Vital Signs: Is the Worst of the Recession Over?

On deck: GDP with revisions to previous years, new home sales, home prices, consumer confidence, durable goods orders, Beige Book, employment cost index

By James C. Cooper

The markets will have plenty of economic news to digest in the coming week, but the main course will come on Friday (July 31), when the Bureau of Economic Analysis releases its first estimate of second-quarter GDP. In addition, the BEA will issue extensive revisions to GDP and its components going back several years, the first so-called benchmark revision since 2003. The report is expected to offer evidence that the worst recession since the 1930s is very nearly over, and that a return to growth in the current quarter is very likely.

The sharp contraction in the economy that began in December of 2007, according to the National Bureau of Economic Research, appears to have moderated substantially last quarter. Economists expect real GDP to have declined between 1% and 2%, after plunging 5.5% in the first quarter and 6.3% in the fourth. The expected drop would be the fourth quarterly shrinkage in a row, something that has never occurred since quarterly data were first published in 1947.

Economists will be mainly interested in the breakdown of the GDP components, because of its implications for growth in the second half. In particular, business inventories are expected to have declined at a record quarterly rate, which would come after a record four-quarter liquidation. At the same time, overall demand also appears to have fallen for the fourth quarter in a row. Weakness in consumer spending, capital spending by businesses, and homebuilding more than offset positive contributions from net exports and government outlays.

Despite the ongoing weakness in demand, this outcome would actually be a plus for second-half growth. Overall output in the economy has fallen so far below total spending that some increased production will be necessary in order to slow the overly rapid depletion of inventories. This impetus will almost certainly push real GDP into positive territory in the third quarter, which might well mark the trough quarter for the downturn. If so, this recession will have lasted somewhere between 19 and 21 months, exceeding the 16-month downturns in 1973-75 and 1981-82.

The BEA's benchmark revisions—a revamping done every five years or so that includes new source data, new methods of calculation, and changes in definitions and classifications—will be of particular interest on at least two accounts. First of all, given the historically tight correlation between the unemployment rate and GDP growth, the sharp rise in the jobless rate suggests that the drop in GDP over the past year has understated the depth of the recession, suggesting the downturn will turn out to have been even deeper than the data now show.

In addition, historical revisions to retail sales, which are source data for consumer spending and have not yet been incorporated in the GDP numbers, suggest much weaker consumer spending over the past year. At the same time, the BEA has made a major attempt to capture underreported income using new information from the Internal Revenue Service. This combination of new data may well result in a significant upward revision to the personal saving rate. If so, households may have adjusted their finances more quickly than current data now show.

Here's the weekly economic calendar, from Action Economics:

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