Growth Stepping Up

Real GDP has been soft in the past year, growing only 1.3% in the year ending in the second quarter. In the four quarters before that, however, real GDP grew 3%. That's what it's supposed to be like in a Plow Horse economy, with real GDP growth averaging around 2%, sometimes a little faster, sometimes slower.

Now, after going through a relatively soft period, it seems like the economy is starting to pick up again, clocking in at a 2.5% growth rate in the third quarter. In addition, we expect growth to be around this rate in both the last quarter of the year as well as the full year ahead.

Slightly faster growth shouldn't be a surprise. Monetary policy is loose – and will remain loose even when the Fed raises rates in December – and tax rates have not moved up recently. In addition, businesses have been shrinking inventories, and that leaves room for more growth as that process eventually comes to an end.

The problem is that the growth in the size and scope of government is offsetting the strides made by entrepreneurs and innovators. Fixing that problem will take a major change in direction in Washington over the next several years.

Here's how we get to our forecast of a 2.5% annual real GDP growth rate for Q3.

Consumption: Auto sales rebounded in Q3, growing at a 9.2% annual rate, but retail sales outside the auto sector rose at a tepid 1.2% pace. Overall, it looks to us like "real" (inflation-adjusted) personal consumption of goods and services, combined, grew at a 2.5% annual rate in Q3, contributing 1.7 points to the real GDP growth rate (2.5 times the consumption share of GDP, which is 69%, equals 1.7).