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Output Growth Likely to Rebound Amid a Healthy Labor Market

June 23, 2014 · Update in PDF PDF

Economic indicators released in May and June present a picture of modest growth so far in 2014. In its second estimate, first-quarter output growth fell further from an already tepid advance estimate. Indicators reflecting current economic activity signal a rebound for the second quarter. Employment was positive in the transition from April to May, continuing to show gains and rising above its prerecession peak. Meanwhile, the unemployment rate remained unchanged but at its lowest point since September 2008. Inflation showed acceleration in several measures.

Output Contracts in Latest Release

Real gross domestic product (GDP) contracted at an annualized rate of 1 percent in the first quarter, based on the Bureau of Economic Analysis’ second estimate (Chart 1). This represents a sharp decline from the first estimate of a 0.1 percent increase and is well below the recovery average of 2.4 percent. Among major components, real personal consumption expenditures (PCE) was the lone positive contributor, adding 2.1 percentage points to real GDP growth.

Negative contributions (0.2 percentage points each) from residential and nonresidential fixed investment were expected due to unusually harsh winter weather early in the quarter. Private inventory, a volatile component, saw the largest decline at 1.6 percentage points. The decline is not surprising considering that the component has contributed strongly to growth the past few quarters and that such behavior is historically followed by a negative contribution.

Net exports, another volatile component, shaved off 1 percentage point from overall growth following a strong positive contribution in the fourth quarter. Government spending was less of a drag, subtracting 0.2 percentage points, compared with a full percentage point the quarter before.

Labor Market Follows Moderate Course

The payroll survey showed improvement in labor market conditions (Chart 2). Total nonfarm employment grew by 217,000 in May. Private sector nonfarm payrolls increased by 216,000, while the government sector added 1,000 jobs. Since the start of 2014, nonfarm payroll gains have averaged 214,000 per month.

According to the household survey, the unemployment rate held at 6.3 percent. The labor force participation rate was unchanged at 62.8 percent. Real average hourly earnings for production and nonsupervisory employees fell for the second straight month at an annualized monthly rate of 2.68 percent.

In addition to employment and unemployment figures, data on the efficiency of the labor market offer clues to the health of the job market. One way to determine this is to examine the degree of labor mismatch occurring. The classic illustration expressing mismatch is the Beveridge curve. The curve shows an intuitive relationship between the rate of vacancies and unemployment: A higher rate of unemployment usually occurs with a lower rate of vacancies, along with the reverse.

The recovery’s pattern has shown that for a given vacancy rate, the unemployment rate is higher than what would have been the case prior to the recession (Chart 3). The latter observation means a less efficient labor market for the recovery since the same vacancy rates correspond to higher levels of the unemployment rate. However, this isn’t abnormal in recoveries.[1] Beveridge curves tend to follow a counterclockwise loop once a recession hits. Hence, the current relative inefficiency (the ability or inability of workers to be paired with firms) shown in the data is typical of past recovery movements.

Another way to examine the mismatch is the distribution of labor demand and supply among firms. In other words, to what extent are some firms having more difficulty finding workers than others? If there are significant differences across firms, the result should be a significant disparity in wage growth. With the latter in mind, an analysis across 190 industries was done to find the typical deviation from mean wage growth (Chart 4).[2] As the chart shows, under this wage-based approach, labor mismatch appears no more significant now than it was during a good portion of the prerecession years.

Inflation Measures Accelerate

Several measures of headline and core inflation accelerated in the latest readings. Headline Consumer Price Index inflation rose on a 12-month basis to 2.1 percent in May following a 2.0 reading in April. Headline PCE inflation was 1.6 percent in April on a 12-month basis on the heels of a 1.1 percent reading in March.

After establishing a year of low, stable rates, core measures finally jumped (Chart 5). Movements in core rates are useful in forecasting their headline counterparts. For PCE, the latest observations suggest a headline rate of 1.6 percent over the next 12 months.

A couple of factors explain the rise in inflation in April’s data. First, all of the indexes shown in Chart 5 experienced steep drops in April 2013 due to a number of causes, including sequestration of Medicare reimbursements. Consequently, these lower levels had been pulling down the 12-month rates until the April data came in. Second, though less impactful, there was acceleration in recent one-month rates.[3]

Signs Point to Improved Second-Quarter Output Growth

More current data on output growth have been positive. The Institute for Supply Management (ISM) nonmanufacturing business activity subindex climbed in May to 58.8 following a rise in April. Given that the index has been strongly positively correlated with real GDP growth in the past, these increases portend a rebound for output growth in the second quarter.

In addition, ISM manufacturing index readings (55.4 in May, up from 54.9 in April) and the ISM new orders subindex (56.9 in May, up from 55.1 in April) indicate stronger economic activity.

Private forecasts are consistent with improvement, with the Blue Chip consensus projecting 3.7 percent growth (seasonally adjusted and annualized) in the second quarter and 3.1 percent for the second half of the year.

—Alan Armen

Notes
  1. See “Why has the U.S. Beveridge Curve Shifted Back? New Evidence Using Regional Data,” by Robert G. Valletta, Federal Reserve Bank of San Francisco Working Paper no. 2005-25, December 2005.
  2. For each industry, wage growth is the 12-month growth in average hourly earnings. The measure of dispersion is the standard deviation of wage growth across industries as a percent of the mean wage growth. See http://mathworld.wolfram.com/StandardDeviation.html.
  3. “Behind the Numbers: PCE Inflation Update, April 2014,” by Jim Dolmas, Federal Reserve Bank of Dallas, www.dallasfed.org/research/pce/2014/pce1404.cfm.
About the Author

Armen is a research assistant in the Research Department at the Federal Reserve Bank of Dallas.

 

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