Ever since positive GDP growth resumed in the summer quarter of last year, the consensus outlook for the economy has underestimated the strength of the expansion. It’s easy to see why. Once the global financial system seized up in September 2008, economic activity throughout much of the industrial world started a steep decline. It was a good bet that the U.S. was in the worst downturn since the 1930s, and it was possible that the downward spiral would go unchecked for an extended time.
History will applaud the policy responses that helped stop the decline by mid-2009. But doubts remained about virtually every sector of the economy and doubts dominated the aggregate business outlook. The Philadelphia Federal Reserve’s average of GDP forecasts made in the second quarter of 2009 anticipated an annual growth rate of 1.2 percent over the last two quarters of the year. But GDP actually grew at a 3.9 percent rate over that period.
The job market has badly lagged the gains in output. The unemployment rate continues near its post-Depression peak. The widely followed change in payroll employment declined at over a 2 percent rate during the last half of 2009 even as output growth resumed, and only leveled off in the first quarter of this year. Output typically grows faster than employment, all the more so in a period of cyclical recovery. But the difference of 6 percentage points in their growth rates during the last half of 2009 is unusually large and not sustainable.
There is reason to believe employment growth is already beginning to strengthen. In a research paper a few years ago (Gauging Employment: Is the Professional Wisdom Wrong? Brookings Papers on Economic Activity: 2005), I showed that the employment change available from the survey of households is as useful as the change in the payroll data. When the two diverge for a time, they tend to come back together in future quarters. As a rule of thumb, the best measure of what is actually happening to employment is a simple average of the change in the payroll and household data. In the first quarter of this year, the household data rose at a 1.4 percent rate. The weak job market is finally improving, even though the payroll data has not yet shown it. Payroll employment for April, which will be reported next week, should reflect the improvement.
Sustained job growth will require a strong economic expansion and the prospects for GDP growth are good. The health of the financial sector is no longer a risk for the overall economy. The big banks that needed government intervention a year ago are prospering and their balance sheets are improved. Bank lending is still down, probably reflecting both cyclically reduced demand and more conservative lending standards. But unlike a year ago, when the excessive reluctance to lend threatened the economy somewhat higher standards are now desirable and unsurprising. Bad commercial real estate loans continue to burden regional banks, but the crash in residential construction is behind us.
Some new central banking issues have emerged. In Europe, the sovereign debt crisis poses new risks for policymakers and the banking system. The U.S. has been affected mainly through the appreciation of the dollar, and that would have to go considerably further before it posed a dilemma for policymakers here. The Federal Reserve still must get rid of the mortgage assets it purchased to support the banking system during the crisis. But it can be trusted to do so at a pace consistent with its continuing commitment to economic expansion.
In this supportive financial environment, consumers seem to be feeling better and are spending more. Capital goods orders are rising, helped by orders from growing economies abroad. The expansion in 2010 should easily exceed the current 2.9 percent consensus forecast, starting with the GDP report for the first quarter that will arrive this Friday.