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Posted by on Jul 31, 2009 in Economy | 2 comments

A Quick Word On GDP

The advance estimate for GDP for Q2 came in at -1.0% which isn’t too bad. I’m sure the press will spin this as showing the recession is close to ending, but there are a few caveats. This post at Naked Capitalism and The Big Picture offer words of wisdom, caution and optimism. This is what jumped out at me:

GDP is highly prone to revisions. This is just the advance estimate and may change +/- 2.0% over the next few months. Even then we’re not out of the woods. As Ed Harrison noted, Q1 was revised to -6.4% from -5.5% respectively. So even though Q2 beat the consensus of -1.5%, overall we are in worse shape than anticipated. Moreover, Q1-Q3 2008 were revised from 0.9% to -0.7%, 2.8% to 1.5% and -0.3% to -2.7% respectively. These are massive downwards revisions and total a bit over 1.0% more contraction than previously believed [although they said there was more growth before then so overall everything evens out].

In any case, how the economy “felt” and the numbers now line up more accurately.

Also, GDP is highly influenced by the GDP deflator estimate, which subtracts from GDP when positive and adds to it when negative (which I’m not sure it’s been negative since the Great Depression). The GDP deflator is NOT the same as the CPI (measure of consumer prices), it is a weird measure of domestic inflation, with import inflation having a negative effect on it. This means that when imports rise a lot in price very quickly (cough oil) then it perversely raises the GDP. The effect of the oil price hikes don’t revert until it makes its way through the domestic product chain, so what has been happening is that we’ll see a massive addition or subtraction to the GDP due to oil one quarter, and then have it reversed the next. I’ve read many macroeconomists trying to justify this behavior, but I still don’t buy the justification.

Anyway, as Barry Ritholtz points out, the GDP deflator was only 0.2% instead of 1.0% (most likely due to the massive increase in oil prices) and so the Q2 GDP probably “felt” closer to 1.8%, and will be reflected as much when the Q3 GDP deflator comes out.

Lastly, GDP doesn’t pay attention to government debt and as such the government can spike it as much as they want. Q2 saw an 11% increase in government contribution, and since the government makes up a bit over 40% of total GDP, this means that it added somewhere between 3.5% and 4.0% to the GDP calculation! In fact, it’s not a stretch to say that the GDP for Q2 was nearly as bad as Q1 and Q4 2008, but it’s just the stimulus measures that are masking it! Edit: sorry it was 1.1% read update #2. I would say that the primary difference was the smaller decrease in investment, although there was a sizable contribution from the government as well.

The media is not going to tell you that.

If the stimulus was spent wisely then that money will filter into the economy, stop job losses and we will eventually reap the rewards. If not, then when the stimulus is cut off then GDP will plunge immensely.

Ed Harrison says he expects the recession to end in the latter half of the year, but he didn’t expound on that much. Before he has said (along with Nouriel Roubini and several other people that called the crisis) that he expected private industry to merely stabilize and the increase in government spending will bring us to a positive number…which then could turn negative at a later date.

Well I guess this ended not really being a “quick” word, but I hope it explains why it requires a lot of effort to read the GDP number and determine how it relates to the real economy.

For the real (every man on the street) economy measures, I’d pay attention to unemployment (specifically weekly initial claims falling below 200-300k will signal a significant improvement, right now it’s nearly at 600k), consumer spending, and inventory restocking. If those don’t improve, then the headline number is meaningless, and if they do for a couple of quarters then we can proclaim the government response a success.

Update: Barry has another post up showing another important aspect. Exports are contracting quickly, but our imports are contracting even more. The way GDP is calculated that *adds* to the GDP (for the same reason that import price rises subtract from the GDP deflator) which is um, stupid.

This current recession must be seen in the global context, especially because of the massive interconnectedness of the system, and so looking at the GDP of any one country doesn’t give a good understanding. Michael Pettis is the go to guy for matters relating to China, and he has shown that China is really putting the hurt on other emerging markets through massive subsidies even though doing so will have severe negative effects (here and here). This is why Japan, Korea, SE Asia and Eastern Europe (with Germany on the edge) are contracting at Depression rates, which in turn is threatening the global financial system and why Bernanke recently admitted that this may be worse than the Great Depression overall, a statement backed up by statistics.

Update #2: I knew my government contribution didn’t seem to make total sense. That’s because I forgot about the other factors not related to spending.

Here are the contributions to the GDP over the last three quarters from the source:


Personal Consumption -2.15 .44 -.88
Services .26 -.13 .04
Investment -3.91 -8.98 -2.64
Net Import/Export .45 2.64 1.38
Government .24 -.52 1.12

In other words, people spent less, but investment stabilized, while the government had a large swing in its contribution.