Getting Fourth Quarter GDP Right

When the Mets were an expansion team in 1962 and on their way to losing a record 120 games, their manager Casey Stengel reportedly cried out in frustration after a Mets error, "can't anybody here play this game?" Readers of the coverage of the 4th quarter GDP report must have felt the same way.

Most of the coverage was along the same lines as the Washington Post headline, "U.S. Economic Recovery Picks Up Pace." At the most basic level, this is true. GDP grew at a 2.8 percent annual rate, up from 1.8 percent in the third quarter and its strongest showing since the second quarter of 2010. However a closer examination of the data indicated that there was little cause for celebration.

There are always a number of random factors that will affect measured GDP in any given quarter. Often they average out so that the measured GDP is pretty much in line with what we may view as the underlying rate of growth. Sometimes they don't average out so that the headline number might be notably better or worse than the economy's underlying growth rate. This is the situation for the last two quarters.

The most obvious wildcard in GDP numbers is inventory changes. These are erratic. Sometimes they reflect conscious decisions of firms to build-up or run-down inventories. Sometimes firms accumulate inventories because they didn't sell as much as expected. Sometimes it is just the timing of when items get counted in stock.

Whatever the cause, inventory fluctuations often have a very large impact on GDP growth. And, this impact is often reversed in the following quarter. (The impact on growth is the change in the change. If inventories grow by $50 billion in both the third and fourth quarters then inventories add zero to growth. The $50 billion growth in inventories only boosts growth in the fourth quarter if we added less than $50 billion in the third quarter.)

This is worth noting because more than the entire difference between the third quarter growth rate and the fourth quarter growth rate can be explained by the movement in inventories. Inventories subtracted 1.35 percentage points from growth in the third quarter, when they rose at just a $5.5 billion annual rate. They added 1.95 percentage points to growth in the fourth quarter when they rose at a strong $63.6 billion annual rate.

Needless to say, this speedup in the rate of inventory accumulation will not continue. In future quarters inventories are likely to grow at a somewhat slower pace. In the absence of this inventory growth we would have been looking at 0.9 percent growth rate in the fourth quarter.

Fortunately, there were a couple of items on the other side which will certainly not be repeated. Defense spending fell at a 12.5 percent annual rate, lopping 0.73 percentage points off growth for the quarter. Defense spending is heading downward with the winding down of the wars in Iraq and Afghanistan, but certainly not at 12.5 percent annual rate. This just reflects the erratic timing of defense expenditures.

Similarly the category of housing and utilities showed a sharp drop in the quarter, reducing growth by 0.4 percentage points. This is a measure of the rental value of housing, it can only fall if fewer homes are occupied. The likely cause of the sharp drop was better than usual weather, which means less spending on utilities. This drop will almost certainly be reversed in the first quarter of 2012.

However, there is one more negative in the picture. Car sales grew at a 48.1 percent annual rate, adding 0.81 percentage points to growth in the quarter. This was largely a reversal of a decline earlier in the year that resulted from shortages due to the earthquake in Japan. It is not going to be repeated. Car sales will add much less to growth in 2012.

The long and short is that there was likely little change in the underlying rate of growth from the third quarter to the fourth quarter. The winding down of the stimulus, coupled with the negative impact from the Japan earthquake brought growth to a near halt in the first half of the year.

Now that the stimulus has almost fully unwound we are back on a growth path of around 2.5 percent -- pretty much the economy's trend rate of growth. This means that we are making up little or none of the ground lost during the recession. That is a really bad story.

So what do you expect?
written by Luke Lea, January 28, 2012 9:29 AM

Newspapers aren't in the information business. They are in the selling papers business. Data blips are gold!

GDP Growth in 2011 Was Half What the Fed Predicted a Year Ago
written by PAUL, January 28, 2012 10:03 AM

Yet the Fed is doing nothing to increase growth despite its mandate to reduce unemployment.

Of course the President and Congress are doing their best to reduce growth by cutting government spending and taking no action to increase consumer demand - sales tax holiday anyone?

Just the blind leading the blind.

