U.S. Economy Ignores Fiscal Cliff, but Growth Remains Weak
Despite the reported shrinkage in GDP of 0.1 percent in the 4th quarter of 2012, the U.S. economy actually advanced in most categories at an acceptable pace. The shrinkage was largely a statistical illusion. The two big factors slowing growth in the quarter were a sharply slower rate off inventory accumulation and a big drop in defense spending. If these quirks are pulled out, the economy grew at a 2.5 percent rate in the 4th quarter, in line with its recent trend.
Both the inventory and defense numbers can be easily dismissed as quirks. In the third quarter, inventories grew at an extraordinary $88.2 billion annual rate, almost twice its average over the last two years. It was virtually certain that the rate of accumulation would slow in the fourth quarter. The decline to a more typical $43.8 billion annual rate subtracted 1.37 percentage points from growth for the quarter. Going forward, inventories will likely continue to increase at roughly the roughly the fourth quarter rate.
The story with defense spending was similar. While the general direction for military spending is downward, both because of the winding down of the war in Afghanistan and efforts to reduce the budget, the 22.2 percent rate of decline reported in the fourth quarter was an anomaly. This was in part driven by a 12.9 percent jump in defense spending in the third quarter. Defense spending is always erratic. It is likely that the third quarter number was inflated by the recording of a large delivery of military equipment or some other item. That virtually guaranteed a large falloff in the 4th quarter. This also will not be repeated, and likely partially reversed, in subsequent quarters.
The fourth quarter GDP data essentially refuted the idea that consumers and businesses were delaying purchases due to worried over how Congress and the president would resolve the budget disputes hyped as the “fiscal cliff.” Consumption grew at a respectable 2.2 percent annual rate. More strikingly, the category of durable goods, which includes big items like cars and refrigerators, grew at a 13.9 percent annual rate. These are the purchases that consumers would most likely be delaying if they were concerned about the state of the economy.
There is a similar story on the business side. Spending on equipment and software grew at a 12.4 percent annual rate. This was its strongest growth since the third quarter of 2011. Businesses were clearly not worried about the outcome of the budget negotiations.
It seems that most of the public largely ignore the theatrics in Washington over the budget. They assume that whatever their differences, Congress and the president will resolve them in a way that will not be catastrophic for the economy. Thus far they have been proven correct in this belief.
If the hype over the impact of the fiscal cliff can be dismissed, there is still not much cause for celebration in the fourth quarter data. The fact that most of the bad news was attributable to quirky factors on the negative side means that much of the growth reported for the third quarter was attributable to quirky factors on the positive side.
Averaging the two quarters together gives a growth figure of 1.5 percent. This is well below anyone’s estimate of the economy’s potential growth rate. This means that we falling further behind potential GDP in an economy that already stands 6 percent, or $1 trillion below its potential level of output.
Furthermore, the budget cuts and tax increases that have already been put in place, or are likely to be put in place later this year are likely to act as a further drag on growth. The United States will be lucky if the economy adds jobs fast enough to keep the unemployment rate from rising.
There was one clear piece of good news in this report that should not be overlooked. Spending on consumer health care services, which accounts for three quarters of all health care spending, rose at just a 2.3 percent annual rate in the fourth quarter, bringing its rate of increase to 3.7 percent over the last year. This continues a pattern of slower growth that is been in place for the last five years.
While the recession has clearly contributed to slower cost growth, as many people have put off trips to the doctor, the slower growth path has been in place for too long to be explained solely by the weak economy. And, with the economy recovering from the depths of the recession there has been no corresponding uptick in the rate of cost growth.
The implications of slower health care cost growth for the budget and the economy will be enormous. For the economy this means that health care costs will not be the albatross that had been projected. It also means that the budget deficits will be much more manageable than current projections show. The real question now is how long it takes Congress and the president to notice the slowdown in health care cost growth.
Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.