The Economy: Expectations and Reality Check

August 14 - Real GDP fell by 6.4 percent and then 1.0 percent in the first two quarters of the year. As of the second quarter, real growth was 4 percent below where it was a year ago.

But most economists think that the worst is behind us. Growth is widely expected to be turning positive now and forecasters have become increasingly optimistic about the immediate outlook. According to the latest Blue Chip survey of top private sector forecasters (August), real growth is expected to pick up to 2.2-2.3 percent for the rest of the year, then to trend modestly upward in 2010.
The big debate about the recovery is over its shape:  will GDP come back in the usual "V" shape, a more gradual "U" shape, an "L" shape (no pick up) or even a "W" (double dip recession)? Most economists are concerned that the recovery will be L or W-shaped because of the severity of the crisis and lingering weakness of the underlying financial sector. However, several noted economists expect a more traditional "V" shaped recovery based on the standard translation of pent-up consumer demand into a pick-up in spending.  (Larry Meyer, former Fed Governor, of Macroadvisers, and Jim Glassman of JPMorganChase, for example.)   
There is however great uncertainty about the forecasts.
  • Typically at any turning point, there is a large difference between high and low forecasts surveyed by the Blue Chip.  For 2010, the strongest 10 growth forecasts average 3.1%, while the lowest 10 average 1.4%. Whether the high or low case occurs has crucial implications for jobs, housing market prospects, the ability to finance the U.S. budget deficit, business survival - just to name a few concerns. 
  • Plus, data surprises can lead to large revisions (either up or down.).  For example, growth forecasts were revised up because of upside surprises. (Second quarter real GDP was not as bad as expected; July's job losses were smaller than anticipated;  auto sales under the "cash for clunkers" program seemed on fire.) Yet, a lot of this week's data has raised doubts about the extent of the optimism: autos were the only bright spot in July's retail sales, which were very weak otherwise (and auto purchases weren't all that strong); first time unemployment insurance claims reversed course and may be heading up again; consumer price data for July suggests that deflation still remains a worry.
On balance, strength in the economy is primarily coming from the stimulus package and improvement on the trade side. But, the key engine of growth (ie, the consumer) continues to be weak apart from car purchases boosted by the "cash for clunkers" program.  Until hiring resumes, it is difficult to see where income will come from. Other than production ramp ups in the auto sector to meet demand, the business side has not yet picked up (although, on the positive side, firms are strengthening their balance sheets through productivity increases.) Housing has not yet stabilized. Plus, lurking in the background are the toxic assets still sitting on financial companies' balance sheets - including nonperforming commercial real estate loans. While inflation remains subdued, deflation continues to be a risk. 

We will remain dependent on the ramp up of the stimulus package for awhile until the economy becomes self-sustaining. If tentative signs that our trade partners' economies are picking up faster than expected are confirmed (Eurostat surprised most observers by estimating that second quarter German and French growth was positive, although barely), this will help.