May 5, 2008
GDP grew by only 0.6 percent at an annual rate in the first quarter of 2008, repeating the performance of the fourth quarter of 2007. (See Snapshot) Compared to potential growth, which the Congressional Budget Office estimates at 2.8 percent, this is a dismal showing.
Several factors helped to keep GDP growth low. Consumer spending -- the single largest component of total demand -- increased at an annual rate of one percent, slowing markedly from 2.3 percent in the previous quarter. Residential fixed investment declined by 26.7 percent, reflecting the continuing crisis in the housing market. Nonresidential fixed investment declined by 2.5 percent as businesses reduced their spending on plant, equipment and software.
Growth in net exports and increased inventory accumulation by business were the principal factors offsetting the consumption slowdown and investment declines. Without these sources of demand, GDP growth would have been negative. Final sales to domestic purchasers, which excludes net exports and inventories, declined by 0.4 percent at an annual rate.
The slowdown in economic activity is clearly reflected in the labor market. The economy shed 20,000 nonfarm payroll jobs in March. Jobs lost during 2008 now total 260,000. The Federal Reserve, responding to these developments in the real economy, as well as to continuing problems in the credit markets, lowered the target Federal funds rate by ¼ percent at the meeting of the Federal Open Market Committee (FOMC) on April 30. The target rate is now at 2 percent, and is down 3.25 percent from its level in August 2007.
The Fed’s assessment of the risks to the economy remains distinctly downbeat. A statement released by the FOMC indicated the Fed’s belief that the recent substantial easing of monetary policy, combined with efforts to foster liquidity in financial markets, should help to produce “moderate growth over time and mitigate risks to economic activity.” However, the statement voiced continuing concerns about household and business spending, financial market stress, “tight” credit conditions, and the continuing contraction in the housing market.
The Fed’s concerns about risks are clearly visible in economic data. Housing is a very clear example. The Case-Shiller 20-city index of housing prices has fallen 14.8 percent since its peak in 2006. As prices fall, many potential buyers stand on the sideline. At current sales rates, home builders have an 11 month supply of new homes, the largest inventory level since 1981.
In addition, many mortgage holders are recognizing that their homes are now “underwater” or worth less than the value of their mortgage loans. For example Credit Suisse has estimated that in December 2007, thirty percent of subprime borrowers – approximately 1.5 million households – were in a “negative equity” position. Negative equity significantly raises mortgage default rates, which implies that the supply of houses is likely to increase as foreclosures rise.
Given these and other indicators of downside risk, the somewhat sobering assessment by the Fed seems very understandable
Wednesday, May 7 | |
Productivity and Costs (1st Quarter Preliminary) |
Pending Home Sales (March 2008) |
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Consumer Credit (March 2008) |
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Thursday, May 8 |
Wholesale Trade Report (March 2008) |
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Friday, May 9 | US International Trade in Goods and Services (March 2008) |
MONTH | QUARTER | YEAR | ||||||
KEY INDICATORS | Apr | Mar | Feb | Q1 2008 | Q4 2007 | Q3 2007 | 2007 | 2006 |
Real GDP (% growth) | - | - | - | 0.6 | 0.6 | 4.9 | 2.2 | 2.9 |
Unemployment (% of Labor Force) | 5.0 | 5.1 | 4.8 | 4.9 | 4.8 | 4.7 | 4.6 | 4.6 |
Labor Productivity Growth (%) | - | - | - | #N/A | 1.9 | 6.3 | 1.8 | 1.0 |
Labor Compensation Growth (%) | - | - | - | 3.0 | 3.4 | 3.1 | 3.4 | 3.1 |
CPI-U Inflation Growth (%) | n.a. | 3.7 | 0.0 | 4.3 | 5.0 | 2.8 | 2.9 | 3.2 |
Core CPI-U Inflation Growth (%) | n.a. | 2.4 | 0.0 | 2.5 | 2.5 | 2.5 | 2.3 | 2.5 |