Bill McBride on private domestic investment

Bill McBride offers:

A little holiday cheer …

Discussions of the business cycle frequently focus on consumer spending (PCE: Personal consumption expenditures), but the key is to watch private domestic investment, especially residential investment. Even though private investment usually only accounts for around 15% of GDP, the swings for private investment are significantly larger than for PCE during the business cycle, so private investment has an outsized impact on GDP at transitions in the business cycle.

The first graph shows the real annualized change in GDP and private investment since 1960 (this is a 3 quarter centered average to smooth the graph).

GDP has fairly small annualized changes compared to the huge swings in investment, especially during and just following a recession. This is why investment is one of the keys to the business cycle. (Worth a visit to view the graphs)

The key downside risk for the US economy in 2013 is too much austerity, too quickly. However, barring a policy mistake (I expect a fiscal agreement), it seems unlikely there will be a sharp decline in private investment in 2013. This is because residential investment is already near record lows as a percent of GDP and will probably increase further in 2013, and that suggests the US will avoid a new recession in 2013.
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