If there were any doubts about the health of the economy, two reports issued in the last ten days should have eliminated them. First the second quarter GDP showed the economy growing at just a 2.4 percent annual rate. Then the Labor Department reported on Friday that the economy created just 12,000 jobs in July after removing the impact of temporary Census employees. Both reports are really bad news about the economy’s near-term prospects.

In the case of the GDP report, it is important to realize that final demand – GDP excluding inventory fluctuations – grew at just a 1.3 percent annual rate in the quarter. This is important because the economy is coming to the end of an inventory cycle. In a recession, businesses first run down their inventories then start to build them up again. The reversal from shrinking to rapidly growing inventories added substantially to GDP growth over the last four quarters.

However, this cycle is now over. Inventory growth is unlikely to accelerate further in future quarters. This means that GDP growth will look like final demand growth, which has averaged just 1.2 percent over the last four quarters.

As 1.2 percent growth sounds, most of the obvious sources for change point downward. The plunge in home sales following the end of the homebuyers tax credit in April will reduce housing investment, and a renewed fall in house prices will weaken consumption. Federal stimulus spending has peaked and will be headed downward in the 4th quarter of 2010 and first quarter of 2011. In addition, state and local governments will be making cutbacks to deal with massive budget shortfalls.

These are reasons to expect to growth to slow further. Given the severity of the downturn, we should be expecting growth in a 5-6 percent range. Instead, we will be lucky if it stays positive.

The picture on jobs was equally bad. The new report, coupled with a sharp downward revision to the June numbers, implies that the economy essentially created no new jobs for the last two months. Even the 36,000 job growth in manufacturing was largely illusory. The Detroit manufacturers did not shut down for retooling in July as they would ordinarily. This explains the 20,000 job growth reported in the auto sector. It will be reversed in August.

At this point in a recovery, the economy should be generating 300,000-400,000 jobs a month. Instead, we are flirting with zero.

So, we are sitting here with a moribund recovery that promises to leave tens of millions of people unemployed or underemployed for the indefinite future. And the political options at the moment seem to be between Democrats who tell us things are good and Republicans who say the economy stinks, but don’t have a clue on how to make things better.
Just to be clear, we do now how to make things better, we just lack the political will. Spending money creates jobs. Even Tea Partiers will work for money, in most cases even if the money comes from the government. Unless the private sector somehow will spend less because the government spends more (tell me the loony story, I love fairy tales), then more stimulus will create more jobs.

More stimulus does not have to create a debt burden for our children. The Fed can buy and hold bonds so that the interest is paid to the Fed and refunded to the Treasury. Japan’s central bank has done this and its interest burden is less than ours even though its debt is more than three times as high compared to the size of its economy. And, its main problem continues to be deflation – inflation is nowhere in sight.

The Fed can do more. It can set an inflation target of 3-4 percent. This would give businesses more incentive to invest. (Suppose that they knew all prices would be on average 15 percent higher in five years.) It also would alleviate the debt burden of homeowners by raising their nominal wages and house prices.

Finally, if we can’t boost the economy, we can restructure work. Germany and the Netherlands have both gone the route of work sharing, using unemployment benefits to give firms credits to shorten workweeks rather than layoff workers. The unemployment rate in the Netherlands is hovering near 4.0 percent. In Germany it is 7.1 percent, but that is lower than it was at the start of the downturn.

There is no excuse for the mass suffering the country is now experiencing. The people in charge messed up disastrously. They are still messing up disastrously. The public has every right to be furious at the incredible level of incompetence shown by those in charge. They should demand better.  

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