Today’s GDP Results: It’s Really Not That Bad

‘Steak House Index’ Update – July 27, 2016
July 27, 2016
WSJ: Weakest Recover Since 1949
July 31, 2016

Earlier today, the BEA released the “official” advance reading for the 2016: Q2 GDP number.   It was a disappointing 1.20%.    Ouch.


Why You Should Care:   We talk a bunch about the GDP.  For one reason:  It’s the MAJOR LEAGUES.  The big game.   This is the most important financial and economic metric we track.  It impacts everything:  Interest rates and FED rate decisions, the stock and bond markets, consumer and investor behavior, the housing market, everything.   So we must pay close attention…and attempt to make intelligent choices before and after we receive the data.


Taking Action:  Today, frankly, I don’t think we need to do anything different than what we’re doing.  I don’t think we’re trending in a concerning direction.

Yes, the GDP reading was disappointingly low.   But there’s an interesting twist here.   I’ll talk more about this in my blog below,  but for now, let’s simply keep watching the data.

In my most recent Nowcast blog (https://terryliebman.wordpress.com/2016/07/15/july-15-2016-nowcast-update/) I reported the NY FED was forecasting a Q2 figure of 2.2% and the ATL FED, 2.4%.    Were they wrong?   Close?   Why did they fail to report the ‘actual’ GDP number, as we saw today, of 1.2%?

Read on.


The BLOG:  Yes, it’s true.   The Q2 ‘advance’ GDP figure is only 1.20%.   At first glance, this is quite disappointing.  No doubt.   This is a weak number.   And it suggests our economy may be slowing…losing more steam than I thought…and trending in a concerning direction.

Rest assured, I agree that we should be a little concerned.  But there are two reasons why we shouldn’t overreact.   Let’s dig deeper and look behind the headline number.

Here’s a nice chart from today’s BEA release:

GDP

This chart does a great job showing the GDP trend since mid-2012.   It highlights how the last 6 readings (including this quarter) are not only fairly consistent, but – in general – rather weak by historic standards.   But here’s what it doesn’t show.

First, this is the ‘advance estimate’ of Q2 GDP.    This is the 1st of 3 figures we’ll get from the BEA.   And the advance estimate is notoriously wrong.   It often changes.  Sometimes significantly.   Both up and down.   Here is what the BEA says about the data used in the advance estimate:

Source Data for the Advance Estimate:  The advance GDP estimate for the second quarter of 2016 is based on source data that are incomplete and subject to updating. Three months of source data were available for consumer spending on goods; shipments of capital equipment; motor vehicle sales and inventories; durable goods manufacturing inventories; wholesale and retail trade inventories; exports and imports of goods; federal government outlays; and consumer, producer, and international prices.”

For major source data series where only two months of data are available, the BEA makes assumptions about the 3rd month.   So their second estimate – due out on August 26th – will incorporate updated, and more complete, data.

The second reasons why we should step back from the cliff, put away the sleeping pills, and take the bullets out of the gun is this (hmmmm….that’s some dark humor right there 🙂 ) :   Did you notice the word that precedesGDP’ in the chart above?   Take a look.

The word is ‘Real‘.   As you will recall from my prior blogs, this word means “adjusted for inflation“.   Let me elaborate.  In the body of the BEA release, you’ll find this comment:

“Current-dollar GDP increased 3.5 percent, or $155.9 billion, in the second quarter to a level of $18,437.6 billion. In the first quarter, current dollar GDP increased 1.3 percent (revised), or $58.9 billion.”

Hmmm…that’s interesting, right.   The ‘real’ US GDP increased 1.2% in Q2…but in ‘current-dollars’ it increased by 3.5%.   What are ‘current dollars’?  In a nutshell, current dollars is another way of saying ‘nominal’ or non-inflation adjusted.   But the GDP price index – which is the index used to ‘deflate’ GDP growth – is not the same as the CPI or even the PCE.   I know.  It’s a bit confusing.   Bear with me.

The official definition of the Gross domestic product (GDP) price index suggests that the GDP-PI “Measures the prices paid for goods and services produced by the U.S. economy and is derived from the prices of personal consumption expenditures (PCE), gross private domestic investment, net exports of goods and services, and government consumption expenditures and gross investment.

OK…what does THAT mean?  Simply this:  Every GDP number is inflation adjusted, using an index (the GDP-PI) which is similar to the PCE or CPI.   Similar – but not the same.   Here’s how the CPI-U compares to the GDP-PI for the last 10 years:

GDP price deflator

I know…this is pretty opaque.   Again, let me make it a bit simpler.

While the ‘real’ GDP number for Q2 only reflected a 1.2% improvement, when measured in dollars not adjusted for the effects of ‘inflation’ our Q2 GDP actually increased by almost $156 billion for the quarter.   Annualized, this is about a 3.5% improvement.  Pretty good, actually.   Here’s a chart showing the quarterly current dollar GDP figures, in billions of dollars, since 2014:

GDP current $

Is this an unnecessarily complex process?   Why doesn’t the BEA simply give us the ‘current dollar’ figures and leave out all these machinations?   Good questions.   I suspect we’ll never know.

But by digging into the numbers, as we have here, we see our economy is actually on sound footing, growing comfortably, whether or not we adjust the figures for inflation.

  • Terry Liebman

Comments are closed.