10/31/2014 02:40 pm ET Updated Dec 06, 2017

Government Spending Boosts Q3 Economic Growth

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WASHINGTON (MarketWatch) -- The U.S. economy grew by a 3.5 percent annual rate in the third quarter, fueled by a surge in exports and the biggest jump in federal spending in five years, screamed one headline this week.

That is all we need to know to understand why U.S. economic growth is finally returning to the long term average that has prevailed since the Great Depression. This is in spite of the Great Recession and a busted housing bubble that is taking years to recover, record wealth inequality that has kept consumers from spending, and ultra-conservative House Republicans that have refused to allow even the most basic public works spending; such as to repair and replace the roads and bridges that have so fallen into disrepair, not to speak of keeping up with the educational needs of a growing population.


Graph: Calculated Risk

This first graph from Calculated Risk shows the increasing contribution to GDP for residential investment (RI) and state and local governments since 2005. It's the beginning of recovery from the huge slump in RI during the housing bust (blue), followed by the unprecedented period of state and local austerity (red) not seen since the Depression.

It doesn't tell the whole story, of course, as continuing austerity policies that cut government spending and some taxes in Japan and Europe have kept them in recession, whereas the pro-growth actions of the Fed (and boosting of some taxes) have reduced the budget deficit and kept the U.S. government solvent.

It is a phenomenal recovery, even a miracle that this could even happen with a Congress locked in a battle over ideologies, and race. So it is thanks mainly to Ben Bernanke and Janet Yellen's Federal Reserve QE actions, in particular, part of their pro-growth policies that pushed interest rates (especially long term rates) to record lows, just because the Fed could act outside of politics as usual.

"What's more, the U.S. is adding jobs at the fastest rate since the recession ended in 2009 and consumers are feeling the most confidence in seven years, buoyed by a rising stock market and falling gasoline prices. As a result, most analysts believe the U.S. is likely to expand at a 3 percent pace or so in the fourth quarter to string together the best stretch of economic growth since before the Great Recession," said the MarketWatch announcement.

So government spending was the largest contributor, up 10 percent mostly for defense, and exports up 7.8 percent annually. State and local governments' spending rose 1.3 percent, and consumer spending slowed to a 1.8 percent annual pace from 2.5 percent in the prior quarter.

Business investment on equipment decelerated from the second quarter's 11.2 percent gain to 7.2 percent, but is still strong. Residential housing investment grew at a low 1.8 percent rate after an 8.8 percent increase in the spring.

What does all this data mean? That there are ways around Congressional gridlock, if the executive branch and Federal Reserve concentrate on pro-growth policies that keep interest rates low, raise taxes sufficiently to lower the budget deficit, lower health care costs, support collective bargaining of employees, as well as lobby for higher household incomes to boost consumer spending (and the housing market).

And best of all, this happened with very low inflation, in spite of warnings that more government spending and the Fed's QE policies would cause soaring inflation. Instead inflation as measured by the PCE index rose just 1.2 percent annually, down from 2.3 percent in Q2, as cheaper energy prices has kept inflation ultra-low. The core PCE that excludes food and energy rose just 1.4 percent.

We can now say we have the goldilocks economy that prevailed through the 1990's -- not too hot or too cold -- that should boost economic growth for years to come, if Congress can be ignored.

Harlan Green © 2014