Lesson 2 GDP and US

Advanced Annualized GDP in 2009 dollars for the first quarter of 2015 was reported to equal $16.3 trillion. For those of you who are not good with trillions or counting zeroes, that amount is more than what Roseann Barr used to weigh. After the GDP number was announced the stock market had a fit, virgins sought lovers, and the press wrote 7 million stories. Rush Limbaugh was, well, Rush Limbaugh.

A couple of weeks ago we talked about me doing a better job of teaching macro to those of you who don’t wake up each morning thinking about supply and demand and Paul Krugman in skivvies. It is one thing to try to capture macroeconomic events; it is another thing to try to explain economic events to people who think an asset is an anatomical part. So this is Lesson 2 and it involves an economic indicator that was announced with great sound and fury last week. You would think that Bruce Willis had grown hair but this kind of frenetic reaction is often the case. Gross Domestic Product is one of those national macroeconomic indicators that tell us how our national economy is doing. It doesn’t tell us everything and it doesn’t often warrant all the commotion but it does have its place and communicates something to us. Of course, like when the doctor says your heartbeat is registering 23 beats per minute, you start asking a lot of questions about the future. And that’s where it gets more interesting. The same is true for GDP.

First, the actual words I used above came from the Bureau of Economic Analysis table in which it was presented to us. It uses words like, first quarter, annualized, advanced, and 2009 dollars. Each of these technical words has meaning and each word helps you understand GDP.

But before we discuss those words, recall that GDP is a measure of national output or production. It is how much we produced. In the first three months (first quarter) of this year, we apparently produced $16.3 billion of goods and services. GDP is not a measure of beauty nor is it an infallible measure of national welfare. It is just output.

The word Advanced means that even though this number was published after March 31 when the quarter ended, it is considered advanced. It will take a lot longer before the full story about Q1 is known. In a month or so we will get a second reading. And that will be followed by even more revisions.

Annualized means that we wave a magic wand and transform the quarterly number into a yearly or annual equivalent. If Hillary Clinton played for the Indianapolis Pacers and she scored 7 points in the first quarter, you could say she was scoring at “a full game pace” of 28 points. Of course, if her hair got mussed we will never know how much she might have scored in the whole game. Accordingly, we actually produced something more like $4.1 trillion goods and services in the first quarter. If that pace kept up for four quarters, it would translate into roughly $16.3 trillion. When it comes to GDP “talking annual smack” is more understandable than “talking quarterly smack.”

I feel the need to have a smoke even though I don’t smoke.

We still need to say a few more words about measuring national production. Note that it is easy to think of all the goods and services piled up in a big mound. It would be a big mound but you can imagine all the cars and trucks, and buses, and haircuts that got produced in Q1 2015. The big question is what happens after we die. But another big question is how we actually measure that really big pile of stuff.  And the answer is pretty easy. If something got produced in Q1 then only three things could have happened to it: (1) It got finished and went to a buyer who forked over some money for it. Or (2) it got finished and is sitting in finished goods inventories because it was too ugly to buy or (3) it didn’t get finished and half of a truck is sitting somewhere waiting to be completed.

The stuff that got finished and sold is said to be final demand. Final demand is broken down by who gets the goods and services. It is traditional to break it down into two parts – Donald Trump and the rest of us. No just kidding. It is broken down into four parts – Consumption measures goods and services going to households; Fixed Investment measures stuff going to firms like plant and equipment and also new houses; Government spending measures goods and services purchased by governments; and Net Exports measure the net purchases of the foreign sector.

Okay, one more thing. GDP is supposed to measure the quantity of production (sometimes referred to as real GDP) but we all know that when this stuff is sold as Final Demand that it is purchased at the latest (Q1 2015) prices. So with another magic wand, poof, we remove all the price change since 2009. The stuff this year gets valued as 2009 prices so as to not muddy the physical output measure with price change.

Here are a few things we know from the recent GDP data announcement. At $16.3 trillion in Q1 it was the highest output ever recorded in the USA. Way to go team! It was a mere $10 billion higher than production in Q4 2014. Compared to a year before GDP was up $500 billion. Compared to Q1 2008 it was almost $1.5 trillion higher in 2015. Clearly that pile of stuff is getting bigger.

None of the above seems to warrant champagne and wild parties with scantily clad ladies playing beach volley ball. But the truth is that we do not get excited about GDP because of its past value. We get excited because the past values are our latest clues as to what might be happening in the future. The future does excite us. We want to be ready for the future. Firms need to decide how many people to hire and what to pay them. Households must decide whether to buy that new refrigerator. GDP yesterday might tell us something about tomorrow’s economy. Or it might not. Consider some of the facts told about GDP in Q1 2015:

            The Q1 increase was small because of temporary negative things like a dock strike and bad weather

            The Q1 increase was small because the foreign balance deteriorated.

            The Q1 increase was small because after four quarters of strong growth, firms cut back on buying equipment and building new structures

            The Q1 increase was small because state and local governments cut spending and the federal government spent less on national defense

            Consumers continued buying at a decent clip in Q1

These facts help firms, investors, and the rest of us think about what might happen in the future. Q1 has come and gone but this report helps us think about our decisions today that impact the future. The report doesn’t tell us the future and it doesn’t make our decisions. But it does give us something to think about as we move forward. And as we do we will also pay attention to the latest information about other indicators like employment, wages, and Bill Clinton’s speaking fees.