Housing is Contributing to Economic Growth

Over the last two years, home building has experienced significant growth, albeit off of low levels. And this expansion has added to overall growth of Gross Domestic Product (GDP). In fact, since the last quarter of 2011, advances in home building have been responsible for 20% of total economic expansion.

While the economy as a whole has slowed somewhat over the last year, the expansion of home building has picked up steam. The home building component of the GDP accounts, as measured by the Bureau of Economic Analysis, is Residential Fixed Investment (RFI). RFI includes spending on residential structures and some equipment. The category of residential structures includes new construction of single-family and multifamily housing units, improvements and remodeling that expand or extend the life of housing units, expenditures for manufactured homes, brokers’ commissions on the sales of residential property and net purchases from government agencies. The bulk of this spending is associated with construction of new single-family and multifamily units, plus improvement spending.

It is also worth noting that this measure of home building’s contribution to economic growth does not include other housing-related spending, such as the average $7,400 spent by buyers of newly built homes on furnishings, appliances and other items in the two-year period after the purchase.

Since the last quarter of 2011, RFI has averaged a 14% growth rate. And as seen in the green line above, this growth has added between 0.19 and 0.43 total percentage points to the headline GDP growth rate in the last six quarters. For example, GDP growth in the first quarter of 2012 totaled 2%. Of that total, 0.43 points (or 21.5%) was due to advances in home building . Absent the expansion in residential construction, GDP growth in that quarter would have been only 1.6%.

As a result of this growth in home building and remodeling, housing’s overall share of the economy is climbing – slowly – back to historic norms. Housing’s share of the economy, determined by the contribution of the sum of housing services (the flow of economic benefits from the housing stock) and RFI (the contribution of home building and remodeling to the capital stock) has typically totaled 17 to 18 percent.

As of the first quarter of 2013, the total share of GDP due to housing stood at 15.18%, with 2.89 percentage points of that total due to home building. This is up from the cycle low share for RFI of 2.44% for the first quarter of 2011 at the end of the federal home buyer tax credit program.

GDP Growth in the First Quarter – Better and Sadly Maybe the Best

The Bureau of Economic Analysis (BEA) advance estimate of real GDP growth for the first quarter of 2013 is 2.5%, somewhat bouncing back from the 0.4% growth last quarter. The largest contributions to growth came from accelerating personal consumption expenditures and inventory investment. Growth was restrained by continuing declines in the government sector and a surge in imports that outpaced growth in exports.

Today’s figure was in line with our forecast of 2.6% which was predicated on a reversal of the sharp inventory pullback and no repeat of the steep decline in defense spending, the two factors that gutted growth in the fourth quarter. Unfortunately, this is likely to be strongest growth of the year. After a strong contribution in the first quarter inventories are likely to be more neutral going forward and the impact of the across-the-board spending cuts will restrain growth beginning in the second quarter and unfolding over the year. Both the federal and state government sectors will continue to be a drag on growth through the year.

GDP Growth – Inching Up, But Trouble Ahead

The Bureau of Economic Analysis (BEA) third estimate of real GDP growth for the fourth quarter of 2012 revises growth up to +0.4% from the initial estimate of -0.1% in the advance estimate and +0.1% in the second estimate. Non-residential fixed investment and exports were revised upward, personal consumption expenditures were revised downward. Real GDP grew at a 3.1% annual rate in the third quarter.

GDP growth is slightly higher than previously estimated and significantly lower than last quarter, but the biggest development with respect to economic growth is the apparent acceptance of the “sequester.” We’ve estimated that these across the board spending cuts will lower GDP growth in 2013 to 2.0% from 2.5% (Q4/Q4). Our expectation was that these cuts would be avoided but it appears that was overly optimistic.

Our next forecast update will reflect the impact of the sequester. Instead of growth rebounding in the first quarter of 2013 and accelerating through the year, the first quarter bounce will be weakened in the second quarter and significantly reduced in the second half of the year as direct cuts in federal spending, grants to state and local governments, and government transfer payments (e.g., unemployment benefits, food stamps, etc.) trickle down to reduce growth indirectly through lower consumption and investment. The annualized growth rate in the second quarter will be reduced by roughly 0.5 percentage points (from 2.4% to 1.9%) while growth rates in the second half of the year will be reduced from roughly 3.0% to closer to 1.0%

This was an outcome worth avoiding.

 

GDP Growth in the Fourth Quarter – Second Estimate

The Bureau of Economic Analysis (BEA) released the second estimate of real GDP growth for the fourth quarter of 2012. The BEA advises that the revised estimate is based on more complete source data than were available at the time of the advance estimate. Real GDP growth was revised upward by 0.2 percentage points, from -0.1% in the advance estimate to +0.1% in the second estimate. The upward revision was based on stronger exports, weaker imports (which subtract from growth) and stronger nonresidential fixed investment. These improvements were partially offset by weaker inventory investment.

