Slow-Growing But Solid

What is the bottom line for the U.S. economy?

My forecast calls for U.S. Gross Domestic Product to rise by 3.2 percent in 2006, and by 2.7 percent in 2007. For an expansion that is getting a little long in the tooth, those are very solid numbers.

After all, the expansion is already more than 52 months old, which is the average length of the eight expansions we have experienced in the post World-War II era (1945-2001). But the projected year-over-year percentage increases in GDP are smaller than both the 3.5 percent increase reported for 2005 and the 4.2 percent gain reported for 2004.

There are two main reasons why I believe the pace of GDP growth will slow rather than hold steady or accelerate: First, I am absolutely convinced that activity in the housing market will diminish.

Second, I believe that slower growth in consumer spending lies immediately ahead, despite the strong start this year. This deceleration in consumer spending will be heavily concentrated in spending on goods, such as new automobiles, home-related items including furniture and appliances, and discretionary items such as clothing and eating out.

In most product categories, I am only talking about slower growth in spending, but in the case of new cars, I expect a sharp — outright — drop in spending rather than just smaller percentage gains. That doesn’t bode well for Ford and GM’s recently announced restructuring plans.

Why the slowdown in consumer spending? One reason is my expectation that both long- and short-term interest rates will increase. Another is that by almost any measure households already are overextended.

Put those two factors together and a slowdown is almost inevitable. The household debt service ratio, the ratio of debt payments to after-tax personal income, is in uncharted territory — reaching an all-time high of 13.9 percent in the second half of 2005. If you add in automobile lease payments, rental payments on tenant-occupied property, homeowner’s insurance and property tax payments you get a financial obligations ratio that was 18.7 percent in the final quarter of 2005. That’s also an all-time high.

To find still more evidence of household extravagance, look at the household savings rate. It was -0.4 percent in 2005, the first year since the Great Depression of the 1930s that households actually dipped into their wealth to fund current consumption.

Undoubtedly, many households rationalized this extravagance based on heady increases in household’s net worth. Household net worth increased by 8 percent in 2005, buoyed primarily by the increased value of real estate assets, which rose by more than 15 percent.

In the face of puny gains in wages and salaries, households increasingly opted to boost current spending by extracting wealth from their appreciating homes; this was facilitated by historically low mortgage rates. This window is closing rapidly because net worth will rise by only 5 percent in 2006-07. If you combine mid-single digit gains in net worth with rising short- and long-term interest rates, taking out a reverse mortgage to finance current consumption suddenly becomes much less appealing.

The upshot is that people will actually begin to save a small portion of their current incomes, although households will not come anywhere close to the 5 percent average of the 1990s or the 9 percent average of 1961-1990. But the savings rate should reach 1 percent by late 2007 or early 2008.

Several factors will work to keep GDP expanding; this is why the growth slowdown won’t be too dramatic. These supports will keep the risk of outright recession in 2006 or 2007 very, very low. Four supports I am counting on to partially offset the reversal of housing markets and the slower growth in consumer spending are: businesses’ robust spending for capital equipment; higher outlays for nonresidential construction; higher spending by state and local government; and solid growth in U.S. exports.

The jobs outlook is fairly good, and is another reason I believe the slowdown in consumer spending will be gradual. In 2006, total nonfarm employment will expand by 1.4 percent, only slightly lower than the 1.5 percent gain the nation posted in 2005. This solid but not overwhelming gain will be sufficient to keep the unemployment rate from rising and to ensure some acceleration in wage growth.

Dr. Jeffrey M. Humphreys is director of the Selig Center for Economic Growth at the University of Georgia’s Terry College of Business. E-mail him at

Categories: Economic Development Features, Features