Cliff Diving

The preliminary estimate of the nation’s gross domestic product (GDP) for the fourth quarter of 2008 should silence those who claim that the economic situation is not that bad and that a federal recovery package was unnecessary. The data released this morning by the U.S. Bureau of Economic Analysis (BEA) show that the nation’s economy is in the longest, and most likely deepest, recession of the postwar era.

According to the BEA, the nation’s total output of goods and services dropped at an annualized rate of 6.2 percent over the last quarter of 2008. With the exception of government spending, every major component of GDP — personal consumption, private investment and net exports — contracted at alarming rates. Private investment, for instance, declined at an annualized rate of 20.8 percent.

Highlights from the report include the following:

1) The nation is dealing with the collapse of a massive real estate bubble. During the 4th quarter, real residential fixed investment decreased at an annualized rate of 22 percent and real nonresidential fixed investment declined at an annualized rate of 5.9 percent.

2) Private sources of demand have disappeared. Consumer spending dropped at an annualized rate of 4.3 percent with spending on durable goods contracting at an annualized rate of 22 percent. Similarly, overall business spending fell at an annualized rate of 20.8 percent. And foreign demand for American products also dropped.

3) Right now, the only real source of demand is government consumption and investment, primarily in the form of federal spending on non-defense purposes. While overall government spending grew at an annualized rate of 1.6 percent, federal non-defense spending grew at an annualized rate of 15.1 percent.

The widening gap between what the economy can produce and actual levels of overall demand explains why a large federal recovery package was needed. Right now, only the federal government has the ability to provide the demand for goods and services that private actors either are unwilling or unable to provide.

At the same time, the widening gap means that the recently enacted federal package may prove too small to meet the challenge, especially given its unfavorable balance between its spending and tax components. If the GDP trends from late 2008 continue, another package may prove necessary.