October 31, 2005
JS-3001

Assistant Secretary of the Office of Economic Policy
Mark J. Warshawsky
Statement for the Treasury Borrowing Advisory Committee
of the Bond Market Association

In the three months since the Advisory Committee's last meeting, the economic scene has been dominated by the serious hardship suffered by so many Americans as a result of Hurricanes Katrina and Rita.  But the quarter's initial, solid momentum, combined with the national economy's overall resilience, provided a foundation of strength.  Despite the hurricanes, the U.S. economy continued to grow strongly: real GDP, our most complete measure of activity, grew at a 3.8 percent annual rate in the third quarter as reported in the advance estimate just last Friday, accelerating from the second quarter's 3.3 percent pace.  Strength was evident in consumption, selected categories of investment, and residential construction.

Consumer spending continued to anchor the economy.  Personal consumption expenditures advanced by a strong 3.9 percent, buoyed early in the quarter by sales of motor vehicles as consumers responded to employee discount incentive programs.

Business capital spending provided more support to growth.  Investment in equipment and software increased at an 8.9 percent rate in the third quarter, in line with the 9.5 percent pace of the first half of the year.  Business investment in structures continued its recent uneven pattern, dipping 1.4 percent in the third quarter.  Nonetheless, we expect to see some rebound in private nonresidential construction expenditures as post-hurricane rebuilding proceeds.

Although remaining at a high level, growth in real residential investment slowed in the third quarter to a 4.8 percent annual rate.  Much of the slowdown was due to reduced brokers' commissions as growth in home sales flattened out at a high level.

Inventory investment, which had subtracted 2.1 percentage points from growth in the second quarter, reduced growth by an additional 0.6 percentage point in the third quarter.  The private inventory-sales ratio has been cut sharply in the last two quarters, suggesting that businesses may well need to rebuild stocks, and that inventory investment could make a positive contribution to growth over the next few quarters. 

The foreign trade deficit narrowed a bit, making a small positive contribution to real GDP growth for the second straight quarter, after six quarters of posing a drag.  Both exports and imports were affected by disruptions to port facilities.  Complete data for the quarter are not available, yet preliminary figures show exports slowed -- likely owing to hurricane disruptions -- growing by 0.8 percent in the third quarter after eight straight quarters of robust, and sometimes double-digit, growth.  Total imports were flat in the third quarter, after falling by 0.3 percent in the second quarter.

Hurricane-related disruptions boosted energy prices and caused the overall inflation rate to jump.  The price of West Texas Intermediate crude shot up near the $70 a barrel mark in early September, and gasoline prices briefly exceeded $3 a gallon.  The broadest measure of inflation, the GDP price index, rose by 3.1 percent at an annual rate in the third quarter, and consumer prices in September were 4.7 percent above the year-earlier level.  Outside of the energy sector, however, the inflation picture remains remarkably tame.  The core PCE price index, which excludes energy and also food, rose just 1.3 percent in the third quarter, well below the 2 percent average rate over the preceding two years.  Clearly, recent inflationary pressures have been centered in energy, which underscores the importance of the Administration's efforts to encourage the expansion of domestic energy supplies and a more efficient use of energy.

Although underlying employment conditions outside of the affected areas remain healthy, the impact of Hurricane Katrina on employment was significant.  We know from regional employment data that Louisiana and Mississippi suffered large one-month job losses of 251,000 and 60,000, respectively.  The city of New Orleans alone lost 237,000 jobs -- a drop of almost 40 percent.  The national unemployment rate rose 0.2 percentage points to 5.1 percent in September, and payroll employment fell by 35,000 -- the first decline in 28 months.  Every effort is being made to rectify the consequences of these job losses through a variety of Administration programs and proposals targeted toward unemployed hurricane survivors.  Programs already in place include the "Pathways to Employment" Initiative, the Hurricane Recovery Job Connection, Disaster Unemployment Assistance, and the National Emergency Grant employment program.  In addition, the President's Gulf Opportunity Zone proposal would provide immediate job-creating incentives to area businesses. 

Overall, we're optimistic that future real growth will remain solid with continued gains in payroll jobs.  Crude oil prices have receded by roughly $10 a barrel from their late August peak, and gasoline prices have declined by about 15 percent since then, suggesting the potential for more favorable headline inflation going forward.   We agree with private sector estimates suggesting growth above 3 percent in the fourth quarter, accelerating to about 3.5 percent in the first half of 2006 -- above-trend growth as post-hurricane reconstruction proceeds.

As we move from focusing on disaster response to recovery, we will be faced with an array of decisions and choices.  The desire to rebuild immediately must be tempered with the need to rebuild wisely.  In this regard, it is important that we recognize that all federal choices -- whether explicit or implicit -- will have an impact on future redevelopment.  Further, we must ensure that redevelopment plans minimize the future exposure of all taxpayers, in recognition of the fact that the federal government is effectively often the insurer of last resort in large-scale disasters.  Fulfilling this task involves accounting for potential future costs in current government decision-making and ensuring that the appropriate incentives are in place for the private sector to do so as well.

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