More Bad News: The Slump Further Deepens

Center for American Progress: The Slump Further Deepens

Household spending on new homes and home improvements dropped by 17.4% in Q3

By Christian E. Weller

RISMEDIA, October 30, 2006—The Bureau of Economic Analysis has released its advance estimates for economic growth in the third quarter of 2006. According to these figures, the economy expanded at an annualized rate of 1.6%, the slowest growth rate since the first quarter of 2003.

Inflation remained modest because oil prices leveled off. This kept growth numbers higher than they could have been if inflation had maintained the same pace as previous quarters. The implicit GDP price deflator, used to calculate inflation adjusted GDP, grew by only 1.8% on an annualized basis, down from 3.3% in the first quarter—the lowest increase since the second quarter of 2003. This means that less of the economic expansion in the third quarter was eaten away by price increases than in the prior three years.

The underlying story is that since the sharp end to the housing boom, there has not yet been a replacement to drive the economy. Other sectors of the economy either failed to grow fast enough to compensate for these declines, or presented an additional strain on the economy.

If you are looking for the headline number in the report, it is undoubtedly the drop in residential real estate activity. In the third quarter, household spending on new homes and home improvements dropped by a stunning 17.4%, after already declining by 11.1% in the first quarter. This is the fourth quarter of declines in this sector, and it is the largest decline since the first quarter of 1991. This decline pulled economic growth down by 1.12 percentage points, which means that the other sectors would have had to add 1.12 percentage points to economic growth just for the economy to stay flat.

The widening trade deficit further exacerbated this situation. In inflation adjusted terms, the trade deficit grew to an annualized rate of $639.9 billion—the highest level since the BEA began keeping records in 1947. The trade deficit, relative to the size of the economy, again expanded to 6.1%, tying the record set in the fourth quarter of 2005. The expansion of the trade deficit, caused by a surge in imports, drained another 0.58 percentage points from the economic growth.

The contribution of government spending to economic growth was a mixed bag. Federal spending outside of defense accelerated significantly, growing by 6.9%, up from a decline of 9.3% in the second quarter. At the same time, defense spending shrank 0.7% in the third quarter, following a decline of 2.0% in the second quarter. Spending by state and local governments on consumption and investment, which is almost twice as large as consumption and investment spending by the federal government, grew 2.1% in the third quarter, which is roughly half its 4.0% growth rate in the second quarter. Given financial realities, particularly at the federal level, it is unclear whether the federal government can contribute much more to economic growth.

Consumers maintained a steady pace, largely by spending more than they earned in income. Consumption growth increased slightly to 3.1% from 2.6% in the first quarter, due mainly to faster sales of durable goods such as cars and refrigerators. But at the same time, the personal saving rate remained a negative -0.5%. The negative savings rate, by definition, means that families are either spending down their assets or increasing their debt. With the housing slump deepening, it is unclear how much longer families can continue to live off the value of their homes.

The bright line in today’s report is business investment. It expanded by a solid 8.6% in the third quarter, up from 4.4% in the second quarter. Both structures and equipment investments expanded at a strong pace. Structures or commercial construction expanded by 14.0%, which possibly absorbed some of the decline in the residential construction sector. Equipment investments also grew by 6.4% after declining by 1.4% in the second quarter.

The important question is whether the continued expansion in business investment will be enough to create new jobs with higher wages and spur income-led consumption growth. Inflation adjusted wage growth slowed again in the third quarter, after all. On an annualized basis, the total sum of wages and salaries expanded by 2.3%, down from 3.2% in the second quarter. Total compensation growth, which includes benefits, slowed even faster, going from 3.4% in the second quarter to 2.2% in the third quarter. For the economy to regain a healthier footing and end its dependence on debt, income needs to grow faster again.

Christian E. Weller is the senior economist for the Center for American Progress.

For further information about the Center for American Progress visit www.americanprogress.org.

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