Sunday, February 1, 2009

The Incredible Collapse of U.S. Domestic Demand

I believe macroeconomic stability is best achieved by having macroeconomic policy aim to stabilize nominal spending. This approach, rather than stabilizing inflation or the price level, gets at the source of macroeconomic volatility rather than the symptom. Given this understanding--see my previous posts here, here, and here for more on targeting nominal spending--I was alarmed to see in Friday's GDP numbers that nominal spending or domestic demand in the United States crashed in the 2008:Q4. The BEA release showed that final sales to domestic purchasers--GDP minus private inventory change minus exports plus imports--declined at an annual rate of about 10%. This rate is the sharpest quarterly decline for the entire post World War II era as can be seen below: (Click on figure to enlarge.)

Excluding government spending, domestic demand declined even more at a rate of approximately 11% in 2008:Q4. Given the nominal rigidities--sticky prices--that exist in the U.S. economy, this incredible collapse of U.S. domestic demand does not bode well for the economy moving forward. Maybe I missed it, but it seems this development should be getting more attention.

Update: The above graph is in nominal terms. On a real basis the collapse in domestic demand is still large but no longer the biggest one since WWII.

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