I’ve had a little more time to ponder the meaning of some of the economic data released last
week, and here’s what I’ve come up with.
Last week I reported
that the new GDP figures released by the Bureau of Economic Analysis led to a slight
increase in my GDP-based recession probability index from 3.4% to 4.7%. Pro-Growth Liberal of
Angry Bear, in comments placed at the blogs of Economist’s
View and William
Polley, expressed amusement that the same GDP figures led him, a pessimist, to become more
optimistic, and led me, an optimist, to become more pessimistic.
Prompted by the reaction of many others to the new GDP figures, I was curious to take a further
look at why the recession probability index was reacting the way it did. Argmax.com in particular
emphasized that part of last week’s news release included downward revisions to the estimates of
GDP for a number of earlier quarters, and my algorithm uses the complete new history as released
last week to form an assessment about where things stood in the first quarter. Out of curiosity, I
tried the experiment of just adding a 3.4% growth rate for 2005:II without changing any of the
other numbers as they had been reported last May, and found that, if there had been no revisions to
earlier data, the index would only have risen to 4.3 rather than 4.7. So BEA’s downward historical
data revisions explain part of the reason I was coming up with a slightly pessimistic reading of
the new GDP data. But the biggest factor remains the one I mentioned last week, that 3.4% is
actually a bit slower annual growth rate than we typically observe during an economic expansion.
Nevertheless, I was perhaps negligent in not emphasizing last week that a value of 4.7 for the
index still represents a very, very favorable economic outlook.
There was quite a range of other interesting responses to the new GDP figures around the
blogosphere, including Angry
Bear, Tim Duy,
General Glut, the Big Picture, Lakeshore Laments, and
Spectator. I found all of these very informed and informative, but the colorful variety of
responses persuaded me all the more that there was also some value added in what I attempted, which
was to provide a purely objective summary of the numbers. And the nature of that summary is, if
you look just at the GDP figures themselves, ignoring the individual components, the economy
appears to be chugging along nicely, though the overall effect of the new figures, including the
historical revisions, would be to make an objective observer ever so slightly more bearish than he
or she might have been before seeing the numbers.
But while I was playing statistician, others were busy being real economists, finding some very
important information in the individual components that make up the GDP totals. Tim Duy in
particular, as well as William Polley
Bear, noted that inventory reductions were contributing a net drag on GDP that amounted to
-2.3% growth at an annual rate, meaning that, if inventory additions had continued at their
previous pace rather than fallen, real GDP would have grown at a 5.7% annual rate in the second
Changes in inventories of course should not just be ignored– any sales that come out of
inventory mean no new income generated for those who produce the goods, and in many cases the
economic downturn associated with a recession can be entirely attributed to precisely this reality.
However, inventories are often very important to examine because they can help predict where GDP
is likely to head next. In the present case, if inventory additions in 2005:III just return to the
average value we’ve seen over the last year, that alone would kick in an extra 2% to the GDP annual
growth rate calculated for next quarter. So, even if final sales are fairly lackluster from here,
we should still get a good value for GDP growth for the coming quarter.
This cheery outlook is also not without some concerns of its own, however. The Big Picture
notes that a huge chunk of the inventory drop was due to auto sales incentives on which GM managed
to lose $1.2 billion in the second quarter. Tim Duy helped me track down these inventory figures
(from BEA Table 5.6.6B), which show
that the change in automobile inventory investment accounted for 38% of the total national change
in inventory investment in 2005:II, contributing -0.9% to GDP growth just from the auto sector.
GM’s losses led me to worry earlier that big
production cutbacks from the U.S. automakers could be coming soon
argues that GM and Ford are less important for the U.S. economy than they used to be. Although
I agree that the day is coming when they will not be that critical (and GM is perhaps doing its
part to precipitate the arrival of that date), I’m not convinced that it’s here yet.
Bear noted that the GDP figures also show a decrease in the contribution of consumption and
increased contribution of net exports. With exports increasing and imports decreasing in 2005:II
compared to 2005:I, net exports contributed +1.6% to the second quarter annual GDP growth rate. It
would surely be far healthier for U.S. economic growth to be led by exports rather than by
consumption spending. I’ve been watching to see if any of this might bring some more cheer to Brad
Setser’s gloom, but so far, it seems
In addition to all this, last week we received news that housing construction
remained very strong in June. Taken together, these details lead me to lighten some of the pessimism about housing
that I’d expressed before these data came out. My reasoning had been that since lower interest
rates produced the house price increases, rising interest rates could easily set that same process
into reverse. The new data lead me to conclude that the economy should be able to withstand a few
more rate hikes before that happens, which is just as well, since that’s doubtless what the Fed is going
to do anyway. I nevertheless continue to urge the Fed to keep watching autos, housing, and the
yield curve with great caution.
But I can’t allow Angry Bear to be more of a Cheerful Optimist than I am, can I?