National Economic Update
Economic Growth Poised to Accelerate
March 22, 2013 · Update in PDF
Gross domestic product (GDP) growth should accelerate from modest to moderate over the course of 2013 and into 2014, after stalling at the end of 2012. Since the autumn of 2011, the level of financial stress has been on a downward trend and has been at or below average since the summer of 2012, indexes show. The labor market is improving, and the latest Institute for Supply Management (ISM) survey data are positive. Financial stability, firming employment growth and positive survey data all point to more tailwinds for the economy in 2013; yet, the fiscal outlook looms as a headwind. Against the backdrop of sequestration, growth prospects during the first half of 2013 are anticipated to remain at a modest pace before increasing in the second half of 2013 and into 2014.
GDP Growth Forecasts Relatively Optimistic
Real GDP growth is forecasted to accelerate from modest to moderate from first quarter 2013 through first quarter 2014 by the Survey of Professional Forecasters (SPF). The SPF forecasts first-quarter growth to be 2.1 percent, gradually increasing to 2.7 percent growth in first quarter 2014 (Chart 1). Fourth quarter 2012 real GDP growth was upwardly revised in the second estimate of GDP from a 0.1 percent contraction to a 0.1 percent expansion. The SPF forecasts continue to be less optimistic than the forecasts given in the Summary of Economic Projections (see table 1 of Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, March 2013 ) produced by the Federal Open Market Committee (FOMC). The annual growth rate of real GDP was 2.2 percent for 2012. The SPF predicts moderate annual real GDP growth for 2014, coming in at 2.8 percent. Financial stability and less economic uncertainty contribute to the more optimistic outlook for output growth.
Financial Markets Continue Stabilization
Measures of overall financial stress are stabilizing (Chart 2); both the Kansas City Fed and St. Louis Fed financial stress indexes have remained below zero since at least July 2012 and have continued on a downward trajectory. Decreased levels of financial stress should provide less drag on the real economy; however, political instability in Europe continues to have the potential to inject some anxiety into the financial markets. The two previous episodes of above average financial stress coincide with the initial Greek crisis in the summer of 2010 and the euro debt and financial crises in the autumn of 2011. Keeping in mind the potential hazards associated with events in Europe, continued easing of financial stress should benefit the overall economy.
Employment Growth Remains Moderate
Labor market conditions improved recently. After adding only 119,000 jobs in January, employers added 236,000 jobs in February, a sign that current fiscal concerns are having less impact on hiring decisions. Government payrolls decreased by 10,000 jobs in February, and they are set to lose even more jobs as the automatic budget cuts known as sequestration begin to take effect. The level of nonfarm payroll employment has risen at a fairly steady pace since November 2012 (Chart 3), with the three-month moving average of nonfarm employment growth hovering around the moderate rate of 200,000 jobs per month. With positive news coming out of both the financial market and the job market, the largest identifiable headwind is sequestration's effect on government employment and spending outlays.
Sequestration Is Primary Headwind
Chart 4 highlights the differences in budget authority and outlays through 2021 as the decrease in outlays can be seen to lag budget cuts. Budget authority is the authorization to spend federal funds, while budget outlays are actual spending by the federal government. Thus, budget outlays are the determining factor related to federal spending cuts that will impact GDP growth. As the graph shows, the majority of the negative effects on outlays, and thus GDP growth, will become more severe in 2015 and beyond. Indirect effects of the sequestration include reduced personal consumption as furloughs and salary cuts weigh on personal income growth and also a slower pace of job growth due to reduced government hiring. Despite the drag on overall economic growth that will be caused by the government sector, real private final demand is expected to continue its steady improvement, as seen in recent survey data.
Both ISM Indexes Increase
The ISM manufacturing and nonmanufacturing (services) indexes are both greater than 50, suggesting a positive outlook for both sectors (Chart 5). The strength in the ISM manufacturing index is a welcome signal of improving conditions following weakness in manufacturing in the second half of 2012. The nonmanufacturing index posted an increase in February from 55.2 to 56, continuing along the upward trend it has followed since June 2012. Following stalled GDP growth in fourth quarter 2012, both ISM indexes have increased, easing any fear of back-to-back quarters of little to no growth. The recent strength in both indexes lends more credence to the optimistic SPF forecasts of real GDP growth.
GDP growth in 2012 was fairly weak, but most data point to steady improvement throughout 2013 and into 2014. GDP should outperform the very modest 1.6 percent average growth it exhibited in the second half of 2012. Recently, the levels of financial stress and economic uncertainty have fallen, and equity prices have surged. The labor market is improving, with the unemployment rate falling to a new postrecession low in February. The latest ISM and SPF survey data are positive, suggesting that GDP growth will accelerate to a moderate rate by early 2014. Long-term inflation expectations are well anchored, so inflation in 2013 and 2014 should fall within the target range of the FOMC. The main threats to growth are the fiscal outlook and the European sovereign debt crisis. Despite fiscal drag on the economy due to sequestration, underlying economic growth appears ready to accelerate.
About the Author
Cooke is an economic programmer/analyst in the Research Department of the Federal Reserve Bank of Dallas.
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