Economy eased in 2Q but less than expected

GDP rose 2.9% as inflation dipped

pay gains surprise

August 31, 2006|By New York Times News Service

The economy grew more quickly in the second quarter than initially estimated and inflation was slightly lower, the Commerce Department reported yesterday.

While the revisions were largely in line with expectations, economists said the report was a welcome sign at a time of significant uncertainty about the economy's direction.

"Steady as she goes," said Brian Bethune of Global Insight, an economic and financial research company in Lexington, Mass. "The economy is in reasonably good health."

The gross domestic product, adjusted for inflation, increased at an annual rate of 2.9 percent, up from an earlier estimate of 2.5 percent, while a closely watched measure of prices that excludes food and energy rose 2.8 percent, rather than 2.9 percent. But the growth rate for the economy still slowed sharply from the 5.6 percent pace of the first quarter.

Stocks closed with modest gains for the day, though they seemed driven mostly by the recent decline in oil prices rather than the sharper picture of the economy that emerged from the revised data.

Perhaps the biggest surprise in yesterday's report was new evidence of a surge in wage-and-salary income in the first half of this year. Between the fourth quarter of last year and the second quarter of 2006, pay grew at an annual pace of about 7 percent after adjusting for inflation, up from an earlier estimate of 4 percent, according to MFR Inc., a consulting firm in New York.

As a result, wages and salaries no longer make up the smallest share of GDP since World War II. They accounted for 46.1 percent of all economic output in the second quarter, down from a high of 53.6 percent in 1970 but up from 45.4 percent last year.

Total compensation - including health benefits, which have been rising in cost - equaled 57.1 percent of the economy, down from 59.8 percent in 1970.

Still, compensation makes up a larger share of the economy than it did through the 1950s and early 1960s, as well as during parts of the mid-1990s and the last couple of years.

Economists said that this increase in income suggested that the recent slowdown in the overall economy was less likely to turn into something more dangerous, since households might have more money to spend than earlier estimated.

Joshua Shapiro, chief U.S. economist at MFR, said much of the income increase probably went to people who work on Wall Street or for hedge funds. The biggest spike occurred in the first quarter, when financial companies typically pay bonuses. Other data, including Labor Department figures on wage growth and private-sector surveys on consumer confidence, suggested that most families were not receiving pay increases that outpaced inflation.

Upper end

"If this were more widely spread around," Shapiro said, "we would be seeing it in readings on confidence and sentiment. It tends to indicate this is pretty concentrated on the upper end."

Even concentrated income growth, however, may help the economy in coming months. Research by Federal Reserve economists suggests that upper-income households spend a larger share of their incomes than they once did.

In the second quarter, consumer spending - the bulk of economic activity - grew at an annual pace of 2.6 percent, down from 4.8 percent in the first quarter and 3.5 percent in 2005.

At the same time, one of the essential props supporting the economy's recent growth now looks weaker than before. Home building and other residential investment fell even more quickly than the government had earlier said - at an annual pace of 9.8 percent.

But that drop was offset by a 22 percent rise in construction spending by businesses.

The value of goods stockpiled in company warehouses also grew more quickly than reported earlier, which helped lift growth but can be a worrisome sign for the future if it is not supported by healthy consumer spending.

Exports up 5.1%

In another sign of shifts in the economy, foreign trade, for the first time in a year, helped lift overall growth as the value of imports rose just 0.6 percent while exports grew 5.1 percent.

With the housing market weakening, economic growth has slowed markedly this year, posing a greater challenge for the Fed in its effort to contain inflation without throwing the economy into a recession.

Three weeks ago, the Fed held its benchmark interest rate steady at 5.25 percent; that was the first meeting since summer 2004 that did not include a rate increase.

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