GDP falls, deflation looms

The new 4th quarter figures from the BEA are so shocking not because they are surprising, but because one couldn't quite believe one's own expectations:

The U.S. economy contracted at a 3.8% annualized rate in the fourth quarter but the decline would have been worse except that the government counts an unwanted buildup of goods on store shelves as growth.

A clearer picture of the scope of the weakness in the fourth quarter, which excludes the inventory buildup, contracted at a 5.1% pace, the weakest in 28 years.

Even with inventories, the growth rate is the worst since 1982.

. . . 

The economy has grown just 1.3% in the past year, the weakest growth rate since 2001.

The business cycle committee of the National Bureau of Economic Research said the recession began in late 2007. But this is the first two quarter decline in GDP.

Consumer spending fell 3.5% in the fourth quarter after a 3.8% drop in the third.

Of course, last quarter had a massive financial contraction.  But the real resetting of expectations downwards is just taking place now, as layoffs hit and people begin to emotionally grapple with the fact that it's not temporary.  I'm more pessimistic than most commenters about the possibility that we will emerge from the mire to any great extent over the next two quarters.

Especially not because we are apparently now eye-to-eye, toe-to-toe with deflation:

There was a sea-change in the inflation picture. The core price index (excluding food and energy) retreated to a 0.6% annual rate in the fourth quarter from 2.4% in the third, leaving the annual rate at a 2.2% gain.

But headline consumer inflation fell at a 5.5% annual rate, the biggest drop on record.

Given the drop in inflation, real disposable income rose 3.3% annualized in the fourth quarter, after falling 8.8% in the third quarter. The savings rate was 2.9% in the fourth quarter, up from 1.2% in the third.

This is one of the little ironies of a severe, deflationary recession:  they actually increase the real income of most wage earners, because wages are sticky downwards.  In strictly material terms, the Great Depression probably increased the purchasing power of people who were in work.  It's just that it did so at the expense of a great deal of suffering on the part of the unlucky 20%, and the pervasive fear everyone else experienced.  We'll probably see much the same over the next few years:  if you can keep your job, it will become easier to buy a house, pay for fuel, go on trips.  But no one is going to want to do any of these things, because they're too afraid of losing their jobs.

As a friend, another journalist, just told me, "I am slightly concerned that everything, here and around the world, really may go to some serious [expletive deleted] this year".

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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