U.S. annualized real GDP growth of 1.2% through Q3 2011 was driven by personal consumption, accounting for 91% of it.  Yet only 44% of personal consumption growth was driven by higher incomes.  The other 56% was accounted for by unsustainable items: a decline in savings (36%) and the payroll tax cut (20%).  The latter will expire in two months time unless Congress acts to extend it again. Read more »

On September 21st the Fed announced that it would be selling $400 billion in short-term Treasurys and buying $400 billion in longer-term Treasurys to replace them – a maneuver titled “Operation Twist.” Atlanta Fed president Dennis Lockhart explained what it would mean for the economy: “It means lower interest rates – a lower cost of borrowing – across a whole spectrum of loan maturities.” Is he right? Well, China, Russia, and Brazil have conducted their own version of Operation Twist over the past several years, replacing roughly $330 billion in short-term Treasurys with long-term ones. The 10-year Treasury rate went sideways over that period, as shown in the figure above. Whereas the BRIC* Twist may have put some modest downward pressure on longer-term rates, other factors overwhelmed it. Don’t expect much from the Fed’s similar-sized version.

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In its most recent update to the Budget and Economic Outlook, the Congressional Budget Office projects robust GDP growth of 4.4% in 2014 and 5.0% in 2015.  This projected spurt is unexplained, but appears to have been reverse-engineered from the belief that the United States should return to the trend growth it seemed to be following prior to the financial crisis—as can be seen in the figure upper-left above.  There is precedent for this: after the double-dip recession of the early 1980s, strong growth in 1983 and 1984 quickly closed the gap between actual and so-called potential levels of output—as can be seen above, upper-right.  But the CBO would be wrong to assume that economic history is destined to repeat itself.  In the early 1980s, industrial capacity continued to expand throughout the recession, while the labor force remained at the same level.  The recent downturn, however, has seen declines in both industrial capacity and the labor force of 2% and 5%, respectively—as seen in the bottom figures.  There is little justification for believing that potential economic activity has continued to grow while critical inputs to economic activity—labor and capital—have shrunk.  If potential output has shrunk along with them, then the U.S. faces considerably greater fiscal challenges than the CBO’s analysis implies. Read more »