Stagnant wages, increased unemployment, a negative job growth, a weaker dollar, with inflation (higher CPI) thrown into the mix.
It's more expensive for most Americans. The Middle Class. Where most of the votes are.
U.S. Economy
National Update
June 2003
Evan F. Koenig reviews recent economic conditions in the United States.
It’s a familiar story. Consumer spending is following a steady upward track, while all of our other “hard” indicators of real activity are, at best, stagnant. Hope comes from a rebound in financial-asset prices. Analysts have for some time predicted that an acceleration in economic activity is “just around the corner.” Judging by stock prices and junk-bond spreads, investors are betting that the analysts have finally got it right. Meanwhile, despite all the talk about deflation, core inflation is more likely to increase than fall in the year ahead.
Near-Term Outlook: Been Down So Long It Looks Like Up to Me
The good news is that we may well have hit bottom. The bad news is that it was a deeper hole than we thought. Press reports have emphasized the small recent job declines in the new payroll employment data. However, Chart 1 shows that the main message from the revised data is that job losses since March 2001 have been substantially larger than previously estimated (2.5 million versus 2.1 million jobs). The double-dip pattern we saw in the data for 2002 and 2003 is now largely gone, replaced by a steadier, gradual decline.
Chart 1 |
Chart 2 plots real retail sales and industrial production through May. Note the absence of any recent significant break in the now three-year-old upward trend in consumer demand. In sharp contrast, industrial production has followed an obvious double-dip pattern similar to the one present in the old employment data.
Chart 2 |
Man Bites Dog
Some analysts rely on initial claims for unemployment insurance for early warning of improvement or deterioration in employment growth. The usual rule of thumb is that payroll employment is rising or falling, depending on whether initial claims are below or above 400,000. Regression analysis confirms the validity of the 400,000-claims threshold. However, all is not well with the conventional wisdom. The highest correlation between initial claims and employment growth occurs when employment growth is lagged by about three months relative to claims. In other words, jobs growth leads claims, not the other way around. Chart 3 shows the link between initial claims and jobs growth three months earlier.
Chart 3 |
Longer-Term Outlook: The Spirit Is Willing, but the Flesh Is Weak
Leading indicators that reflect consumer and investor attitudes have generally painted a brighter picture than indicators physically linked to future output growth. For example, two-thirds of May’s 1 percent increase in the Conference Board’s leading index was accounted for by indicators measuring financial conditions and consumer expectations (Table 1). During the prior six months, when the leading index was essentially flat, a strong positive contribution from financial/expectations indicators was nearly offset by a strong negative contribution from “real” indicators.
Table 1
| Deconstruction of Changes in the Conference Board’s Leading Index | ||||
|
Horizon
|
||||
| Contributions to change in the Index (percentage points, not annualized) |
May '03/April '03
(percent) |
April '03/Oct. '02
(percent) |
||
|
0.7
|
1.0
|
||
|
0.3
|
–0.8
|
||
|
1.0
|
0.2
|
||
| NOTE: Financial/expectations indicators include consumer expectations, stock prices, the spread between the long- and short-term interest rates, and real M2. Real indicators include building permits, ISM vendor performance, initial unemployment claims, average weekly hours in manufacturing, new orders for nondefense capital goods, and new orders for consumer goods and materials. | ||||
| SOURCE: The Conference Board | ||||
What explains the real/financial dichotomy? Partly, it results from unusually strong productivity gains that have improved the profit outlook for businesses (strengthening financial indicators), while simultaneously adversely affecting the labor market (weakening real indicators). Partly, the real/financial dichotomy results from intense import competition that has had an especially strong adverse impact on the goods-producing sector. Four of the six real-side leading indicators included in the Conference Board index are drawn from this sector.
The recent behavior of the Conference Board index implies that we will see only a modest pickup in growth over the next few months. However, longer-leading financial indicators—such as the junk-bond spread, the real short-term interest rate and changes in stock prices—suggest that the pace of growth will accelerate significantly late this year and on into early 2004.
Inflation: As Good As It Gets?
Chart 4 shows that the gap between spending growth and the short-term interest rate has been a strong predictor of year-ahead inflation changes. Roughly speaking, a 1-percentage-point gap between spending growth and the interest rate translates into a 0.3-percentage-point increase in the inflation rate over the subsequent four quarters. The additional predictive power of the unemployment rate for inflation is small. Since growth in sales to domestic purchasers is currently running over 3 percentage points above the level of short-term interest rates, core inflation is more likely to increase than to decrease over the next year, despite slack in the labor market.
Chart 4 |
Net Exports a Big Drag
Most analysts believe that the economy’s real growth potential is about 3.5 percent per year. If that estimate is accurate, then a long-run inflation rate of between 1 and 2 percent (effective price stability) requires spending growth of between 4.5 and 5.5 percent. Domestic purchases have been increasing at a rate just slightly below the lower end of this range (Chart 5).
Chart 5 |
If spending growth is nearly on track, how is it that output and employment growth have been so weak? A big part of the answer is the unusually large 1-percentage-point gap that currently separates growth in domestic purchases from growth in sales of domestic product. This gap reflects a rapidly increasing trade deficit: Domestic purchases are increasing faster than sales of domestic product because a larger and larger fraction of spending is on foreign-produced goods and services. Presumably, this trend cannot continue.