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August 24, 2009
A New Beginning?
Recent data revisions show that output fell much more steeply last year than was first thought. Newly available monthly indicators suggest, though, that the downturn will soon end, or has in fact already ended. Production is stabilizing, new orders are rising, and firms are making progress in controlling their inventories. Long-leading financial indicators signal that growth is likely through at least the end of 2009.
A Deeper Hole Than We Thought
Estimates of real gross domestic product (GDP) released late last month show a much steeper decline in economic activity during the 2008–09 recession than was previously indicated. From 2007:Q4 to 2008:Q4, the new data show a cumulative GDP decline of 1.86 percent—a full percentage point larger than the prior estimate (0.85 percent). From 2007:Q4 to 2009:Q1, similarly, the new data show a 3.48 percent decline, against 2.24 percent previously. Real activity dropped further in second quarter 2009, and the cumulative fall in real GDP now stands at nearly 3.75 percent.
Economic Activity Begins to Stabilize
The latest monthly indicators suggest that output declines may be ending. After hitting lows late last year, the Institute for Supply Management’s composite manufacturing and nonmanufacturing indexes both have risen to levels consistent with expansion of the overall economy (Chart 1). The manufacturing composite index rose to 48.9 in July, suggesting approximate stability in manufacturing output. The nonmanufacturing index eased down from 47 to 46.4. [1]
New Orders Are Up
The various ISM subindexes provide valuable advance information on the near-term course of important segments of the economy. Movements in the New Orders index from the ISM’s manufacturing survey, for example, lead swings in equipment and software investment (Chart 2), changes in the growth rate of industrial output (Chart 3), and changes in the rate of job growth in the goods-producing sector of the economy (Chart 4). The latest readings on the index signal that equipment and software investment will soon begin making a positive contribution to real GDP growth, that industrial production is about to expand, and that jobs growth in the goods-producing sector is normalizing.
Drag from Inventory Investment About to Disappear
Inventory investment subtracted 0.8 percentage points from GDP growth in the second quarter of 2009. Forecasts of a turnaround in the economy assume that the rate of inventory disinvestment will stabilize or moderate, causing this drag on GDP growth to disappear. Recent changes in the balance between ISM respondents reporting rising and reporting falling inventories suggest that these forecasts are on the mark (Chart 5).
A Second-Half Bounce
The monthly indicators examined so far provide insight into the likely direction of the economy over the current quarter, at best. For guidance over a longer horizon, it’s useful to consider financial and market indicators like (1) changes in the level of real short-term interest rates, (2) changes in the junk-bond spread, (3) changes in stock prices, (4) the slope of the yield curve, and (5) any rise in the real price of oil not attributable to increases in U.S. oil demand. Using these indicators, two-quarter average GDP growth can be forecasted a full two quarters in advance (Chart 6). The latest forecast—updated early last month—calls for 4 percent annualized average GDP growth during the second half of 2009. [2]
The specifics of this forecast shouldn’t be taken too seriously: The forecasting model’s errors are sometimes large, and its timing has sometimes been off by a bit. Still, it’s fair to conclude that we are likely to see a couple of quarters of above-trend growth beginning sometime this summer or fall.
Self-Sustaining Growth?
The big question is whether the economy will gain enough upward momentum to sustain growth once fiscal stimulus begins to fade, first-time homebuyer tax credits expire and the inventory correction runs its course. Household spending will undoubtedly not return to its prerecession path. Consumption growth may, nevertheless, normalize, which would go a long way toward supporting continued economic expansion.
—Nicole Ball, Evan F. Koenig and Max Lichtenstein
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