Happy New Year!

Happy new year ? What do you mean – it is February. Are you talking about the Chinese New Year? No – you mean that we need to celebrate that the latest great depression has ended, right? Well the numbers are showing the start of a turn around, aren’t they? That is certainly good news but unfortunately, there is still a long way to go. Are you confused as to what the numbers mean and when we will be back on a normal trend? Please read Bill Woolsey’s article below to find out his thoughts on our current economic situation.

By Bill Woolsey, Special Economic Correspondent of The Free Enterprise Foundation

Evidence continues to build that the Great Recession ended in the fall of 2009. Fourth quarter GDP increased at a 5.7 percent annual rate. The January unemployment rate decreased to 9.7 percent. Real GDP measures the real volume of goods and services produced in the U.S.—consumer goods and services, capital goods, and government goods and services. The preliminary estimate for the 2009 fourth quarter was $13,155 billion. If prices were back to 2005 levels (about 10 percent lower than today) and production continued for an entire year like the last three months of 2009, then $13,155 billions worth of goods and services would have been produced.

The fourth quarter real GDP increased $182 billion or 1.4 percent from the third quarter. If production continued to rise at that rate for an entire year, then it would be up 5.7 percent. This is the second quarter with an increase in real GDP. The third quarter figure was $12,973 billion, which had increased at a 2.2 percent annual rate from the second quarter. The trough, or low point, for real GDP for the Great Recession looks to have been $12,901 billion, in second quarter 2009. That is 3.8 percent below the peak in second quarter 2008 of $13,415. Already, output has risen 2 percent above its low point.

Unfortunately, there is still a long way to go. Real GDP needs to increase another 2 percent to return to its past peak. But more importantly, it should have been growing all along. Real GDP is currently 9.57 percent below its 3 percent trend growth path. Even if real GDP were to continue to grow at an annual rate of 5.7 percent, it would take several years to return to trend. However, the Congressional Budget Office’s estimate of the potential output of the economy shows that approximately 1/3 of the decrease in output is due to lower productive capacity. Worse, they forecast slow growth in productive capacity for the next decade, with real GDP being 15 percent below its long run trend by 2019. Sadly, this may be realistic, since the current administration appears committed to adopting the policies of other “advanced industrial democracies.” The Germans and French are about 15 percent poorer than Americans. We have to “catch up” somehow.

Leaving aside this bleak long run projection, what about the short run? Will real GDP rapidly rise to close the current 6.2 percent shortfall from the CBO estimate of productive capacity? At current rates of growth, that gap could be closed in 18 months. Unfortunately, there is a problem. While the output of goods and services increased by 5.7 percent, most of that was an accumulation of unsold inventory. Firms produced more than they sold. The real volume of final sales of domestic product only increased at a 2.2 percent annual rate.

A rapid increase in inventory can be very worrisome. If firms were producing goods they planned to sell, and were surprised by slower than expected sales, output might fall sharply in the future. There is some evidence, however, that firms had sold more than expected in the third quarter, and much of the buildup in inventory in the fourth quarter was rebuilding to normal levels. While a rapid reversal in production is unlikely, future increases will be limited by the real growth in sales. If future growth of real GDP is no more than 2.2 percent, the gap between the production of goods and services and the capacity of the economy will never close.

What about employment? The good news was the decrease in the unemployment rate to 9.7 percent from the 10 percent rates in both December and November. While it is still possible that unemployment will rise again over the next few months, it is looking more and more likely that the peak unemployment rate for the Great Recession will be the 10.1 percent rate in October.

The unemployment rate measures the proportion of the labor force that is actively looking for work. The labor force includes the employed and the unemployed. What has happened to employment? In January, total employment was 138 million. That was an increase of 541 thousand from December, a 4.7 percent annual rate. The annual growth rate of employment during the Great Moderation was only 1.4 percent, so employment is recovering nicely.Unfortunately, there is a long way to go. Employment remains nearly 5.5 percent below its peak value in January of 2008. There are 8,088,000 fewer people working today than when the Great Recession began. This is not the number of people who lost their jobs during the recession. Many more people lost their jobs. And many people quit. And many people were hired. This is the difference between the number of new hires and separations—quits, firings, and layoffs.

More importantly, if employment had continued to grow at its trend of the Great Moderation, it would now be 152 million. Unemployment remains nearly 9.7 percent below its long term trend. Even if employment consistently grew at current rates, it would take several years to return to long term trend, and for unemployment to fall back to something close to pre-recession levels.

The GDP deflator, which measures the prices of consumer goods, capital goods and government goods, (rather than just the consumer goods measured by the Consumer Price Index,) grew at a .6 percent annual rate in the fourth quarter of 2009. Prices are about 1.5 percent below the long term trend of 2 percent.

While it is good news that the economy has begun to recover, I still think that a new policy is appropriate. I continue to call for the Fed to begin targeting nominal spending in the economy—$16.2 trillion dollars for the first quarter of 2011. While an 11 percent spending increase over little more than a year is significant, real output and employment have a long way to go before the economy isn’t just recovering, but will have finally recovered.

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Copyright © 210 by William Woolsey and The Free Enterprise Foundation. All rights reserved

About the author: Professor William Woolsey is a member of The Free Enterprise Foundation's editorial staff and senior writer on national economy reporting. Dr. Woolsey is a distinguished Professor of Economics in the Citadel’s School of Business Administration and a former Libertarian candidate for Congress. Professor Woolsey, a regular contributor to The Mercury is a professor of economics in the School of Business Administration at The Citadel and a former Libertarian candidate for Congress.

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