Smith Faculty Opinion Article	July 31, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

GDP Increases 2.5 Percent in Second Quarter Recession Risks Apparent

The Commerce Department announced today that GDP grew at a 2.5 percent annual rate in the second quarter. This was below the consensus forecast, 3.2 percent, and my forecast published by Reuters, which was 3.0 percent.

Consumer spending slowed significantly, expanding at a 2.5 percent annual pace in the second quarter as compared to 4.8 percent in the first quarter. Higher interest rates, higher oil prices and mounting debt are burdening consumers. With the housing market cooling, consumers are no longer able to use the equity in their homes to finance ever larger purchases of clothes, electronics and other goods and services.

Overall, private investment was up a disappointing 1.7 percent in the second quarter, as compared to 7.8 percent in the first quarter. Investment in equipment and software were down 1.0 percent, though nonresidential construction expanded 12.7 percent. The residential sector continued to cool, with housing construction falling 6.3 percent in the second quarter after falling 0.3 percent in the first quarter.

Looking forward, consumer spending and housing construction will continue to moderate, and strong business investment will be needed to power the economy or the expansion will falter.

Despite good corporate profits growth, the stock market remains in the doldrums and many companies are using their profits to buy back stock rather than expand capacity to serve domestic demand. The lack of credible energy policies and the trade deficit are tapping off domestic demand for U.S. made goods and services, dampening business investment and keeping the U.S. economy from achieving its growth potential, which is about 4 percent a year.

The weak stock market, companies buying back stock and a weaker market for computers and other technology products reveal faltering business confidence and indicate that productivity and GDP growth will underperform their potential for the next several quarters.

Although the second quarter GDP report appears to indicate the economy is navigating the shoals of higher interest rates, a slowing housing market and instability in international oil markets, recession risks remain real and apparent. If the Fed does not push up interest rates too much further, the economy should accomplish a soft landing, baring a significant disruption in oil supplies. However, like handicappers at the track, economic prognosticators can offer no guarantees.

Two things are certain. The lack of credible policies to reduce oil imports and to lower the value of the dollar against Chinese yuan, Japanese yen and other Asia currencies are making the Federal Reserves job a whole lot tougher. Chairman Ben Bernanke's failure to effectively articulate the constraints imposed by failing energy policies and an overvalued dollar make him as culpable as the Bush Administration for creating the conditions for slower growth and the risk of recession.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.