Government Spending Helps Slow Economic Freefall

Economic Declines Are Slowing, But Sustained Recovery Will Take More Time

SOURCE: AP/Jeff Roberson

An employee at Baldor Electric Co. works inside the company's factory in St. Louis. A new government report shows the economy sank at a pace of just 1 percent in the second quarter of the year. It was a better-than-expected showing that provided the strongest signal yet that the longest recession since World War II is finally winding down.

By Christian E. Weller | July 31, 2009

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The Bureau of Economic Analysis released its first estimates for economic growth in the second quarter of 2009 this morning, showing that the economy is no longer in freefall. The data show that the economy shrank a lot less than in previous quarters—only 1 percent—largely because government spending increased and other parts of the economy did not shrink as fast as they had before.

The BEA also released today an updated estimate of economic growth for all past observations. These revisions show that the recession was actually a lot worse than originally thought. The revised data show an average annual decline of 2.8 percent from the end of 2007, when the recession started, through the first quarter of 2009. That is a deterioration of 55.6 percent in the economic growth rate from the original decrease of 1.8 percent. The growth rate for 2008 was also cut to almost a third from its previously estimated level—0.4 percent compared to 1.1 percent—which means that last year saw the slowest growth rate since 1991. That is, Congress and the administration relied on data that turned out to be too optimistic when they debated and enacted the stimulus that is now beginning to show signs of supporting economic growth.

The economy shrank at a much slower rate in the second quarter of 2009 than in the prior three quarters. Second-quarter growth declined at an estimated 1.0 percent, compared to a 6.4 percent decline in the first quarter of 2009, a 5.4 percent decline in the fourth quarter of 2008, and a 2.7 percent decline in the third quarter of 2008.

International trade made the largest positive contribution to economic growth in the second quarter. But this news needs to be taken with a grain of salt. The economy would have shrunk by an additional 1.4 percentage points if the trade deficit had not shrunk as much as it did. And the trade deficit declined because imports fell by 15.1 percent, which was much faster than the 7.0 percent decline in exports. These large declines in imports and thus in the trade deficit will likely disappear once the U.S. economy gains strength and consumers and business start to spend more on all types of products.

The initial interventions through the American Recovery and Reinvestment Act also seem to have borne some fruit. The economy would have shrunk twice as fast—or an additional 1.1 percentage points—without increases in government spending, part of which is likely due to the stimulus. Federal government spending expanded by 10.9 percent in the second quarter, which added 0.8 percentage points to the economic growth rate. State and local government spending also expanded by 2.4 percent, contributing 0.3 percentage points to the overall economic growth rate. Especially state and local government spending would likely have grown a lot less or possibly even fallen without the passage of the economic stimulus package.

But these improvements are still a long way off from a recovery. After all, the economy is still shrinking because all other sectors are declining. They just decreased more slowly than before. Business investment declined by 8.9 percent in the second quarter, for instance—a far cry from the 39.2 percent drop in the first quarter. Household spending on homes also fell by a still remarkable 29.3 percent, although it was well below the 38.2 percent drop in the first quarter of 2009.

And consumers went into retreat again. Consumer spending declined by 1.2 percent in the second quarter of 2009 after increasing temporarily by 0.6 percent in the first quarter of 2009. The drop in consumer spending was led by a 7.1 percent decline in spending for consumer durables, such as cars and refrigerators, followed by a 2.5 percent decrease for nondurables, such as food.

The slowdown in the economic freefall was also aided by two additional factors. First, businesses drew down their inventories more slowly than in the past. The drop in business inventories lowered economic growth by 0.8 percentage points in the second quarter, compared to a drag of 2.4 percentage points in the first quarter. Second, prices increased much more slowly at 0.2 percent in the second quarter compared to the 1.9 percent increase in the first quarter. Inflation thus robbed the U.S. economy of less growth than before.

Today’s data release gives us a much clearer picture of the current economic situation. The economic hole we were in during the winter was much larger than originally thought. But public policy interventions, especially the economic stimulus, have helped to slow the slide in the economy as government spending increased. The hope now is that expanded government activity will eventually translate into more jobs, which could have a positive effect on consumption and investment in the future. The signs from today’s data are encouraging, but for the time being the economy is still shrinking and losing jobs. Additional policy attention is thus required to generate a sustained and strong recovery that will help to bring back millions of lost jobs for America’s struggling families.

Christian E. Weller is an Associate Professor at the University of Massachusetts Boston's Department of Public Policy and Public Affairs, and a Senior Fellow at the Center for American Progress.