The economy is, statistically speaking, out of a recession. GDP and job gains have occurred in the past two years. But for ordinary folks, a sizable number believe we are still in a recession. That is an understandable sentiment given the unemployment rate is not back to normal, foreclosures are still happening, and inflation ate up all salary increases. Consumer confidence still shows well below normal levels of 90 to 100.
Let’s review more in-depth what has happened and what we can expect regarding the economy. Economists define recession as prolonged period of output decline. Two consecutive declines in GDP normally qualifies as a recession. The fact of the matter is that the U.S. GDP has expanded by 11 straight quarters. The latest growth rate of 2.2% in the first quarter is nothing to get excited about since it is below the 3% historical average growth rate, but the economy is nonetheless producing more. As for jobs, the low point was in early 2010 when there were 8 million fewer people working compared to just two years prior. But since the low point, the U.S. economy has added almost 4 million net new jobs. We are still down from the peak, but well off the bottom and continuing to add jobs with each passing month.
As to the forecast, it is very hard to see how the economy could sink back into a recession. Each of the major components suggests further economic expansion. The equation for Gross Domestic Product (all the stuff we produced) is defined by this simple equation:
GDP = Consumer spending + Investment spending by businesses + Government spending + Net international trade.
Consumer spending will be positive for the simple reason that aggregate income has been rising because of job creations and because of wealth gains in the stock market. Housing wealth is still not yet definitively positive, but it will no longer be negative. By year end, home prices will have shown some modest gains, and therefore, a higher housing wealth effect will help consumers to open their wallets. The home price increase projection is based on a diminishing rate of distress property sales as the year progresses and from the declining levels of distressed homes in the pipeline, the so-called shadow inventory. Also home sales have been rising and visible inventory levels have been falling.
Business investment spending will be positive due to the simple reason that corporations have an abundance of cash on their balance sheets. Banks also have plenty of cash reserves. Housing or residential investments, which had been negative for most of the past 5 years, have been growing solidly because of rising home sales. The only holdback is small businesses, who are still struggling to accumulate profit and tap borrowing. But this condition has been persistent so that small business spending cannot possibly turn lower from already low levels. The only direction for small business spending to go is up.
Government spending, meanwhile, has turn negative. State and local governments in particular have been shedding spending for the past 3 years. The federal government has also begun to cut, primarily in defense. In the short-run, declines in government spending mean lower economic activity. Fired government workers and defense contractors cannot spend money as they used to. But the improvements to budget deficit may raise the confidence of bond investors and thereby help assure attractive low interest rates for those private consumers and businesses in need of borrowing.
As to the final component, the international picture has been fairly neutral. Both import and export growth rates have been about the same and this is not expected to change all that much. A slight fall-off in exports to Europe may occur be compensated by rise in exports to Asia.
Of the main components above, the two big players are consumers and businesses. And as said above, it is hard to foresee how consumers and businesses can retrench. Therefore, U.S. GDP will continue to expand, albeit at the somewhat subpar rate of 2% to 2.5%, this year. Job gains will likely be around 2 million. We are in a recovery phase and clearly out of the recession, but the slow recovery is sure making people believe that the economy is not normal and still lingering in the recession.
The only caveat to the forecast is that a new federal budget needs to be agreed upon by Congress and the White House before the end of the year. If no new budget passes, then there will be sizable automatic government spending cuts to domestic and defense programs. Taxes will go up sharply. The dollar amount taken out of the economy will be equivalent to 3% of GDP. All this happens suddenly on January 1, 2013, if no new budget is passed. A potential 3% GDP subtraction on an economy that is now growing at 2% will then put the economy into a recession.