RELEASE: Stimulus Aids Strong Economic Rebound

Third quarter GDP numbers show strong growth aided by the American Recovery and Reinvestment Act, but it’s not a strong and sustained recovery yet, writes Christian E. Weller.

Read the report on CAP’s web site.

There is light at the end of the tunnel, and the American Recovery and Reinvestment Act got the economic engine closer to that light. The economy grew at an annual inflation-adjusted rate of 3.5 percent in the third quarter of 2009, the Bureau of Economic Analysis reported this morning. This is the first time that the economy has expanded after five-quarters of declines, and it is the strongest quarterly growth rate since the third quarter of 2007.

This is the clearest sign to date that the economic contraction and the recession ended some time this summer. Public policy has had a strong hand in getting the economy back from the brink of disaster and moving the economy into positive territory. Additional public policy attention is needed, however, to get the labor market unclogged, jobs growing, and the unemployment rate falling in the near future, after large-scale policy efforts did the same for financial markets and economic production.

The consumer is back. Consumption spending increased by 3.4 percent this quarter, its strongest growth since the first quarter of 2007. This was largely due to a 22.3 percent jump in spending on consumer durables, such as cars. Car sales jumped 56.4 percent in the third quarter of 2009 with the help of the additional incentives, known as “Cash for Clunkers.”

Consumer spending on a number of other items also increased at a healthy rate. Spending on recreational goods grew by 13.8 percent, furniture spending by 6.5 percent, and other goods by a respectable 6.2 percent. Food spending, a non-durable goods item, rose by 5.0 percent in the third quarter.

There are encouraging signs, based on one quarter of data, that the housing slump seems to have come to an end. The housing market expanded for the first time in almost four years. Spending on new homes increased by a strong 23.4 percent in the third quarter, the first increase since the fourth quarter of 2005. This is also the largest gain in more than two decades since the second quarter of 1986. The increase in spending on housing was aided by price declines during the previous years and low interest rates and the momentum in the housing market could thus very well last.

Much of the momentum in consumer spending came from increased after-tax income in the prior quarters. Families had received tax cuts, additional Social Security benefits, and more unemployment insurance benefits since early spring. They spent some of this money in the third quarter, thus contributing to strong economic growth. The personal saving rate fell to 3.3 percent in the third quarter of 2009, down from 4.9 percent in the second quarter, and its lowest level since the second quarter of 2008.

The spending increase and the decline in saving are likely a middle class phenomenon. Wages, Social Security, and unemployment insurance increased slightly before adjusting for inflation. On the other hand, capital income, such as interests and dividends, fell even before inflation, which disproportionately affected higher-income families. Other government transfer payments, which include many assistance programs for the poor, also declined. The resulting decline in total inflation-adjusted after-tax income by 3.4 percent is thus not necessarily reflective of the experience of moderate-income and middle-income families, but more an indication of cuts to incomes for higher-income families and the poor.

Now that consumers are back in the game, it is critical that businesses start to invest again, so that a labor market recovery can follow the economic gains. Business investment still shrank by 2.5 percent in the third quarter, less than one-third the decrease of 9.6 percent in the second quarter.

There are signs of a burgeoning investment recovery, however. The most recent drop in total investment is the smallest decline since investment began its slide in the second quarter of 2008. This drop was primarily a result of a continuing slump in commercial construction, which fell by 9.0 percent. What’s more, business investment spending on equipment, such as computers, trucks, and machinery, grew by 1.1 percent, the first increase since the fourth quarter of 2007. And businesses are beginning to restock their shelves. Without inventory rebuilding, the economy would have grown by only 2.6 percent instead of the 3.5 percent that was reported. There is thus hope that business investment will soon gain more momentum as consumers come back, which is also reflected in the fact that industrial production has risen for three months in a row according to the Federal Reserve.

The economy was also aided by growth in government spending in the third quarter. Federal government spending rose by a respectable 7.9 percent. Defense spending increased by 8.4 percent, and non-defense spending by 6.8 percent. These increases were more than enough to offset the decline in state and local government spending of 1.1 percent in the third quarter, which reflects the deteriorating fiscal position of many states.

Not all economic data comes up roses. This is only one-quarter worth of positive economic news and workers who have been waiting for a turnaround in the labor market for the past 21 months need many more quarters like this to see substantial improvements.

And there is enough in today’s data signaling that challenges remain. State and local governments are struggling with a fiscal crisis and will likely continue to do so for a while. The trade deficit also increased again to 2.7 percent of gross domestic product as imports increased faster than exports with 16.4 percent compared to 14.7 percent. And wage growth is meager, reflecting the continued job losses that are only partially offset by small wage increases.

The data show that economic stimulus efforts have helped the economy turn the corner. The policy attention now has to shift to creating a sustained, strong recovery that can bring back millions of jobs that were lost in the past 21 months. In the short-term, state and local government spending and the plight of the long-term unemployed are natural targets for additional public policy attention that can support the goal of a strong and durable economic recovery.

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