This revision hasn’t materially changed fourth quarter growth or our expectations going forward. As stated previously (January report) the main sources of weakness in fourth quarter growth were declining defense spending and a slowdown in inventory investment, both unlikely to be repeated in coming quarters. In particular, it is more likely the slowdown in inventory investment will be reversed in coming quarters, adding to rather than subtracting from growth. We still expect growth to rebound next quarter and accelerate through 2013 and 2014.

At this point the “sequester” is the biggest downside risk to the forecast. The March deadline is upon us with little promise of a deal. Now the question is how long the stalemate will last. If no post-deadline deal is reached and the $85 billion in spending reductions scheduled for the last seven months of this fiscal year (ending September 30) run their course, followed by the remainder of the scheduled $1.2 trillion in cuts over the next decade, the near-term result will be a 0.5 percentage point reduction in growth in 2013 with the bulk of the pain coming in the second half of the year (our current forecast assuming no “lasting” sequester is 2.0% growth). Payroll employment growth will be 370,000 lower by the end of 2013 if the sequester sticks. Additional economic damage in 2014 and later will depend on how the cuts are implemented.

 

Near Term Economic Growth – A Fiscal Cliffhanger II

The Bureau of Economic Analysis (BEA) released the third (and final) estimate of real GDP growth for the third quarter of 2012. Growth was revised to a seasonally adjusted annual rate of 3.1%, up from 2.7% in the second estimate (last month) and 2.0% in the advance estimate (October), a marked improvement from the second quarter pace of 1.3%. The revision was largely due to upward revisions to personal consumption expenditures (PCE), exports and state and local government spending, and a downward revision to imports, which reduce output growth.

Real GDP growth above 3% represents a more self-sustaining and momentum generating recovery, but the composition of this upgrade could be better. The uptick in PCE is a positive but the 1.6% pace is still low relative to a more robust recovery. Exports can be expected to slow with a slowing global economy, and the modest increase in state and local government spending is in contrast to the string of declines since the official end of the recession in mid-2009. Similarly the decline in imports is at odds with recent trends.

But in a reprise of last month’s commentary (Fiscal Cliffhanger), the source of the greatest uncertainty about economic growth in the near term is the fiscal cliff, the combination of tax increases and spending cuts scheduled to take effect absent some agreement between the Administration and Congress on an alternative. Surveys of business leaders and consumer confidence indicate that this uncertainty is already restraining economic recovery by holding back hiring, investment and consumption. The consensus is that a complete breakdown in negotiations and full implementation of these policies would most likely tip the economy back into recession, but also that this worst case scenario will be avoided and some agreement will be reached.

Our forecast assumes that the fiscal cliff will be largely avoided, but that some fiscal tightening will occur. We’ve lowered our forecast for growth in the last quarter of this year and the first half of 2013, but expect that more robust growth will resume in the second half of 2013.

 

Near Term Economic Growth – A Fiscal Cliffhanger

The Bureau of Economic Analysis (BEA) released the second estimate of real GDP growth for the third quarter of 2012. Growth was revised upward to a seasonally adjusted annual rate of 2.7%, up from 2.0% in the advance estimate last month. Real GDP grew at a 1.3% pace in the second quarter. The revision was largely due to upward revisions to inventory investment and exports. It’s a positive signal that growth has increased from the second quarter, but less encouraging that the upward revisions came from inventory and exports, factors unlikely to make a large contribution to growth in the fourth quarter.

But the source of the greatest uncertainty about near term economic growth is the so-called fiscal cliff, the combination of tax and spending policies scheduled to take effect in January 2013 absent some agreement between the Administration and Congress on an alternative. The politics will be messy but the impact on the economic outlook is clear enough. The Congressional Budget Office (CBO) estimated earlier this year that the full effect of these policies would lower real GDP growth in 2013 by roughly 4 percentage points, from 4.4% growth to 0.5 %, relative to growth under a continuation of current policies.

Our forecast assumes that the fiscal cliff will be largely avoided, but that some fiscal tightening will occur and that the ongoing uncertainty surrounding the ultimate resolution of this issue will restrain growth in the coming quarters. As a result, our forecast calls for a deceleration in growth next quarter and in the first half of 2013 before accelerating in the second half of the year and into 2014.

 

GDP Growth in the Third Quarter – Improved But Still Slow

The Bureau of Economic Analysis (BEA) released the advance estimate of real GDP growth for the third quarter of 2012 last week. Real GDP grew at a seasonally adjusted annual rate of 2.0%, up from 1.3% in the second quarter. Key contributors to growth were personal consumption expenditures (PCE), federal government defense spending and residential fixed investment (RFI).

Growth in PCE accelerated from 1.5% last quarter to 2.0% in this quarter, while the annual growth rate in defense spending jumped to 13.0%. Growth in RFI accelerated to 14.4%, from 8.5% last quarter as homebuilding appears to be gaining momentum. RFI has shown strong growth over the last four quarters, and is currently 13.8% above the third quarter of last year, compared to 2.3% growth for GDP overall. Restraints on stronger growth included declining exports and nonresidential fixed investment.

