Should the Fed Respond to 2011's Sub-1% Growth?

Even if the central bank wants to help, it may have a hard time finding the right justification to do so

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This morning we learned that the U.S. economy grew at an annualized rate of just 0.8% in the first half of 2011. That's terrible, by pretty much any measure. Surely, this isn't the recovery policymakers or economists were hoping for. While Washington isn't poised to do much for the economy as partisan politics threaten even the nation's debt rating, the Federal Reserve could. It has the delightful advantage of not having to really answer to anyone. If a majority of its Federal Open Market Committee members agree to provide monetary stimulus, it shall be done. Should the Fed act accordingly now that the recovery looks far weaker than most economists thought?

Projections vs. Reality

For starters, by how much will the Fed's GDP projections change? About a month ago, the central bankers predicted that 2011 GDP growth would be between 2.5% and 3.0%, with the central tendency between 2.7% and 2.9%. So let's say the average estimate was about 2.8%.

But at that time, they also thought that the first quarter's growth was 1.9%. If consensus estimates are any indication, they likely assumed that the second quarter's growth would be similar, if slightly lower. So they had always assumed the second half of the year would be stronger than the first half. If they had assumed that the growth rate would average 1.9% for the first two quarters, then the second half of the year would have needed to average 3.7% to achieve 2.8% growth in 2011.

That was a pretty optimistic assumption to begin with, considering that the second half of 2010 only grew at the rate of 2.4%. But now that we have a new estimate of 0.8% for first half growth, in order for their June projection to be correct, second half of GDP would have to be even higher. For 2011's GDP growth to come in at 2.8%, the second half will have to account for a growth rate of 4.8%.

The chances of growth suddenly swelling to 4.8% are virtually nil. The strongest growth rate we've seen since the recession ended in any single quarter was 3.9%, in the first quarter of 2010. In fact, in the last decade GDP has only been higher than 4.8% in two quarters -- Q3 of 2003 and Q1 of 2006. And remember, to hit the Fed's June projection, growth would have to average 4.8% for two quarters straight.

GDP Isn't Unemployment

So we'll almost certainly see the Fed lower their projections for GDP in their next round of estimates this fall. To expect much higher than an annualized rate of 2% at this time would be pretty optimistic. If the third quarter grows at the rate of 3% for the second half, then full 2011 growth would still be a little shy of 2%.

While this would -- and certainly should -- concern the central bank, it isn't an issue that its charter requires that it respond to. Its mandate is to seek full employment -- not strong economic growth. While the two generally walk hand-in-hand, unless employment begins to contract again or maintain its anemic growth in the months that follow, the Fed might not change its course.

GDP Is Just a Number

To be sure, the knowledge that the U.S. economy only grew at the pace of 0.8% in the first half of 2011 should please no one. But GDP is complicated. Consumer spending actually grew at a modest pace in the first quarter, though it slowed in the second. Business investment maintained modest strength in both quarters. And although net exports cut GDP in the first quarter, exports have been consistently expanding for two years. That just leaves the government, which has been a drag on growth for three quarters straight, mostly due to state and local spending cuts.

Presented by

Daniel Indiviglio was an associate editor at The Atlantic from 2009 through 2011. He is now the Washington, D.C.-based columnist for Reuters Breakingviews. He is also a 2011 Robert Novak Journalism Fellow through the Phillips Foundation. More

Indiviglio has also written for Forbes. Prior to becoming a journalist, he spent several years working as an investment banker and a consultant.

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