Who is Holding the Economy Back

[Havakasha]

Who is holding the economy back?
By Ezra Klein


Grim GDP news today: We had thought that the GDP grew in the fourth quarter of 2010 by 3.2 percent. We were wrong. According to the revised data released today by the Commerce Department, growth was closer to 2.8 percent. As you can see on the graph above, that's back in "normal" territory. But normal territory isn't good enough after a deep recession. We need better than normal. Much better than normal. And we almost had it. But for two factors, growth would've been at or above seven percent.

So, who's holding us back? First, the government. But not in the way you might think. The problem isn't that we're spending too much but that, in an effort to cut deficits, we -- particularly state and local governments -- are spending too little. The federal government's spending dropped by 0.2 percent, but state and local spending dropped by 2.4 percent. The gross domestic product is essentially a measure of people buying and investing in things. When the government cuts back on its purchases and investments, it's the same as a substantial portion of the population cutting back on its investments and purchases.

The other major headwind was private inventories. "Private businesses increased inventories $7.1 billion in the fourth quarter, following increases of $121.4 billion in the third quarter," the Commerce report said. That's bad for this GDP number. How bad? If you remove the private inventory data, we would have grown at almost seven percent last quarter, and everyone would be celebrating.

But perhaps we'll be celebrating soon. Consumer spending was strong, and so were exports. Businesses are going to have to add to their inventories going forward. If the data that's healthy in this report stays healthy, if the government can avoid premature austerity measures, and if businesses begin adding to their inventories, the next report should look pretty good. But that's a lot of ifs. And watching the states slash their budgets and Congress talk about how much it can cut during the remainder of 2011, it seems certain that government spending cuts, at least, will continue to be a drag on the economy through the rest of the year.

[SiriuslyLong]

Like we discussed yesterday, if government spending is the only thing keeping this economy afloat, we're in trouble. What we've built might very well be a house of cards.