Economic Commentaries

22

Delayed by the government shutdown, the Commerce Department reported this past week that real GDP grew 2.8% in the summer and that inflation was at a 1.9% rate. A surge of inventory investment boosted growth as final sales rose at only a 2% rate. Consumption and investment were especially weak while residential investment was strong.

Activity in September, the quarter’s final month, was especially soft for final demand and this spilled into October. The back to school selling season failed to materialize for retailers; motor vehicle sales dropped for a second month; and housing demand faltered despite a relapse in mortgage rates. Household demand is continuing to suffer from an absence of income growth. In the third quarter wage and salary income rose by only 0.5%. And in October hourly earnings rose only 2.2% year on year. Thankfully food and energy prices are easing so as to free up what little discretionary income exists.

Given this demand weakness we suspect retailers will be quite cautious in building inventory and in hiring workers for the coming holiday season. Thus, whatever boost inventory investment provided to the third quarter is likely to be taken back in the current quarter. The upshot is that while quarterly patterns can show deviations, the underlying trend of weak growth remains in place.

Low inflation remains in place as well. Japan has been fighting outright deflation for two decades without notable success. Inflation in Europe is dropping sharply even as the euro zone shows some economic stability. And in this country falling food and energy prices will exert significant downward pressure on the price indexes in coming months.

A decline in food and energy prices is a mixed blessing, helping households but hurting the energy and agriculture sectors. On balance it is a positive for the economy near term but the risk is that price weakness in these areas spills over to other sectors because of weak aggregate demand. Indeed used car prices are slipping and motor vehicle manufacturers are becoming more aggressive in pricing. With home demand softening and inventory re-emerging, price strength is easing back nationally and in some markets it is reversing. Were this to cumulate it would be very damaging to already weak consumer confidence.

Central Banks are doing their best to fight these deflationary trends, but Japan’s experience is testimony to the difficulty they face, especially when interest rates are already at the zero bound. To date financial markets have faith in the ability of Central Banks to achieve growth and price stability. And with Central Banks now signaling that they are willing to do even more and for longer to achieve these goals this faith may be unwavering. But with fiscal policies neutered and banking systems worldwide under the regulatory thumb, Central Banks will have to keep fighting an uphill battle. We should hope they eventually win.

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