Popular Economics Weekly

The recession has ended with the large increase in Gross Domestic Product for the third quarter just ended. So positive signs are accumulating that the economic recovery will be sustainable. That means it will continue to grow even when the various government stimulus plans cease sometime next year. I am even more optimistic than the New York Times’ Paul Krugman in seeing a sustainable recovery. He believes another stimulus package will be needed if we want to bring back the 7 million jobs already lost in this recession.

The main reason for such optimism? A weak dollar is causing soaring exports, consumers have decided to increase their spending, and labor productivity has soared, meaning much more is being produced even with a reduced work force.  Employers will have to begin hiring soon, however, as workers are again closer to the 40 hour week, and it is cheaper to hire than pay more overtime to existing workers.

Since consumers make up 70 percent of economic activity, they must be the main driver of any recovery. And consumers have shown they will dig into their pocket books when they feel confident that their situation is improving. But we should not be looking at comparisons to the bubble years to know what kind of recovery this will be. Those years were an anomaly that won’t be repeated anytime soon.

The most positive sign was the 3.5 percent increase in third quarter Gross Domestic Product. It expanded in all areas, including an increase in residential construction. But consumers and businesses also increased their spending. Exports (read manufacturing mostly) in Q3 increased 14.7 percent, vs. 4.1 percent in Q2, while imports increased even more—16.4 percent vs. a decrease of 14.7 percent in Q2.


This is why personal consumption contributed 2.36 percent to Q3 growth, the highest percentage since Q1 2007. Residential construction contributed the most in 3 years. (Construction spending as a percentage of GDP had begun to decline in 2005—just when subprime loans became widely available.)

But because our economy is so dependent on consumers, it will be job creation that determines how much consumers will spend. With labor productivity soaring upwards of 6 percent (via more technology investment), employers have the luxury of increasing production up to a certain point without increased hiring.

The big surprise was the rise in private residential construction. It rose 0.8 percent in September, but is still 12 percent below last year’s total to date–another sign of a real estate recovery. Residential investment grew 23.4 percent in the Q3 GDP report, reversing the 23.3 percent decline in Q2, and contributed 0.53 percent to Q3 GDP.

The Calculated Risk Blog has broken down the components of residential investment, and single family construction tops the list. So it will also be one of the largest components of any sustainable recovery. Its historical contribution looks to be around 2 percent, which means 4 times the current production of approximately 460,000 units annually. During the bubble years 2004-06 it regularly exceeded 2 million units annually, hence the current oversupply.


The Federal Open Market Committee also reaffirmed its commitment to keep interest rates low and credit markets flowing. It said, “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The Fed’s statement highlights how necessary is continued fiscal and monetary policy to keep interest rates low and support this recovery. For example, more than 80 percent of all mortgage originations are sold to the government GSEs—Fannie, Freddie, FHA/VA. Confidence has not yet returned to private sector business, unfortunately, the reason for such high unemployment. So confidence has to return to the private business sector, as well as consumers, before we see any substantial job creation.

Harlan Green © 2009