GDP growth down substantially in the fourth quarter. Real (inflation-adjusted) gross domestic product (GDP) grew at an annual rate of 0.6 percent in the fourth quarter, substantially below the 4.9 percent increase in the third quarter. Inventory declines, which were largest among auto dealers, subtracted 1.25 percentage points from fourth-quarter GDP growth. Declines in residential fixed investment subtracted an additional 1.18 percentage points. Increases in net exports added to growth, but that increase was down from the third quarter.
Nonfarm payrolls decline for the first time in over four years. Payroll employment at nonfarm establishments fell by 17,000 jobs last month. Financial markets had expected a gain of 70,000 jobs for the month. The biggest losses came from the construction and manufacturing sectors. Construction employment decreased by 27,000 in January and has fallen by 284,000 since its peak in September 2006. Manufacturing lost 28,000 jobs in January and has lost 269,000 jobs over the past 12 months. The civilian unemployment rate was 4.9 percent in January, essentially unchanged from the December level of 5 percent. The seasonally adjusted average length of unemployment increased in January, from 16.6 weeks in December 2007 to 17.5 weeks in January 2008. The upward trend in the duration of unemployment is shown in the chart below. Hourly earnings lagged inflation in 2007. The Bureau of Labor Statistics reports that average real hourly earnings for private nonfarm production and nonsupervisory workers decreased 0.7 percent for the 12-month period ended December 2007, compared to a 1.8 percent increase for the 12-month period ended December 2006.

Recently released data suggest that the economy is on the cusp of a downturn. During January the number of nonfarm payroll jobs fell by 17,000. Even when compared to the lackluster pace of job creation in the past two years, this is not a good outcome. Job growth averaged 95,000 per month in 2007, and 175,000 per month in 2006. In addition, as can be seen in the left-side chart below, the number of people experiencing long term unemployment has turned up, as often happens near the beginning of a recession. Real output also stalled in the fourth quarter of 2007. The real GDP growth rate of 0.6 percent (at an annual rate) is a significant reversal from the previous month, when the growth rate was 4.9 percent. If our knowledge were limited to changes in GDP and employment, policy makers might conceivably take a “wait and see” approach. Because of the time lags in economic statistics it is often difficult to discern the beginning of a downturn until it is already under way. But events in financial markets counsel against this. Financial markets have been disrupted since the subprime
mortgage crisis began in July. Disruption is evident in interbank lending, in the significant decline in the outstanding volume of asset backed credit, and in the relatively high credit spreads for prime mortgage loans that are too largeto be insured by Fannie Mae or Freddie Mac. The risk posed by these disruptions is that declines in credit availability will reduce consumption or investment demand. The resulting reductions in output and employment can in turn harm banks and other already weak financial intermediaries, which may further reduce credit. This negative feedback loop, sometimes referred to as the “financial accelerator”, is clearly on the minds of policy makers at the Federal Reserve. Last Thursday, the Federal Open Market Committee (FOMC) confirmed that it was departing from a pattern of gradual changes to the Federal Funds interest rate target. At the scheduled Thursday meeting the target rate was reduced by ½ percent, only eight days after it was reduced by ¾ percent at an unscheduled meeting on January 22. These changes bring the target rate to 3 percent, down from 5 ¼ percent in August. The size and speed of these changes are large when compared to changes made in the past few years. (See Snapshot). The Federal Reserve also has invented a device to provide banks with a new source of medium term borrowing. Since December 2007, the Fed has held three auctions at which banks bid for a total of $100 billion in 28-day loans through the Term Auction Facility (TAF). Two additional auctions are scheduled in February. The significant rate cuts and the creation of TAF are an attempt to reduce the risk that financial market disruptions will amplify problems in an already weak real economy. They are intended to be “timely, decisive and flexible,” and the Federal Reserve is apparently prepared to make other rapid policy adjustments. (See http://www.federalreserve.gov/newsevents/speech/
mishkin20080111a.htm) But although the Fed is taking a range of actions, there is little reason to rely exclusively on monetary policy to prevent a downturn. Once a downturn begins, it is difficult to reverse its momentum, and the costs in terms of output and employment can be large. A fiscal stimulus that is indeed “timely, targeted and temporary” will very likely help to reduce significant downside risks.