July 28, 2006

GDP growth slows, housing continues to weaken

by EPI economist  L. Josh Bivens  

Economic growth slowed to 2.5% in the second quarter of 2006, down from 5.6% in the previous quarter, according to data released today on gross domestic product (GDP) from the Bureau of Economic Analysis (BEA).

The deceleration in GDP was broad-based. Personal consumption expenditures grew 2.5% in the latest quarter, following a 4.8% growth rate in the previous quarter. Private investment growth fell to 1.7% following the previous quarter’s 7.8% growth. Export growth slowed to 3.3% from the previous quarter’s 14.0%, and growth in federal government expenditures actually declined 3.4% compared to 8.8% growth in the previous quarter.

Residential investment contracted for the third straight quarter, and by a large 6.3%. This is the first three-quarter span of residential investment decline since 1995, and the largest quarterly decline since 2000.  There seem to be strong signs that the housing sector in the U.S. economy will no longer be providing a big boost to the aggregate economy in the near future. The figure below shows the growth rate of residential investment and its share in GDP in recent years, pointing to a sharp slowdown in this sector’s contribution to growth. A key question about the economic outlook for the next year will be the degree to which other sectors can take up this slack.

Net exports (exports minus imports) contributed slightly to growth this quarter. Export growth was only 3.3%, but import growth was almost flat (rising only 0.2%). The result was a 0.33% contribution to GDP growth this quarter. While small, this is a good sign: net exports will surely have to take up some of the slack generated by a declining housing market referenced above.

The 1.6% growth in domestic demand (i.e., final sales to domestic purchasers) was a marked slowdown relative to the 5.4% reported for the previous quarter. Real disposable personal income grew less than 1% (on an annualized basis) in this quarter. Despite the slowdown in domestic demand, the savings rate of U.S. households continued to be negative (-1.5%)—marking the fifth straight quarter of negative household savings rates.

Core annualized inflation (i.e., inflation in market-based personal consumption expenditures minus food and energy prices) spiked upwards to 2.7% for the quarter, compared to 1.6% the previous quarter. While this spike may spur some to argue for interest rate hikes by the Federal Reserve to stem this inflationary pressure, the slow growth rate reported in this quarter argues otherwise. GDP in the second quarter essentially grew only as fast as productivity, which is a recipe for anemic job and wage growth in the future.

On this score, today’s GDP report also includes annual revisions that show labor income growth was slower between 2003 and 2005 than previously estimated, and another government release today—the Employment Compensation Index—shows year-over-year declines in inflation-adjusted wages of 1.2%. All in all, recent labor market trends (the rapid deceleration of job growth in the last quarter) should be weighed at least as heavily as the inflation number in this report by monetary policy makers.

Today’s BEA report shows signs that the economy is undergoing a transition from an economy based on strong domestic demand and a booming housing market to one that will have to rely more on net export growth in the near future. This adjustment will also require strong growth in wages and salaries to support consumption while also allowing some household savings. Though showing some encouraging signs, this report does not allay all concerns that the adjustment over the medium-term will be painless.

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The Economic Policy Institute GDP PICTURE is published quarterly upon release of the Bureau of Economic Analysis’ quarterly GDP report.

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