Today’s GDP data painted a fairly bleak picture. U.S. economic growth was weak in the second quarter, with real GDP rising at an annual rate of just 1.3 percent. Business spending and exports saw solid increases last quarter, but spending by consumers essentially stalled.
The report also included a significant downward revision to economic growth in the first quarter of this year, which reinforces the notion that the recovery has lost significant momentum. On the whole, the report was even more anemic than most economists expected, with average GDP growth over the last two quarters the weakest since the recession officially ended. Amid nervousness over the budget standoff, markets reacted swiftly and negatively to the report.
There is some good news. Part of the softness in the economy over the last few months has to do with temporary factors. Consumer spending was held back in the second quarter because the run-up in gasoline prices earlier this year took a big chunk out of household income that could have been spent in other ways. Manufacturing output was lower than normal because of supply chain disruptions associated with the earthquake and resulting nuclear disaster in Japan. With the passing of these negative factors, our economy should perk up somewhat. Even so, the odds of a huge bounce are low given that we continue to face some serious structural challenges, including our federal fiscal problems, the financial strains on states and localities, the still-fragile banking system, and the need to do more deleveraging in the household sector.
What role is there for policy? On the fiscal side, the first priority is to commit to a credible medium-term plan that puts government debt on a sustainable path. The current lack of such a plan is damping animal spirits; it has fostered uncertainty and anxiety that has led households to be cautious about spending and businesses to be reluctant about hiring.
But, this doesn't mean we can't also have some measures to support demand in the near-term. For example, there's a good case for extending the payroll tax cuts next year, in order to help households that are stretched thin continue to spend. The most important thing is that any such response is targeted and that it comes hand-in-hand with a commitment to reduce the deficit and debt once the economy is in better shape.
In terms of monetary policy, it looks as though policymakers are probably going to sit tight in the near-term, as well they should. Another round of quantitative easing seems very unlikely-although the unemployment rate remains high, inflation is no longer threatening to enter negative territory as it was last fall. Moreover, the extremely low level of interest rates and high level of bank reserves has fueled angst about inflationary pressures and, in some circles, doubt about the Fed's commitment to low inflation. In this environment, a further easing could spur an unwelcome rise in inflation expectations that feeds through to higher actual inflation.