A Fading Recovery

Today’s new economic data fit into the larger picture of an economy that is noticeably losing steam. In the graph below I’ve presented the 3-month annualized rate of change in core consumer prices and industrial production, including today’s data. I’ve also included two other data series that reveal important clues about the health of the economy, retail sales (deflated by the CPI) and employment. The four are unanimous, and together they provide a nice illustration of what a slowing recovery looks like.

After a nice boost to the economy starting late in 2003 (and led by strong tax cut-fueled retail sales), all four indicators show that growth peaked around April or May and is now slowing.

This may be only a temporary pause in the recovery, but there are some good reasons to think that it may not be. As I discussed last week in a couple of posts, the problem is simply that there is no sector of the economy that can significantly boost demand right now. Given that, the recovery may well have already run its course. And so far, the data is consistent with this interpretation.

What can be done about it? At this point, unfortunately, it’s a bit late for the most effective economic medicine: an appropriate fiscal stimulus in 2002 or early 2003. The Bush administration squandered their fiscal ammunition on a tax cut for the wealthy that did little for the economy other than to cause a temporary spike in retail sales last summer.

Another fiscal stimulus at this point would have to be very carefully designed to be effective. It would have to be explicitly temporary, to avoid spooking the bond market and driving interest rates higher. The tax cuts would have to be directed toward the middle class, and spending increases would probably be most effective if the federal government distributes the money to state and local governments to spend.

Other changes to economic policy would help the recovery, too. An administration with credible and serious economic policy-making might reassure businesses about medium-term economic growth. And some long-run fiscal contraction (e.g. tax increases and spending cuts over the period 2-4 years from now) would help push real long-term interest rates down and encourage optimism about prospects for economic growth, also stimulating investment.

Obviously, neither of these is going to happen under the current administration. But that makes this just another reason to remove it from office.