- The Washington Times - Friday, May 4, 2007

The advance report of gross domestic product (GDP) during the first quarter provided a double whammy of concern. Not only did it reveal the economy had grown at its slowest pace in four years (an annualized rate of 1.3 percent), but it also reported that the price index for GDP last quarter jumped at the fastest annualized rate (4 percent) in 16 years.

Apart from consumer spending, which expanded at a stellar rate of 3.8 percent, much of the economy was in the doldrums. Led by an annualized 17 percent decline in residential investment, private domestic investment fell by an annual rate of 6.5 percent. The government component of GDP grew by less than 1 percent as spending on national defense declined at an annual rate of nearly 7 percent. Exports fell by 1.2 percent and imports increased by 2.3 percent, the effect of which was to reduce GDP growth by nearly four-tenths of a percentage point.

Private fixed investment, which includes residential investment and business investment in plant and equipment, has now declined four quarters in a row. During the past year, residential investment has declined by 17 percent. After falling a worrisome 3.1 percent in the fourth quarter, business investment increased in the first quarter, but it remained below its third-quarter level.

The economy has become increasingly dependent on consumer spending. While inflation-adjusted GDP has increased by $233 billion during the last four quarters, consumption has advanced by $270 billion. In effect, the increase in consumption has accounted for more than 100 percent of economic growth over the last year. A significant portion of the growth of consumption in recent years has been financed by mortgage equity withdrawals as consumers have tapped their soaring home values to help finance their consumption outlays. Personal saving, meanwhile, has now declined eight quarters in a row as personal outlays (which includes nonmortgage interest payments) have consistently exceeded disposable personal income. Before this recent two-year trend, personal saving had not been negative since the Great Depression.

During the first quarter, personal consumption expenditures accounted for 71.6 percent of GDP. During the 2003-06 period, consumption comprised an average of 70.9 percent of GDP, which was more than 3 percentage points higher than consumption’s 67.8 percent average share of GDP that prevailed during the 1997-2000 period. As home values have stabilized (or declined in some markets), mortgage equity withdrawals may no longer be available to finance as much consumption as they have in the recent past. If consumption falters while business investment remains relatively subdued, last quarter’s slowdown may be fondly recalled as “the good old days.”

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