Even if the central bank wants to help, it may have a hard time finding the right justification to do so
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.
So the private sector certainly isn't booming, but it also isn't contracting. Ultimately, this is what should concern the Fed, not an aggregate measure based on a lot of complex variables. And yet, one of those variables is consumer spending. This should be the Fed's biggest worry: personal expenditures barely grew in the second quarter. And unless consumers spend more, businesses won't hire. So second quarter's weak spending numbers would indirectly affect the Fed's mandate to seek full employment.
But Can the Fed Really Help?
If the Fed does see employment growth threatened by the economic data we're seeing lately, should it act? If it were to do so, it would likely engage in more monetary stimulus, probably referred to as a third round of quantitative easing ("QE3"). Through the program, it would likely buy Treasury securities to keep down interest rates and hopefully boost investment.
This is the action it took during an 8-month campaign that began last November and ended in June. So three-quarters of the program took place in the first quarter of 2011 -- the same quarter during which the U.S. economy grew at the paltry pace of just 0.8%. Does this mean that QE2 failed miserably?
We can't know for sure, because we don't know what growth would have been without QE2. Perhaps the economy would have grown at an even lower rate -- or even contracted. We do know: the Fed's $600 billion asset purchase program didn't help the economy to achieve robust expansion in the first half of 2011. So even if the Fed wants to help, whether the central bankers are willing to admit it or not, they must have nagging doubts about the effectiveness of their stimulus at this point.
They've also got inflation to worry about. It has been up recently, and the Fed's dual mandate also stresses price stability. If the Fed worries that additional intervention could result in prices rising even more rapidly, then it might avoid more stimulus.
If you put all of this together, you likely render the Fed useless in promoting further economic growth. While it isn't likely to tighten monetary policy anytime soon, it will have a hard time justifying more expansion. GDP isn't enough to warrant more monetary stimulus, employment continues to grow at the very weak pace that the Fed appears content with, inflation has been rising, and the pathetic first half growth provides critics with more ammunition to shoot holes in the Fed's claims that its stimulus will help.
Without help from Congress or the Fed, Americans might just have to ride this one out on their own.
Image Credit: REUTERS/Frank Polich
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