"That's some good press beating."
written by LSTB, January 28, 2012 10:30 AM

Is all I've got to say.

Why should we expect to recover the lost ground?
written by Dennis, January 28, 2012 11:11 AM

Honest question, trying to get informed, Dean. Why should we EXPECT to make up the lost ground? If the pre-recession growth rate was based on an unsustainable bubble (and it was), then it is NOT the natural growth rate of a healthy economy. Getting back the lost ground would only be the result of inflating another, equally large, bubble, wouldn't it?

Dennis nails Deans doublespeak.
written by pete, January 28, 2012 12:37 PM

Bubble=growth, pop the bubble = recession. Indeed, Krugman said the solution in 2002 to the recession was a housing bubble. How'd that work out for ya!

-1

new headline for the Post
written by JosephK99%, January 28, 2012 12:58 PM

Better headline for the Post:
Zombie US recovery shows signs of life.

Natural growth rates
written by Dean, January 28, 2012 1:38 PM

There was nothing unnatural about the rate of growth in the U.S. economy in the bubble years. The only thing "unnatural" (a better word is "unsustainable," economies don't have natural rates -- they are constructed by people)was the source of growth. Instead of having growth driven by a bubble we should have sought to have it driven by an increase in net exports through a lower valued dollar or increased government spending. We just needed a source of demand.

The limits to an economy's output are determined by its resources: land, labor, capital. We have huge amounts of all three sitting idle now, so we clearly are not at the economy's limit in any real sense.

btw, Krugman never called for a housing bubble. He mentioned the possibility derisively, implying that Greenspan might look to a bubble to spur growth coming out of the 2001 recession. That in fact is what Greenspan did, whether he did so consciously or not we may never know. Anyone who claims that Krugman advocated this path needs to check their source.

The Housing Bubble Was Caused by Private Sector Fraud
written by PAUL, January 28, 2012 1:50 PM

Anyone who doubts this should read Mark Zandi's article in the WaPo today. http://www.washingtonpost.com/...story.html

Fannie and Freddie were primarily bystanders, yet they now get all the blame from politicians and Fox Noise.

As a result, stimulating the housing sector to increase buying and prices has been off the table for 4 years and consequently, the Great Recession grinds on. Because of these malicious political vendettas, unemployment is much higher than it should be at this stage of a recovery.

housing revisionism
written by pete, January 28, 2012 8:08 PM

Do some searches of the literature, trade magazines, etc, in the 90s. Fannie and Freddie were accused of "cherry picking" mortgages in the affluent suburbs, and chastised over and over again by progressives. All banks were accused of redlining. I know, I was in D.C. in the 90s, had lots of friends at FDIC, Fed, and so forth. The onslaught was relentless. So F&F had to lobby to relax regulations on all banks( since they were quite active in the secondary market) in order to accommodate the progressives. CRA was adjusted in 1995, precisely the beginning of the bubble. Barney Frank defended them through the early 2000s, ignoring their shoddy bookkeeping. In early 2008 he said they were in good shape. Krugman said Fanny and Countrywide were competitors. Ha ha they were actually in cohoots. This is up there with his praise of Enron! He may know his macro but his finance sucks. Needs to study securitization.

Yes, yes, Krugman was kind of joking with his bubble thingy, the only thing Greenspan could do was have a housing bubble...be careful what you joke about. While in 2002 Shiller and Baker said we were in a bubble, Krugman jokes that we need a bubble. Sick joke I guess.

Anyway Dean, you do say in the repost that the gnp growth was due to the bubble, i.e., above nature, no? So the bubble did cause boom, and when the hedge funds pulled out the rug in 2006, popping the bubble, the economy return to its normal recessionary mess.

-3

Bubble driven growth
written by Dean, January 29, 2012 8:02 PM

Pete,

the economy's limits are given by supply, not demand. If we didn't have incompetent people in charge of economic policy we could have gotten demand from sources other than a housing bubble, like net exports, or increased government spending. There is not a "natural" level of demand. The problem is just that the folks running economic policy did not have a clue.

Getting Fourth Quarter GDP Right

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