July 30, 2007
HP-514

Treasury Assistant Secretary for Economic Policy
Phillip Swagel
Statement for the Treasury Borrowing
Advisory Committee of the Securities Industry and
Financial Markets Association

Washington- Economic growth rebounded in the second quarter after slowing at the start of the year, and we anticipate growth to continue at a moderate pace through the balance of 2007. The labor market remains healthy, with low unemployment, steady job creation, and ongoing wage gains that should support a rebound in consumer spending. Although the housing sector continues to be weak, and may remain a drag on GDP for the next several quarters, fundamentals provide a firm foundation for solid performance by the other sectors of the economy through the rest of the year. Core inflation appears to be contained, with little evidence that increased prices for energy and food have spilled over into broader measures of inflation.

Real GDP grew at a 3.4 percent annual rate in the second quarter of 2007 (according to the advance estimate released by the Bureau of Economic Analysis on July 27th). A pickup in net exports and increased government spending provided important support for growth. Business investment in structures rose markedly; more modest gains were seen for equipment and software purchases, which moved higher after a lull in the previous two quarters, and for inventory investment, which posted a small increase after slowing sharply in the first quarter. The pace of consumer spending slowed, however, and residential construction continued to subtract from growth (though by somewhat less than in the preceding quarters). For the first half of this year, GDP growth averaged 2 percent at an annual rate, above the 1.6 percent pace posted over the second half of 2006. We expect GDP growth in the second half of the year to slow from the pace of the second quarter but to outpace growth in the first half as a whole.

Declining residential building activity subtracted significantly from GDP growth in the second quarter and there remain considerable uncertainties in the outlook for the homebuilding sector. While housing starts in the second quarter were about the same as in the first quarter of the year, permits for residential construction declined about 6 percent in the second quarter; together, these indicators suggest that there could be some further decline in activity ahead. Sales of new single-family homes were up slightly compared to the first quarter, while sales of existing homes were down nearly 8 percent. The overhang of both new and existing homes for sale remains substantial, and private analysts expect that declining housing activity will reduce overall GDP growth through the rest of the year, though to a more modest degree than in previous quarters. Developments in the sub-prime mortgage market remain a concern for many families, but do not appear to pose a significant macroeconomic risk.

Real personal consumption expenditures rose 1.3 percent at an annual rate in the second quarter, well below the first quarter's 3.7 percent pace. Rising gasoline and food prices combined with uncertainties related to the weak housing market likely contributed to the second-quarter slowdown. The fundamentals underpinning consumer spending remain sound: Household balance sheets are healthy, with net worth reaching a new high in the first quarter of 2007 (and still elevated even with recent equity market reversals), and real disposable income is up 3.2 percent over the past four quarters. Rising incomes and the healthy job market should support consumption going forward and serve to offset the downward impetus from softening housing values.

Business investment rose by 8.1 percent at an annual rate in the second quarter of 2007, after posting a weak increase in the first quarter and a decline in the fourth quarter of 2006. As a share of GDP, corporate profits retreated a little in the first quarter (latest data available) but remain near a 40-year high; in addition, corporate balance sheets are healthy. On balance, then, prospects are favorable for business capital spending going forward.

Along with the advance estimates of second-quarter GDP growth, the Bureau of Economic Analysis released revised estimates of real GDP growth back to 2004. Over the past three years, real GDP growth was revised down 0.3 percentage point per year on average. For 2006, the data now show that real GDP grew 2.6 percent over the four quarters of the year, compared with a previous estimate of 3.1 percent. The revisions to real GDP growth are likely to result in lower estimates of labor productivity growth from 2004 to 2006: Since the end of 2003, productivity growth had previously been pegged as averaging about 1.9 percent annually, while the revisions suggest a rate that is closer to 1.5 percent. Lower productivity growth would suggest that a more moderate GDP growth rate and pace of job creation would be consistent with a stable unemployment rate than was the case in the past decade over which productivity growth was stronger.

Steady job gains and a low unemployment rate underscore the economy's underlying health. Nonfarm payrolls rose by an average of 148,000 a month over the second quarter, about the same as in the first quarter. Over the year ending in June, the economy generated about 2 million jobs, and more than 8.2 million jobs have been added since the employment trough in August 2003. The unemployment rate remained at 4.5 percent in the second quarter, the same low level that it has remained at since the third quarter of 2006. Real wages in June rose 1.2 percent over the preceding year, versus a 0.5 percent decline seen over the previous twelve-month period.

Inflationary pressures remain broadly contained. Headline consumer price inflation was 2.7 percent over the twelve months ended in June, down from a 4.3 percent pace over the year-earlier period. Energy prices increased 4.6 percent over the latest twelve months, although prices have been volatile in this period. Food price growth has increased over the past year; June's twelve-month change of 4 percent was nearly 2 percentage points higher than the year-ago rate. Excluding food and energy, consumer prices advanced by 2.2 percent over the year ended in June, well below the 2.6 percent rise posted over the year-earlier period.

In sum, the economy is growing, economic fundamentals remain strong, and prospects remain strong for healthy growth going forward.