Worst May Be Over But Economy Won't Recover Until 2010


Yes, OK, the worst may be over, says Harvard professor Martin Feldstein.  But don’t go hallucinating that this means it’s going to be all champagne and roses from here.

GDP might actually climb back toward zero in Q2, Feldstein says.  But that’s because the stimulus will add an annualized 6% growth.  Take that away, and we’re right back where we started.  And we are going to take that away, when the stimulus ends.

Feldstein doesn’t see real growth starting again until 2010, if we’re lucky.

[M]y reading of the evidence does not agree with that of those who claim that the economy is actually improving, and that a sustained cyclical recovery is likely to begin within the next few months. Although the stimulus package of tax cuts and increased government outlays enacted earlier this year will give a temporary boost to growth, we are unlikely to see the start of a sustained upturn until next year at the earliest.

The optimists back their claims of an earlier recovery by pointing to a variety of statistics. They note that construction activity is rising, home prices are declining more slowly, disposable personal income increased in the first quarter, consumer spending is up, and the labour market is improving.

But a careful look at these data is less reassuring. In each case, the details do not support what the headline number appears to indicate… [Details here >]

But, although the recent news is not as encouraging as some have claimed, I expect that the next few months will see some real improvements that will reduce the rate of overall economic decline, or even produce a temporary rise in the GDP growth rate, owing to the Obama administration’s fiscal stimulus measures.

The stimulus package will add about $60 billion to overall GDP during April, May, and June, or roughly 1.5% of quarterly output. But when the GDP figures for the second quarter are reported later this summer, the government’s statisticians will annualize the 1.5% increase and add 6% in calculating the annual growth rate. If economic activity apart from the stimulus package is continuing to decline at nearly the 6% annual rate that was recorded in the last two quarters, the temporary boost from the stimulus package will suffice to make the overall GDP change close to zero or even positive.

But the key thing to bear in mind is that the stimulus effect is a one-time rise in the level of activity, not an ongoing change in the rate of growth. While the one-time increase will appear in official statistics as a temporary rise in the growth rate, there is nothing to make that higher growth rate continue in the following quarters. So, by the end of the year, we will see a slightly improved level of GDP, but the rate of GDP growth is likely to return to negative territory.

The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery.

Read professor Feldstein’s whole argument here >

See Also: The Worst Is Over For The Economy

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