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Can good numbers be bad news?

July 31, 2009

Barring any unexpected stumbles, and revisions aside, today will be the last time this year that Americans are told their economy is shrinking.

Indeed, the modest one percent decline in second-quarter gross domestic product could be followed by growth rates as high as three percent in the final six months of the year.

But good economic news can be dangerous, as the Great Depression showed. As growth bounced back after 1933, complacency set in, leading to premature demands for an unwinding of government stimulus and tighter monetary policy.

The result was a second downturn in 1937, as Depression scholar and Obama adviser Christina Romer has pointed out.

A repeat of this blunder becomes more likely the better the figures start to look. The U.S. economy is far from ready to walk without the crutch of government money, and won’t be for some time.

The dependence of the economy on government support was graphically illustrated by today’s GDP figures. The 10.9 percent jump in federal government spending was one of the few positives on the GDP ledger between April and June.

Support from Uncle Sam was invaluable in propping up ailing consumer finances. Real disposable income actually increased by 3.2 percent, despite the appalling state of the labor market. This government infusion will continue into the final six months of the year as the “cash for clunkers” program works its magic on auto sales and infrastructure spending picks up.

In the second half of the year, GDP figures are likely to overstate the underlying vibrancy of the U.S. economy still more. A statistical quirk of the GDP figures ensures that as large negatives turn into zeros, growth turns positive.

For example, much of the boost to GDP in the end of the year is expected to come from a slowing of the pace at which companies draw down inventories. Even if the rate of decline halves, this will give a powerful fillip to headline GDP growth.

Lurking beneath the encouraging growth figures will be a struggling economy. Business may start to draw down stocks less quickly, but there is still no sign they plan to invest in future production.

Investment fell 8.9 percent in the second quarter even after an almost 40 percent slide in the first. There is also no reason to expect that consumers will become less dependent on government largess.

The Employment Cost Index showed private compensation up only 1.5 percent over the past 12 months — a record low. An outright decline in wages is increasingly likely as unemployment rises. For a better gauge of economic health in coming months policy makers should look to unemployment, consumer spending and business investment.

So, alarming as Federal deficits have become, lawmakers need to resist any temptation to withdraw precious government funds from the economy over the coming year. Fed officials should not be too quick to play down the possible need for further credit easing.

If anything, another tap on the accelerator is still in order.

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