Bad Headlines, But a Good Economy

If you had thought, as I did, that the U.S. economic expansion was getting healthier, you would have lost a bet on first quarter GDP growth. The preliminary estimate, which we got in late April, showed the economy grew at only a 2.2 percent annual rate, which was a slowdown from the previous quarter and well below the consensus estimate among economists. The GDP news raised the question of whether the expansion is running out of steam.

A week later, the jobs report for April added to that concern. Payroll employment rose only 115,000, after averaging gains of more than 200,000 a month over the previous half year. And the employment estimate from the household survey, which had been rising even more strongly than the payroll data, was even weaker in April. The unemployment rate did not rise, but only because more of those without work were not actively looking for jobs.

So how worried should we be about the health of the expansion? Fortunately, both the GDP and employment reports had better news in the details than in the headline numbers. A drop of 15,000 in government employment contributed to the weak April jobs report. And a decline in government purchases held back first quarter GDP. Spending on national defense fell by 8.1 percent and purchases by state and local governments fell by 1.2 percent (all changes are annual rates). These declines in government spending were an unwanted headwind that subtracted 0.6 percentage points from first quarter GDP growth. But to judge the underlying health of the expansion, the state of private sector demands provides better clues.

Private demand rose by 2.8 percent in the first quarter, and the gains were strongest in some sectors that typically lead cyclical upswings but have only recently come to life this time. Consumer spending on durable goods rose at a 15 percent rate, with auto sales running 8 percent above year earlier levels. Residential construction, the sector that crashed the hardest in the recession and that has been very slow to recover, rose at a 19 percent rate in the quarter.

Private demands were held back by a 12 percent decline in business investment in structures in the first quarter. But this does not portend a general weakness in business investment going forward. The decline came from drillers shutting down rigs in the gas fields in order to move them to fields with oil and gas liquids whose prices are higher than gas prices. Without this temporary decline in drilling activity, private sector demands would have been up 3.2 percent in the first quarter.

Other recent data further support the view that the economy will be growing, not stalling, in the quarters ahead. Income gains have been disappointingly small in recent months, but spending has outpaced disposable income and consumer credit is rising. Both suggest spending optimism by consumers. Permits for new home construction, which presage new homebuilding, are up sharply. And gasoline prices, which had been widely described as heading for $5 a gallon, have instead recently declined.

The risk that higher oil prices would derail the expansion is now slim. Oil inventories are high, the Saudis have expanded production, the risk of disruptions to Middle East supplies has receded, and U.S. production keeps rising. The risk that eurozone troubles could seriously disrupt the U.S. economy is nearer to being tested. But we seem well insulated against financial spillovers. And, if it comes, a shift to less austerity would be better for Europe and its trading partners than the present situation.

Whether, over the next six months, the economy is good enough to be an asset to President Obama or bad enough to be a help to candidate Romney is still unclear. But economic prospects are better than recent headlines would lead you to believe.