The surge in spending this summer results from the combination of the natural working of the inventory cycle and the bags of cash Washington is dropping on the economy for fiscal pump priming.  The pump priming includes part of the stimulus plan – highway work, checks mailed to tens of millions of people and large subsidies to state governments – as well as “cash for clunkers”, $8,000 for home down-payment assistance, and billions to forgive mortgage payments.

The largest GDP impact of this spending is in the summer quarter because spending is so much higher than in the spring quarter. Spending will be higher yet in the fall but the change from the previous quarter and hence the boost to GDP growth will be smaller.

The surge in spending this summer results from the combination of the natural working of the inventory cycle and the bags of cash Washington is dropping on the economy for fiscal pump priming.  The pump priming includes part of the stimulus plan – highway work, checks mailed to tens of millions of people and large subsidies to state governments – as well as “cash for clunkers”, $8,000 for home down-payment assistance, and billions to forgive mortgage payments.

Inventories plunged in the winter and spring as manufacturers cut production below current consumption and met much of their orders by reducing the excess inventory accumulated last fall after the unexpected onset of a deep recession. Inventory reduction was the major contributor to 5% plus GDP decline in the first half of the year. But this summer, inventory reduction slowed and production increased.  Inventory reduction will have a much smaller negative impact on GDP growth.

During the fall quarter and for much of next year, the smaller change in inventory from quarter to quarter mean that the inventory contribution to GDP growth will be progressively less.

Sustainable economic growth without the temporary factors is now in the 0-1% range. It will gradually rise to about 2.5% by the end of next year. This sub-par growth is the consequence of less credit available for lending after the huge loan defaults suffered by lenders in 2009-09, more cautious, more risk adverse lending and the diversion of $trillions to new federal spending programs.

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