The White House and Congress keep going back and forth with the hope of reaching some kind of agreement that will remove the automatic spending cuts and tax increases scheduled to go into effect Jan. 1. But consumers and financial markets don’t seem to see much risk.
Perhaps we aren’t facing a cliff after all. Maybe we should just roll over this economic hill and see what happens.
The Department of Commerce recently reported that real gross domestic product, which measures the output of goods and services produced in the United States, increased at an annual rate of 2.7 percent in the third quarter of 2012, up from the original estimate of only 2 percent. A good part of the increase in the growth rate, however, was an increase in federal government spending for military items. This military spending is likely to be a one-time boost to GDP, especially with actions in Afghanistan winding down.
What is surprising in the report is the resilience of consumer spending. The political back-and-forth of Washington politics doesn’t appear to be scaring shoppers.
GDP is measured by counting up expenditures in four main categories — personal-consumption spending, gross private domestic investment, net exports of goods and services, and government expenditures. Personal-consumption expenditures account for more than 70 percent of overall GDP, and in the third quarter of 2012 this spending rose 1.4 percent.
Households are also increasing their spending on big-ticket items. Purchases of durable goods, which include refrigerators, automobiles and mobile phones, increased 8.7 percent in the third quarter of 2012, in contrast to a decrease of 0.2 percent in the second quarter.
Despite still-high unemployment and record numbers of households on food stamps, consumers keep going to the store. Survey evidence says consumer confidence is low, but this lack of confidence is not holding them back. U.S. consumption is 12 percent higher than before the recession started in late 2007 and 3.2 percent higher after adjusting for inflation.
Consumers may not be able to keep this up. Real GDP growth of 2.7 percent per year may still not put enough people back to work. The Congressional Budget Office estimates that third-quarter real GDP should have been $14.5 trillion, but the U.S. economy is producing only $13.6 trillion of goods and services, a 6 percent gap. We may be growing, but we need to pick up the pace.
The output gap is likely holding down stock prices, even though volatility in the market is low. The stock market also doesn’t appear to be scared by the fiscal cliff or any other economic tragedies to come.
Overall risk or uncertainty in the stock market is measured by what is known as the Fear Index. The CBOE Market Volatility Index is a measure of stock-option trading from the Chicago Board Options Exchange. The VIX is now around 16 percent, well below the long-run average of 20 percent.
In summer 2011, the VIX spiked to over 40 when Congress and the White house were arguing over the debt limit. But the crisis doesn’t seem to be bothering stock investors. Even gold prices are more stable than in past years.
One explanation for the lack of concern in the financial market is relatively low inflation. Inflation, as measured by the consumer price index, is higher than in the past three years, but still in what policymakers consider an acceptable range.
The U.S. Bureau of Labor Statistics reported that consumer inflation rose 2.2 percent in September over the previous 12 months. This is down from nearly 3 percent at the start of the year but higher than an average of 1.5 percent for 2009 to 2011.
Here in the West, we may not be feeling the pinch of inflation as much as the rest of the nation. The CPI for consumers in western cities with a population base the size of the Boise Valley rose at an annual rate of only 1.5 percent. Our area is experiencing lower energy costs, and housing prices are just now catching up with the rest of the nation.
So why worry?
With consumers keeping up the spending pace, stock prices holding steady, and inflation relative tame, perhaps there is nothing of which to be afraid. Washington should take note and let the economy go over the fiscal cliff.
While the higher tax rates and less government spending will slow the economy somewhat, at least we can all just get back to our lives.
Peter Crabb, professor of finance and economics at Northwest Nazarene University in Nampa. email@example.com