Analysts were pleased with the January 29 news that inflation-adjusted Gross Domestic Product had increased at an annualized rate of 5.7 percent in fourth quarter of 2009. This is the largest quarter-to-quarter jump since 2003, and the second consecutive gain after a rise of 2.2 percent in Q3.

But most observers doubt that GDP will increase in the current quarter by nearly as much. The latest W. P. Carey forecast calls for GDP growth to slow to 3.0 percent in Q1 of 2010 (see forecast table at Economy@W. P. Carey). The national Blue Chip economic newsletter consensus of 50 leading business economists is slightly more pessimistic, projecting a 2.8 percent increase for Q1. While positive, these modest gains will have only a limited impact on labor markets. Nonetheless, the GDP figures signal a rebound in output is underway.

Few expect a V shaped, sharp recovery in 2010, because a number of remaining areas of weakness will take time to overcome. Cautious consumers have cut back on their borrowing and spending, and savings rates are up. Credit remains tight for small business as well as for consumers. The economy is still shedding jobs and unemployment rates were higher in 371 of 372 metropolitan areas in December. But layoffs are down from their peak levels one year ago. Businesses are reluctant to hire, but they increased purchases of equipment and software last quarter, and are busy adding to inventories.

Inventory cycle drove Q4 growth

The change in private inventories was the main force driving the surge in real GDP in Q4. Of the 5.7 percent increase in Q4 GDP, 3.39 of those percentage points came from inventory rebuilding (see table below). But analysts point out that, as producers and sellers continue to restock warehouses and shelves, the ratio of inventories to shipments will eventually move into adjustment and the impacts of the inventory cycle will wane in subsequent quarters.

Inventories, Exports Drove Q4 2009
Growth in Real Gross Domestic Product
GDP: Q4 2009 Percent Change5.7%
Top Five Positive Contributions to GDP Change
Change in Private Inventories3.39%
Export of Goods1.90
Consumer Services0.83
Business Equipment & Software0.81
Consumer Nondurable Goods0.67
Top Five Negative Contributions to GDP Change
Import of Goods-1.55%
Motor Vehicles & Parts-0.57
Nonresidential Structures-0.52
Change in Farm Inventories-0.22
Federal Defense Spending-0.19
Source: U.S. Bureau of Economic Analysis, Q4 2009 GDP Advance Estimate, January 29, 2010

Exports contributed 1.9 percentage points in Q4. However, the global recovery has hit a snag, with financial difficulties in the Euro Zone that may put a damper on export growth in the weeks ahead. Moreover, as the U.S. economy continues to recover, import spending will increase and offset some of the gains from greater exports. Import growth was the largest single drag on GDP growth in Q4. Exports minus imports only contributed one-half percentage point to the 5.7 percent GDP increase.

Business investment spending will help

Consumer spending is expected to increase in the 2 percent range in 2010, not enough to drive a vigorous rebound. If the economy is to continue to strengthen, the business sector must play a bigger role in the recovery.

Producers have benefitted from productivity gains without adding to staff, but they may soon have to begin hiring to increase output further. The national economy will likely start adding jobs soon (the February jobs report is due out on March 5). The Obama administration estimates the economy will add 95,000 jobs per month in 2010, although this will not be sufficient to make much of a dent in unemployment.

Businesses increased their purchases of equipment and software by 13.3 percent in Q4. The increase was the second quarterly increase after six consecutive quarterly declines in such spending. The Q4 spending added 0.81 percentage points to GDP. More double-digit gains in equipment and software spending are expected through 2010.

Storm clouds continue to gather over nonresidential building, down by 15.4 percent in the fourth quarter, dragging down GDP growth by 0.52 percentage points. With vacancy rates on the rise, business spending on offices, factories and retail space is projected to decrease into 2011. So far, the tepid return of residential building has had a minimal impact (adding 0.14 percentage points to Q4 GDP). With both residential and nonresidential building weak, construction will not be the recovery driver it has been in the aftermath of several previous recessions.