The latest available quarterly data on U.S. economic growth show that the U.S. economy ended last year on a solid note. Later this week, we will have official data for the first quarter of this year. To be sure, growth likely slowed, in part because of an unusually harsh winter and perhaps other factors, but we nevertheless anticipate a resumption of faster economic growth over the remainder of the year after this transitory slowing.
The recovery has been driven by the private sector and has proven durable to substantial fiscal retrenchment. Since the recovery began in the second quarter of 2009, real GDP has grown at an average 2.4 percent annual rate, and private domestic final demand has grown at a 2.7 percent annual rate. The private sector started creating new jobs in February 2010, and since then, has created 8.9 million jobs; last month private-sector payrolls surpassed the January 2008 peak. The unemployment rate fell from a high of 10.0 percent in late 2009 to 6.6 percent in January, before edging back up to 6.7 percent in February and March. Household balance sheets, as well as the health of the manufacturing sector, continue to improve. Despite a rise in mortgage rates over the past year and the adverse effects of a harsh winter, the longer-term outlook for the housing sector remains positive in light of the potential for a faster pace of household formation going forward. The economic recovery appears to be self-sustaining and resilient, and considerable progress has been made in putting the federal government on a stable fiscal footing, but more work remains to return the economy to full employment and to ensure longer-run prosperity.
The most recent fourth-quarter GDP data show that real GDP grew at a 2.6 percent annual rate. Though the pace of growth slowed from the third quarter’s 4.1 percent annual rate, contributions from key sectors were exceptionally solid, and growth in the second half of the year was 3.4 percent at an annual rate, considerably stronger than the 1.8 percent annual rate of the first half. Consumer spending grew at a 3.3 percent annual rate – the strongest quarterly increase since late 2010 – and contributed the lion’s share of growth in the fourth quarter. Business fixed investment grew at a 5.7 percent annual rate, as investment in equipment rose at a 10.9 percent pace – the strongest quarterly rise since the third quarter of 2011. Net exports made a sizable contribution to growth in the fourth quarter. Although most of the gain reflected a pickup in exports, the improvement in the trade balance was also supported by the ongoing expansion of domestic oil production, which led to reduced purchases of foreign petroleum. Inventory investment contributed little to GDP growth in the fourth quarter following a rapid accumulation in the third quarter. Residential investment and government spending both fell, subtracting from fourth-quarter GDP growth.
In the first quarter, data releases point to a slower pace of growth than at the end of 2013, but much of the slowing can likely be attributed to transitory factors, such as the harsh winter weather and perhaps a retreat of inventory accumulation after the outsized gains in the latter half of 2013. Growth of retail sales strengthened considerably in February and March, after declining in January. Nevertheless, consumption spending in the quarter as a whole likely grew more slowly than in the fourth quarter. Measures of consumer sentiment, including expectations, have improved, however. The Conference Board consumer confidence index reached a six-year high in March and the Reuters/Michigan consumer sentiment index rose to a near six-year high in April. After a somewhat slow January, industrial production and manufacturing output grew solidly in the remainder of the first quarter, but manufacturing production growth for the quarter as a whole slowed to less than half the pace seen in the fourth quarter. Data on business inventories through February suggest that the strong inventory build in the third quarter is still unwinding and that the change in private inventories could be a drag on GDP growth in the first quarter. This pattern is likely to prove transitory, however. Trade data through February suggest that net exports could also detract from growth in the first quarter, largely reflecting weaker foreign demand for U.S. exports.
Looking at the labor market, over the first quarter of this year, total nonfarm payrolls advanced by an average 178,000 per month, faster than the pace in the fourth quarter. The unemployment rate declined sharply last year and fell to a six-year low of 6.6 percent in January before edging back up to 6.7 percent in February and remaining there in March. Broader measures of labor market underutilization have also improved, and recent readings on labor force participation have shown a leveling off after a multiyear decline. All of these indicators are consistent with gradually improving labor market conditions. The employment report for April 2014 is due at the end of this week.
The underlying condition of the housing sector has improved substantially over the past few years. Last year, total housing starts, new home sales, and existing home sales all reached multi-year highs. House prices have risen notably from their post-recession lows: as of February, the CoreLogic house price index (including distressed sales) had increased 25 percent from its trough in December 2011. This rise in home prices has substantially reduced the share of mortgages that are underwater, although the trend in house price appreciation appears to be moderating somewhat. Since mid-2013, however, existing home sales have been trending lower, and the latest data for March show sharp declines in new and existing home sales. While rising prices and increases in mortgage rates over the past year have caused some declines in housing affordability, on balance, affordability remains high by historical standards and rates of mortgage delinquency and foreclosure have declined substantially and are now near pre-recession levels. Overall, the housing sector appears likely to strengthen over time.
Headline consumer price inflation remains low. For the year through March 2014, the consumer price index (CPI) rose 1.5 percent, matching its year-earlier pace. Core consumer prices—that is, without the volatile food and energy components—rose 1.7 percent in the twelve months through March, slowing from the 1.9 percent pace in the previous twelve-month period. Notably, slower growth of prices for health care goods and services has contributed to the trend of deceleration in the core measure.
Despite the temporary, weather-related setbacks very early in the year, and very low inflation, the U.S. economy still appears poised for faster growth in 2014 and 2015. This acceleration should translate into more jobs and help to return the economy to full employment.
Against the backdrop of a strengthening economy, the fiscal position and outlook of the federal government has improved substantially. The deficit has decreased by more than half from a peak of 9.8 percent of GDP in FY 2009 to 4.1 percent of GDP in FY 2013. As welcome as this improvement in the fiscal position is, it has not been without cost. The nonpartisan Congressional Budget Office has estimated that fiscal consolidation imparted a drag on the economy of roughly 1½ percentage points in 2013. CBO anticipates that drag will fall to about ¼ percentage point in 2014. The underlying strength of the private economy in conjunction with this reduced fiscal drag suggests that the pace of economic growth will continue to strengthen into next year and beyond. The Administration’s FY 2015 Budget would ensure that we would build on the progress we’ve already made, trimming the deficit substantially further over the next ten years and putting the national debt as a share of the economy on a declining path, without risking the economy’s upward trajectory.
