Home > Recession, The Economy > Double-Dip Recessions and the Strange Tale of Final Demand

Double-Dip Recessions and the Strange Tale of Final Demand

from Dean Baker

The 2.4 percent GDP growth figure reported for the second quarter caused many economists to once again be surprised about the state of the economy. It seems that most had expected a higher number. Some had expected a much higher number. It is not clear what these economists use to form their expectations about growth, but it doesn’t seem that they have been paying much attention to the economy. For those following the economy, a weak 2nd quarter growth number was hardly a surprise. 

As a basic way to assess growth economists often separate out final demand growth from GDP growth. The difference between GDP growth and final demand growth is simply inventory accumulation. If the rate of inventory accumulation accelerates then GDP growth will exceed final demand growth. If the rate of inventory accumulation slows, then GDP growth will be less than the rate of final demand growth. If there is no change in the rate at which inventories are accumulating, then GDP growth will be equal to final demand growth. 

The economy has been going through a classic inventory cycle in the last five quarters. Inventories had been shrinking rapidly in the 2nd quarter of 2009. This is standard in a recession as firms look to dump a backlog of unsold goods. Inventories shrank less rapidly in the 3rd quarter, which means they added to growth. Inventories started growing again in the 4th quarter, and growing rapidly in the first two quarters of 2010. Inventories added considerably to growth in these quarters, making GDP growth considerably more rapid and erratic than the growth of final demand.

The growth in final demand over the last four quarters has been very even and slow. It has averaged 1.2 percent over this period with a peak growth rate of 2.1 percent in the 4th quarter of 2009. Growth was just 1.3 percent in the most recent quarter.

The numbers of final demand should be of great interest since it is unlikely that inventories will provide any substantial boost to growth in future quarters. The second quarter rate of inventory accumulation was already quite fast, so future inventory figures are as likely to come in lower as higher. This means that GDP growth over the next few quarters is likely to be close to the rate of growth of final demand.

This should have policymakers very worried. There is no obvious reason that final demand growth will increase from the 2nd quarter rate and several important factors that will push it lower. 

The most obvious factor depressing growth will be the cutbacks by state and local governments that are trying to cope with huge budget shortfalls. A second factor is the winding down of the stimulus. Stimulus spending will stay near peak levels in the 3rd quarter, but will start to wind down in the 4th quarter of 2010 and the first quarter of 2011.

Perhaps the biggest factor depressing growth will again be the housing market. A flurry of sales of homes due to the expiring tax credit helped boost GDP in the second quarter. While the sale price of an existing is not counted in GDP, the fees associated with the sale are counted. The uptick in sales in the second quarter added 0.5 percentage points to GDP. The drop in sales will subtract at least this much from GDP in the 3rd quarter.

More importantly, house prices are falling again, possibly at a rapid pace. This will convince homeowners that the bubble is not coming back and likely lead to a further decline in consumption. (The deficit hawks’ pledges to cut Social Security and Medicare may also lead to lower consumption since they may convince people of the need to save more for retirement.) 
In short, we are looking at a situation where the trend GDP growth rate going into the second half of 2010 is around 1.5 percent, with several factors likely to push it lower. This is a context in which the economy is likely to generate few if any jobs and almost certainly not enough jobs to bring down the rate of unemployment rate.

Getting the economy growing at a more rapid pace will require another round of stimulus from the government. This will require overcoming a massive amount of superstition, as well as pure political obstructionism. However, the first step is recognizing that the economy is not on a healthy recovery path and that something needs to be done. The second quarter GDP report should be enormously helpful in convincing people that everything is not all right.

See article on original website

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy. He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues.

  1. August 5, 2010 at 3:48 pm

    I think that the problem with ongoing stimulus spending is that a lot of the money finds its way into the speculative economy and is used to leverage even more debt.
    The painful solution is to clean up the financial system from top to bottom and that takes enormous political will.
    Given the ownership of the mainstream media by the vested financial interests, the kind of political momentum needed can only come out of a lot of anger and pain.
    Regrettably, we are more likely to sink into a kind of third world situation with a sharp rise in organized criminality like Mexico has.

  2. August 5, 2010 at 4:52 pm

    It is the repetition of the error committed during the 1929 crisis:the stimulus to animate the economy in recession stopped earlier than needed as in our case . It is a pity that Keynes has been forgotten and the domination of neoliberals is almost complete, despite the fact that their fanatic ideology has provoqued the actual crisis.

    • Simon
      August 7, 2010 at 6:33 am

      Maria- I cant agree with your point that Keynes has been forgotten. There has been the greatest stimulus in history. Keynes is misunderstood not forgotten IMHO.

  3. Alice
    August 6, 2010 at 11:55 am

    The painful solution to this mess that no-one hasb on on their economic agenda is to curtail the globalisation of banks and capital and to keep their activities at home (and paying income tax). It will come…eventually, one day…or there wil be more financial crises yet until it is necessary.
    Free goods and services for gloabisation as much as possib;e but keep your banks at home (Keynes).

    We dont learn.

  4. larry martin
    August 8, 2010 at 3:56 pm

    I remember Keynes quite well. He argued quite rightly that gov’t. surplus during the good tines be applied to preventing business cycles from bottoming out national economies during down times – even allowing a little debt so long as its ultimately balanced out. The problem is that the US/West has allowed the hollowing out their income/tax producing sectors and their gov’ts. no longer have surplus – ever. What is there in the kitty to now apply to taking the edge off our downside? more debt with “financial easing? Some will argue that is preferable to the economy without economic stimulation. However, that is a different argument than invoking Keynes. He had his time, now he’s not really applicable(though Alice has it right – above). Its the new economy – such as it is, get used to it.

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