been rising, albeit modestly.


brodero said...

"Indeed, it's likely that the deficits are to blame for most of the underperformance, because they served mainly to redistribute income and finance a lot of wasteful and unproductive spending (e.g., Solyndra et. al.)."

Most of the underperformance is related to residential investment dropping dropping from 6% of GDP to
2% of GDP a 70 year low....that is
a structural change little related to government spending... your dislike of government spending sometimes colors your insightful analysis

William said...

For years, allegedly serious people have been issuing dire warnings about the consequences of large budget deficits - But a funny thing happened on the way to the predicted fiscal crisis: instead of soaring, U.S. borrowing costs have fallen to their lowest level in the nation’s history.

The failure of deficits to produce the predicted rise in interest rates is telling us something important about the nature of our economic troubles.

This is what happens when you have a “deleveraging shock,” in which everyone is trying to pay down debt at the same time. Household borrowing has plunged; businesses are sitting on cash because there’s no reason to expand capacity when the sales aren’t there; and the result is that investors are all dressed up with nowhere to go, or rather no place to put their money.

So they’re buying government debt, even at very low returns, for lack of alternatives. It’s simply crazy to be talking about laying off school teachers and canceling infrastructure projects at a time when investors are offering zero- or negative-interest financing to the US government.

So it’s time to stop paying attention to the alleged wise men who hijacked our policy discussion and made the deficit the center of conversation. They’ve been wrong about everything — and these days even the financial markets are telling us that we should be focused on jobs and growth.

Signed today: Paul Krugman

Pragmatic Investor said...

I don't know what you were looking at. GDP numbers for the past 3 years were revised down, not up. Now with 2010's GDP revised down to 2.4%, this year will mark the third year in a row that you missed the GDP number by a mile.

You should change your blog title to be more humble. There are very knowledge people on the internet that call themselves students of the market, and yet you claim to be a pundit.

marmico said...

It's time for round 12 of cleaning Grannis' clock.

The perpetual "3%+ GDP growth pundit" has been correct 2 out 12 times during the 2009-2012 recovery and now expansion. It's pathetic.

Scott Grannis said...

Re: the contribution of the collapse of residential construction to weak growth. In simple terms residential construction fell from 6% of GDP to 2.5%, thus it subtracted about 3.5% from GDP over the past six years. But GDP has fallen below trend by 12%. So at most, residential construction could account for about 30% of the growth shortfall.

Benjamin Cole said...


What about ethanol? A program perhaps 100 times larger than Solyndra.

Mandated ethanol output is now running at 802,000 barrels (yes, barrels not gallons) a day. That is 33.7 million gallons a day, non-market by federal diktat, and helped by subsidized corn production. Solyndra? A stupid one0time giveaway. Ethanol is permanent.

What about the entire $1 trillion-a-year Department of Defense-Homeland Security-VA complex?

That about $3,333 for every man, woman, and child in the entire United States. About $13k is taken off the dinner table every year when a family of four sits down.

Really, if the GOP cannot think straight on basic issues,--and if the D-Party is well out to sea--who can a voter vote for?

But let's talk about Solyndra....

Benjamin Cole said...

As Bain Capital has said, as Gov. Romney has said and as has been confirmed by independent fact checkers multiple times, Gov. Romney left Bain Capital in February 1999 to run the Olympics and had no input on investments or management of companies after that point. -- Andrea Saul, the Romney campaign

So was Gov. Romney lying to the government when he signed filings with the Securities and Exchange committee identifying himself as the Chairman, Chief Executive Officer and sole shareholder of Bain during all of 1999, 2000 and 2001 -- intensifying the controversy over Romney's true status during those years with respect to the operations of Bain?

--William Lerach

This is puzzling. Romney says he had no involvement in an enterprise of which he is the reported Chairman, CEO and sole shareholder?

brodero said...

Scott...not to get into a numbers battle but in another metric (which I deem more important than the potential GDP gap)...the postponable purchases to GDP ratio is now around 17.5% with the equilibrium being roughly 20.5%...the drop in residential investment accounts for
70% of the gap...a respectful wonkish an aside your emphasis on swap spreads is about the only blog on the internet that
displays this important piece of data.

marmico said...

But let's talk about Solyndra....

Let's talk about Solyndra. The Department of Energy has a portfolio of renewable energy investments. A technological breakthrough in one of those investments will be a net benefit on the portfolio by an order of magnitude relative to Solyndra.

Let's talk about Grannis. He avails himself of state and federal subsidies for solar power on his postage size lot in San Clemente and bitches about transfer payments. What a hypocrite!

Anonymous said...

Please Marmico, I encourage you to avoid the personal attacks. Scott has been transparent, willing to put his predictions in writing, revisit his predictions (and admit when wrong) and provides some wonderful information for all of us to contemplate. His record at Western Asset Management and on this blog has been very good. If you don't agree with him you can always stop visiting his blog.

Squire said...

Benjamin, you say it’s a waste of time to talk about Solyndra but want to talk about Bain. A Bainer? Ethanol is worth talking about as an example of massive crony government/capitalism.

I don’t like GDP because of the distortions from inventory changes. I like Final Sales.

Avg growth rate calendar years:
2010 1.75%
2011 1.70%
2012 1.80% so far Q1 2.4%, Q2 1.2%

Ditto what Dave said to Marmico.

I hear in Argentina everybody got used to inflation. Wages are being adjusted up frequently. It is futile to try to use inflation as a fix for sticky wages.

William said...

Squire, a question please.

The "Avg growth rate by calendar years", are those numbers inflation adjusted?

Ditto what Dave said to Marmico.


Paul said...


"This is puzzling. Romney says he had no involvement in an enterprise of which he is the reported Chairman, CEO and sole shareholder?"

So your burning question while Obama destroys the country is the all-important: "what year did Romney actually leave Bain?"

It's called a "leave of absence." Look it up.

Bob said...

Ditto what Dave said to Marmico, who consistently uses personal attacks. Typical liberal modus operendi.