I mentioned in this post that the financial-balances perspective on the condition of the business cycle can be confirmed by looking at the share of GDP or domestic income taken by the most cyclical components of demand.
Just because one confirms the other does not mean they are both right. This is just one aspect of the story, one that has gone from an unambiguous positive to now more neutral / non-threatening.
The most cyclical components of aggregate demand are basically all forms of investment, excepting – I assert – investment in intellectual property. IP development is not particularly cyclical and until recently the National Accounts did not even treat it as capital spending. Back in the day, it was a cost item.
When the cyclical components are running hot relative to the rest of the economy, a greater share of aggregate demand is likely to be debt financed and contingent on expectations for the future, which can change more abruptly than the reality of the present, which tends to determine the other components of aggregate demand. Hence the link to financial balances.
You might say that a high cyclical spending share reflects optimism. And it is hard to be against that, because optimism now can improve the supply-side performance of the economy later. But not all forms of optimism are equal, and excessive optimism can lead to disappointment. So anyhow, that is my rationalization for looking at this stuff. Doing so, what do I see?
The cyclical spending share is now actually below the lows seen at the depth of prior recessions. So one thing we got going for us: there is no evidence here of too much optimism or too much commitment to spending decisions that relate to the future. Yay Obama! Making America secure by making sure nobody is too optimistic. Kidding! I am a fan.
The cyclical spending share is well off its low, though, which makes this less a no-brainer than it was because – just as in the case of profit margins – I ought not pretend I really know the appropriate mean towards which this should “revert.” Assuming that mean does not move abruptly, we are probably low enough for safety. But the point is that this is no longer so clear. This was an unambiguous positive. Now what we can say for it is that it is non-threatening, taken in isolation.
Recently, the cyclical spending share has ticked down, partly because of a somewhat needed correction of business inventory investment . Nominal investment is now running at -20 billion (ar), which is about $70 billion below the pace required to keep the (real) I/S ratio declining along its secular trend in an environment of normal demand growth for goods and structures. So there is now actually some pent-up demand there. That part I got, but it is not the decisive part.
You can split private fixed investment into two separate components, that done by businesses and that done by households. The former includes investment in equipment and structures, while the latter includes investment in housing and consumer durables.
The business sector has arguably almost renormalized – or is indistinguishable from almost having done so. I lack confidence here because secular stagnation may have introduced a declining trend line into this series.
But the household sector is still pretty retrenched. We all know housing is still running low, which means the recovery there still has a while to go. It is less well known – and occasionally surprises me when I am reminded of it – that consumer spending on durables is also still fairly low.