Stimulus Begins to Work, But More May Be Needed

The economic stimulus package passed by Congress earlier this year helped the U.S. economy grow by 1.9 percent in the second quarter of this year, according to government figures released today. Still, substantial weaknesses in the economy remain, which may require another economic stimulus package in the coming months.

The Commerce Department’s Bureau of Economic Analysis estimates that annualized economic growth in the second quarter of 2008 of 1.9 percent was up from 0.9 percent in the first quarter. The acceleration was the result of faster consumption growth, stronger business investment expansion, and better trade performance than in previous quarters. Much of the acceleration, though, is the consequence of tax rebate checks that were mailed out in the second quarter and which could continue to lift spending in the subsequent quarters.

Today’s figures show that the economic stimulus worked as intended. People are spending some of the additional income that they received from the tax rebate checks, though they clearly remain worried about the combination of higher prices and fewer jobs in a slow economy, and therefore are cutting back on spending that is directly related to higher oil prices, such as cars and travel. This may mean that they will spend the stimulus checks more slowly than expected and that the economy may need additional support for growth to get back on a stronger track.

The details in the data released today may provide some clues The vast majority of the expansion was driven by trade. Exports expanded by 9.2 percent in the second quarter of 2008, the largest increase since the third quarter of 2007. Also, imports dropped faster than before, by 6.6 percent in the second quarter, the sharpest decline since the third quarter of 2001, the last full quarter of the last recession. Faster export growth and a sharper decline in imports means that trade contributed 2.4 percentage points to economic growth in the second quarter. Without trade, the economy would have actually shrunk by 0.5 percentage points in the second quarter.

The decline in imports is especially surprising. Oil prices rose sharply during the second quarter. The price of a barrel of light sweet crude oil for delivery one month later stood at $101.6 by the end of March 2008, and increased to $140.00 by the end of June. Yet, the imports of petroleum and related products dropped by 40.2 percent in the second quarter, reflecting a weaker economy and a weaker labor market, with people cutting back on routine trips and fewer people unfortunately having to drive to work.

In addition, consumer spending rose again. Consumption growth amounted to an annualized 1.5 percent in the second quarter of 2008, the largest increase since the third quarter of 2007. This added 1.1 percentage points to economic growth, up from 0.6 percentage points in the first quarter. This growth came despite a drop in durable goods consumption, which includes cars. In fact, spending on cars dropped by 18.5 percent in the second quarter of 2008, the largest drop since the fourth quarter of 2005.

Consumer spending increases may continue for a little longer. Today’s figures show that families did not spend all of the rebate checks as the personal saving rate increased to 2.6 percent of disposable income, the highest level since the second quarter of 2002. Consequently, consumption may get another bump in the second half of 2008, unless families become more frugal in the face of a troubling economy.

Outside of imports that depend on oil prices, higher consumer demand in the United States resulted in more imports. For instance, imports of consumer goods, outside of cars, increased by 6.4 percent and imports of food rose by 2.8 percent in the second quarter.

Other import figures, though, suggest that families are spending very cautiously. Demand for goods and services linked to higher oil prices and a slowing economy were sharply lower. Imports of cars dropped by 12.7 percent, the third quarterly decline in a row, money spent on travel abroad (a service import) fell by 13.0 percent, spending on passenger fares to international destinations dropped by 29.9 percent, and other transportation abroad, such as driving a car, decreased by 17.5 percent in the second quarter.

The decrease in spending on passenger fares was the largest since the fourth quarter of 2001, when travel nosedived after the 9/11 attacks. Americans also spent less on their cars and stayed more at home due to sharply higher gasoline costs and a weaker economy.

Businesses, too, are growing concerned. Most notably, businesses decreased their inventories more than expected and thus lowered growth by 1.9 percentage points—the largest such adverse effect on economic growth since the second quarter of 2005. This may mean that businesses have become nervous about the future and do not want to hold goods that cannot be sold.

In addition, the troubles in the housing market continued. Household spending on residential properties decreased for the 10th quarter in a row, this time by an annualized 15.6 percent. This is much less than in the previous three quarters, when residential real estate dropped by more than 20 percent each quarter, but still indicative of continuing turmoil in this key sector of the economy

Business investment expanded, but at a slower rate than before. Investment expenditures rose by 2.3 percent, the slowest rate since the fourth quarter of 2006. The slow investment expansion in the second quarter of 2008 was largely the result of declining spending on equipment and software, down by 3.4 percent, the largest drop since the fourth quarter of 2002.

The weaknesses in the private sector were partially offset by stronger government spending. In particular, federal government spending on defense increased by 7.3 percent, the same growth rate as in the first quarter of 2008.

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