But despite improvements in PCE and RFI, growth in overall GDP remains tepid. The 2.0% growth rate is insufficient to bring down the unemployment rate, and is more likely to lead to higher unemployment. Economists credit Arthur Okun for providing a simple, but powerful framework for understanding the relationship between the unemployment rate and GDP growth. Referred to as “Okun’s Law” it is more widely accepted as a rule of thumb. Since originally articulated in the early 1960s economists have explored a range of variations, but the basic idea is that rapid (slow) economic growth will be accompanied by a declining (rising) unemployment rate, and this basic relationship is supported by historical experience.

The chart below shows percentage growth in real GDP (in blue) on the left axis and the unemployment rate (in red) on the right axis, inverted. The gray shaded areas are economic recessions. It’s clear that when the GDP growth is above 2.5% the unemployment rate declines and when growth slips below 2.5% the unemployment rate rises.

Various specifications of Okun’s law have produced a range of numerical estimates, most of which gravitate toward the result that every percentage point of GDP growth above 2.5% lowers the unemployment rate by one half of one percentage point.

The decline in the unemployment rate since the end of the most recent recession has been relatively small and tentative based on the sluggish pattern of GDP growth. Lowering the unemployment rate to between 5% and 6%, a rate considered consistent with a healthy economy, will require a sustained period of higher GDP growth, the faster the growth, the faster the decline in the unemployment rate. The current growth rate of 2.0% is an improvement from last quarter, but still not fast enough.

 

GDP Growth Slows in the Second Quarter

The Bureau of Economic Analysis (BEA) released the advance estimate of real GDP growth for the second quarter of 2012 and their regular annual revisions which cover the first quarter of 2009 through the first quarter of 2012.

In the second quarter real GDP grew at a seasonally adjusted annual rate of 1.5 percent, down from 2.0 percent in the first quarter. The main factor in the slowdown was personal consumption expenditures (PCE) which slowed from a 2.4 percent growth rate last quarter to 1.5 percent this quarter.

The revisions beginning in 2009 show that GDP growth was modestly stronger in 2009, with less contraction in the first half and more growth in the second half, weaker but more stable in 2010, and marginally stronger in 2011, but more volatile. Growth in the first quarter of 2012 was revised up to 2.0 percent from 1.9 percent.

We expect GDP growth to strengthen in the second half of this year and through next year, but progress will be slow with growth below 3.0 percent until the second half of 2013. Even this tepid pace of recovery is based on optimistic assumptions about the two major threats to growth. We assume that we will avoid the looming fiscal cliff at the end of this year, and that the Eurozone avoids any major setbacks that destabilize financial markets.

 

First Quarter GDP Growth – Second Estimate: Not All Bad

The Bureau of Economic Analysis (BEA) released the second estimate of real GDP growth for the first quarter of 2012. The second estimate shows real GDP grew at a seasonally adjusted annual rate of 1.9 percent, down from the advance estimate of 2.2 percent. Growth in the fourth quarter of 2011 was 3.0 percent.

The modest downward revision was based mainly on less inventory investment, boding well for future growth, less government spending, and slower, but still healthy growth in personal consumption expenditures (PCE), 2.7 percent instead of the initial 2.9 percent estimate. PCE growth was 2.1 percent last quarter.

These downward revisions were partially offset by upward revisions to fixed investment, resulting in an upward revision to growth in final sales of domestic product to 1.7 percent from the initial estimate of 1.6 percent. Increased business spending on fixed investment rather than inventory investment represents a positive signal for momentum in growth going forward.

First Quarter GDP Growth – Advance Estimate: Better Than It Looks

The Bureau of Economic Analysis (BEA) released the advance estimate of real GDP growth for the first quarter of 2012. The advance estimate shows real GDP grew at a seasonally adjusted annual rate of 2.2 percent. This is a deceleration from a 3.0 percent rate in the fourth quarter of 2011. The deceleration was the result of slowing inventory investment and declining non-residential fixed investment.

The report is better than it looks because the deceleration from last quarter is really a return to the trend in improvement in 2011 as real GDP growth strengthened from 0.4 percent to 1.8 percent over the first three quarters. The 3.0 percent growth rate in the fourth quarter was inflated by inventory investment which contributed 1.8 percentage points to growth. Growth was expected to slow in the first quarter and inventory investment contributed a more reasonable 0.6 percentage points of the 2.2 percent growth rate. It’s also worth noting that growth in GDP less change in inventories strengthened to 1.6 percent from 1.1 percent last quarter.

A more tangible bright spot in the report is the strength of personal consumption expenditures (PCE) which expanded at a healthy 2.9 percent rate, up from 2.1 percent. PCE will be an important component of a self-sustaining recovery. But continued strength in PCE will depend to some degree on growth in income. Growth in real disposable personal income slowed to 0.4 percent from 1.7 percent. The growth in PCE this quarter was propped up by a decline in the savings rate, which dipped to 3.9 percent from 4.5 percent last quarter. Going forward we expect PCE growth to soften and disposable income growth to strengthen, moving both toward a better balance, hovering above 2.0 percent.