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What’s Happening to the US Economy?

CAMBRIDGE – The American economy has recently slowed dramatically, and the probability of another economic downturn increases with each new round of data. This is a sharp change from the economic situation at the end of last year – and represents a return to the very weak pace of expansion since the recovery began in the summer of 2009.

Economic growth in the United States during the first three quarters of 2010 was not only slow, but was also dominated by inventory accumulation rather than sales to consumers or other forms of final sales. The last quarter of 2010 brought a welcome change, with consumer spending rising at a 4% annual rate, enough to increase total real GDP by 3.1% from the third quarter to the fourth. The economy seemed to have escaped its dependence on inventory accumulation.

This favorable performance led private forecasters and government officials to predict continued strong growth in 2011, with higher production, employment, and incomes leading to further increases in consumer spending and a self-sustaining recovery. A one-year cut of the payroll tax rate by two percentage points was enacted in order to lock in this favorable outlook.

Unfortunately, the projected recovery in consumer spending didn’t occur. The rise in food and energy prices outpaced the gain in nominal wages, causing real average weekly earnings to decline in January, while the continued fall in home prices reduced wealth for the majority of households. As a result, real personal consumer expenditures rose at an annual rate of just about 1% in January, down from the previous quarter’s 4% increase.