The financial crisis (Wall Street) spread to the real economy (Main Street) in the form of the recession we are currently experiencing. While the recession became noticeable in late 2008, it actually started much earlier. The National Bureau of Economic Research (NBER), which is the official arbiter of U.S. business cycles, dates the beginning at December 2007, yet there are signs of an economic slowdown as far back as early 2006.
Business cycles are easy to see in retrospect from the data. The broadest indicator of economic activity is real gross domestic product (GDP), which is the sum of consumption expenditure (C), investment expenditure (I), government expenditure (G), and expenditures on net exports (NX). Most recessions are caused by a decrease in total expenditure on domestic goods and services. Analysis of the data on changes in C, I, G and NX (see Table 1) enables one to see how economic activity in the U.S. (GDP) has slowed and actually decreased since the beginning of the economic turmoil. Negative changes are highlighted in light blue, while positive changes are highlighted in yellow.
The recession began in the housing market. This is a common feature of post-WWII US recessions, but in this case the cause was not tight monetary policy. Rather, it was the collapse of the housing bubble described in our analysis of the financial crisis. Investment growth in residential housing slowed to near zero in late 2005, before turning negative in the first quarter of 2006. The first quarter of 2006 saw a 3.6% decline, and another 16.6% drop in the second quarter. This double-digit negative slide has yet to come to an end. Residential investment posted a 22.8% decline in the fourth quarter of 2008 and a 32.8% decline in the first quarter of 2009. This acceleration is ominous as most recoveries begin where they started-in the housing market. It’s hard to see a sustained recovery occurring until the housing market stabilizes.
The decline in the housing market spilled over into the labor market in late 2007, as shown in the following two figures. The unemployment rate had bottomed out at 4.4% in October 2006, and remained at that level for fourteen months. It began rising in in December 2007, the same month that employment peaked.
The labor force (i.e. the supply of labor) peaked in October 2008. Over the next three months the labor force declined as ‘discouraged workers’ stopped looking for work and dropped out. Despite this offset, by May 2009 the unemployment rate had reached 9.4%, the highest it has been since 1983
Business investment followed investment in residential housing. Expenditure on equipment and software began a negative slide in the first quarter of 2008 that has continued on to a 33.5% decline in the first quarter of 2009. Investment in non-residential structures saw its first decline in the fourth quarter of 2008. Total investment expenditure is in free fall as of the first quarter of 2009, dropping by roughly 50%.
While consumer spending doesn’t usually precipitate a recession, since it represents seventy percent of total spending, and spending drives the economy in the short term, consumption plays a key role in the duration of recessions. Total Personal Consumption Expenditures began falling in the third quarter of 2008 with a -3.8% change which worsened to a -4.3% change in the fourth quarter. Looking at the components of consumption reveals that the majority of the decline occurred in Durable Goods which turned negative in the first quarter of 2008 and snowballed to -22.1% in the fourth quarter of 2008. The decline in durable goods likely coincides with the slide in spending on houses; when people stop buying new homes, they also spend less on appliances, home furnishings, etc. Non-durable Consumption has also declined beginning in the third quarter of 2008 with a -7.1% change and continuing into the fourth quarter at -9.4%. Non-durable consumption is largely a function of income. As GDP declined beginning in the third quarter of 2008, personal disposable income fell precipitously, bringing down non durable consumption for the next several quarters. The final component of consumption, Services, while dipping slightly negative in the third quarter of 2008 at -0.1% turned positive again in the fourth quarter of 2008 clocking in at 1.5%. Even a small negative decline in Services is a matter of concern as this area of consumption is generally the most resilient to economic downturns. One hopeful sign of recovery is that in the first quarter 2009, total consumer spending increased, driven in large part by 9.6% growth in consumer durable spending.
Despite the severe decline in the housing market, the US economy was kept afloat for nearly three years by growth in exports. During the period from the fourth quarter of 2005 to the second quarter of 2008, export growth averaged nearly 10% at an annualized rate. It was this growth that gave hope during late 2007 and early 2008 that the economy might yet dodge a recession. However as the recession became a global phenomenon, the world demand for American exports waned. In the third quarter of 2008, export growth slowed before dropping 23.6% in the fourth quarter. This drop accelerated in the first quarter of 2008, with another 28.7% decrease.
US import growth peaked in late 2005, turning negative in the fourth quarter of 2007, spreading the decrease in demand globally. As American consumption continues to weaken this also affects the import market, much of which is considered luxuries by Americans. Imports saw their first double-digit negative decline in the fourth quarter of 2008 at -17.5%. This decline has accelerated to nearly 40% in early 2009. While helping to move the US economy into recovery, declining imports increase the harm on the rest of the world.
US government spending has not played a large role in the current recession to date. State & local spending has declined as expected, likely a by-product of weakening tax revenues, especially in states that must keep a balanced budget. The net effect has been modest with total government spending growth averaging 2.7%. A substantial decline in federal defense spending in the first quarter of 2009 caused a noticeable 3.5% decline in total government spending. Hopefully, the effects of the federal stimulus package will become more apparent in the next few quarters.
[ next section: Why is this Recession So Serious? ]