Tuesday, August 3, 2010

Quarter 2 Real GDP – Why does the press prefer to look through mud-colored glasses?

The second quarter Real GDP figure was announced last week and as usual it got a lot of attention. There were many stories written and the general tone of most of them was worrisome – the 2.4% annualized rate of growth in real GDP from the first quarter to the second quarter of 2010, was low for two reasons – it was lower than the 3.7% growth in the first quarter and it was lower than experts predicted.

Of course, that is NOT what many people wanted to hear. It reinforced the idea that we might be headed toward a double dip recession (why is a double dip good for ice cream but not for the economy?) or deflation. The Keynesians shouted – “I told you so” – and many articles were written to the effect that we need even more monetary and fiscal stimulus. All this was based pretty much on one number for one quarter! It’s a little like winning one hand at Black Jack and then emptying your checking account so that you can bet your whole fortune on your sure-to-come gambling earnings!

To be fair, there were a lot of articles written and not all of them read like a Keynesian recruitment poster. So let me try to bring in some other facts that put the 2.4% number in a broader and more positive context. If you go to the following link you can get enough GDP data to build an Egyptian pyramid. http://bea.gov/national/index.htm#gdp

First, the 2.4% was the fourth consecutive quarter of positive growth in real GDP. That means a full year of growth since Q3 2009.

Second, real GDP statistics are revised many times. So the 2.4% is not the last word on Q2 of 2010. To emphasize that this first look at the number is based on incomplete information, it is officially called the Advance Estimate. Q1 2010 real GDP got revised upward from 2.7% to 3.7%. Wowee. That’s a big revision. I hate to tell you this, but the last revision to Q2 2010 will come about five years from now. REALLY. I am not fooling. Before then, you will see at least three updates – in one quarter, two quarters, and in one year. So stay tuned to learn more about Q2 2010.So people were oooing and ahhhing and making policy suggestions based on a number that isn’t much better than a lottery ticket.

Third, you can see a lot of very specific data if you go to the above site and download data tables. For example, we are very concerned about personal consumption spending (PCE). You will see that PCE rose by 1.6% in Q2. That is exactly how much PCE rose – an average of 1.6% per year – during the previous three quarters. So with respect to PCE, it was growing at the same rate as it had been during the recovery. I know we want to it grow faster – but there was no slowdown evident in Q2 PCE.

Growth in consumer spending on services – the largest component of PCE – had it fastest growth in several years. Geez I guess they forgot to mention that in their ugly little story. PCE in real annual dollars was about $9.2 trillion in Q2 and PCE-Services spending was about $6.0 trillion. So PCE-Services is roughly two-thirds of all PCE. That makes it almost half of all of real GDP! Note that consumer spending on durable goods was only about $1.2 trillion in comparison. It is fine to worry about the automobile industry – but we should not let the rear view mirror get in the way of watching spending on consumer services.

What else? One major reason that real GDP slowed a bit in the fourth quarter has to do with how we account for imports. GDP is a measure of domestic production. Because imported goods are not produced in the US, they have to be netted out – subtracted from the GDP sales figures. Imports of goods rose by 35.4% on an annualized basis in Q2. So that explains a lot of why real GDP slowed. But note that while it subtracts from output – it does show a resumption of spending. It shows some optimism about future spending. Of course, if all we do is buy imports and do not increase our spending on domestically produced goods and services, this will not help to increase future real GDP.

Missing in some of these articles was an explanation of residential spending – which rose by 27.9% in Q2. Hmmm – and that was only the second quarter that such an increase occurred in several years. Spending on the production of new residences – spending on newly built houses, apartment buildings, condos, etc – fell by 12.3% in Q1 and by 0.8% in Q4 2009. Someone should have made a big noise about this!!!! But I guess it didn’t fit in with their stupid sky is falling story. Supporting a picture of rising construction spending is that Q2 was the first time that spending on business structures (plant, office buildings, etc) showed any growth in years. It grew by 5.2% in Q2.

Part of the good growth story was a 14.1% growth in exports of goods and a 21.9% growth in business spending on equipment and software.

Some of our economist friends and their buddies in the press saw a glass of bourbon sitting on the bar. They preferred to see it as half empty and unworthy of drinking. While this was no batch of Pappy Van Winkle, it was a glass of hooch worth drinking. It is a shame that even a routine data announcement has to be tainted by such incomplete and biased analysis.


  1. I agree that taking a single data point does not always paint a complete picture. Never the less I still see the glass as half full (really less than half full).

    The 800 pound gorilla in the room is unemployment. While it is true that we are no longer losing jobs the number of jobs created is depressingly low, not to mention govt job creation is far larger than private job creation.

    Just to stay even we need to create a lot more jobs (and private sector jobs at that) than we are doing now; probably something like an order of magnitude more.

    It is hard for me to see how any meaningful increase in GDP can occur until the unemployment issue is addressed. There is a double whammy from unemployment. Not only do the unemployed not contribute to GDP growth; they also need welfare/unemployment and other social programs that increase the tax burden on the employed that contribute to GDP growth.

    As has previously been posted recent/current/proposed legislation seems to be aimed at increasing rules and taxes on private employers who create jobs. Until the govt starts to institute policies that result in employers seeing a benefit from hiring new workers I do not see much chance GDP will grow in a meaningful way.

  2. Tom,

    The reason people refer to the unemployment rate as a lagging indicator is because of presumed cause/effect balance going from spending and producing to employment. Unemployment is high right now because demand for goods and services growth has not impressed employers enough to warrant an investment in workers (and their benefits, social security payments, pensions, etc). They are meeting current modest increases in demand by working the existing workforce harder and longer and to some extent by increasing their equipment and software. Once firms are more optimistic they will produce more -- meaning real GDP will increase at a faster pace. This optimism will be the start of more hiring. Unemployment is not a constraint on real GDP. Optimism about the economic outlook is the constraint on both output and employment!

  3. Bottom line for me is that we need to create ~500k private sector jobs every month for a couple of years to get close to ~5% unemployment rate; something I do not see as very likely to happen. In fact high level govt economists are now saying unemployment will go even higher than it is now before it goes to more normal levels, what ever that means.

    It is not easy to be optimistic with unemployment (even if it is a lagging indicator) at the current high level. Not to mention other govt actions that load up firms with more rules, expenses, and uncertain govt action.

  4. Tom,

    I wish I could win the lottery but I don't ever play. We can wish for a swift return to low unemployment but one cannot ignore the reality that this is a deep and unusual recession complicated by a thunderous and nefarious set of new government policies. It is very typical that the unemployment rate rises when things start to improve. Many people dropped out of the labor force. Once things start to get better -- a lot more people will begin looking for jobs. That will cause the unemployment rate to rise even while employment is increasing. So things will probably get worse before they get better....

  5. (I'm in France sending from an iPhone so je m'excuse for the typos.)

    What this discussion ignores so far is that the consumer is reducing his/her debt or increasing savings (as they should be) but not out in the stores buying stuff/services that would create jobs. Seems to me that this is the fundamentalal problem but it's a good problem. Now, if the government(s) would only do the same ...

  6. Jim,

    Eat some snails for me! I agree -- if households go back to their spendthrift ways we will have done little to solve current problems. The government is saying they will reduce the deficits but most of what they say so far is akin to smoke and mirrors...Let's see what the new commission does in December.