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ECONOMIC ANALYSIS: U.S. economy slowing, but still showing vitality

August 7, 2006

By the demanding standards of recent history, the justcompleted second quarter was a tough one for the U.S. economy. The Bureau of Economic Analysis reported an annualized growth rate of just 2.5 percent in the overall economy in the April-June period, significantly lower than historical trends and well below the blistering growth of the preceding three months.

In addition, there was unwelcome inflation news, causing some analysts to dust off an old word that hasn't been used since the early 1980s-stagflation.

Economic stagnation and rapid inflation at the same time? We're nowhere near that miserable situation today, thankfully. And for many of us, the vigilance of today's Federal Reserve leadership, not to mention the important structural changes in the world economy, say that we won't be going there anytime soon, either.

Today, there are enough reminders of the malaise of the mid-1970s to early 1980s to give all of us pause, however. The coincidence of events is almost eerie-high energy prices, an Arab-Israeli shooting war, and dramatically rising market shares for foreign-owned motor vehicle manufacturers.

And with our frosty relationships with major oil suppliers like Iran and Venezuela, the possibility of an oil-supply disruption similar to what occurred in 1973 can't be discounted.

But there were enough bright spots in the second-quarter report on the national economy to keep these fears at bay, thankfully. For many, the slowdown is welcome, offering hope that the Fed will call a halt to the steady interest-rate hikes that have begun to take a bite out of many sectors of the economy. And like it or not, the evidence of a transition in the business cycle of the national economy is all around us.

The once-heady spending of businesses on expansion is showing signs of winding down. Nonresidential fixed investment managed to grow by just 2.9 percent in the second quarter, after averaging 6.8-percent growth in 2005. Spending by businesses on equipment and software was particularly lackluster, actually falling by 1 percent in April-June.

That news should concern Indiana businesses, whose fortunes have tracked business spending in the national economy very closely over the last several years.

Another cool-down is occurring in consumer spending, which has softened for durable goods, and even more precipitously for housing. Vehicle sales in July were off considerably from last year, which says more about the deep discounting of 12 months ago than anything else. But in a month that saw Toyota and Honda leapfrog over Ford and Daimler-Chrysler, respectively, in unit-sales rankings, the winds of change in that turbulent marketplace are blowing stronger than ever.

Housing markets nationally are in retreat, albeit a quite orderly one. Residential investment growth has been negative for the past three quarters, with the decline accelerating to a 6.3-percent annualized rate in the second quarter of this year. Interest rate increases have dramatically cut into the loan refinancings that fueled heady consumer spending in the past. And demand for existing homes, as evidenced by median prices and unsold inventories, has softened considerably as well.

The best news for Indiana has been the surprising, sustained strength of the industrial sector. Helped in part by strong exports, durable-goods manufacturers saw an increase of 1.0 percent in output in June alone, and the strength in new and unfilled orders indicates no signs of a letup for at least the next few months.

But the challenges of surviving and thriving in an economy with higher interest rates, higher energy prices, and less momentum are upon us all. Let's hope we are all up to the task.



Barkey is an economist and director of economic and policy study at the College of Business, Ball State University. His column appears weekly. He can be reached by e-mail at pbarkey@ibj.com.
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