That second quarter GDP report: should we be worried?

August 1st, 2016 at 8:14 am

I didn’t much like that GDP report from last Friday, showing that the economy expanded at an annual rate of 1.2% in the second quarter. OTEers know my methods: I prefer to smooth out the quarterly noise by looking at year-over-year trends. However, as the figure below shows, that doesn’t help so much. In fact, by that measure real GDP growth has decelerated for each of the last six quarters.

Source: BEA

Source: BEA

But before getting too wound up, consider the following:

–Real inventories were a big negative last quarter, reducing the top-line number by 1.2 ppts. Inventories are by far the most volatile component of GDP growth, and over the long term tend to balance out around zero. You can see what I mean in the figure below, which looks like an EKG from someone who’s consumed a few too many grande lattes. Why are inventories such a noisy component of GDP? Because unlike all the other components, the underlying inventory measure is already a “delta”—a change, i.e., an inventory build-up or draw-down—so the quarterly change is a “change-in-a-change,” which is invariably more variable and thus indubitably more doubtable in any given quarter.)

Source: BEA

Source: BEA

–The next question should then be: OK, what’s the trend in real “final sales,” which leaves out the noisy inventory component. That’s averaged a steady 2% over the past four quarters, which is about the economy’s trend growth rate right now, though in the prior four quarters, real final sales grew a point faster.

–The Obama economics team, while they’ve obviously got an angle, provide thoughtful and objective summaries of these reports (you just have to get past the usual “President Obama wakes up every morning thinking about how to boost non-residential fixed investment!”—JK, CEA!). They argue, based on statistical evidence, that a stripped-down version of GDP, comprised of just consumption and investment outside of inventories, provides the best take on where the economy is heading (this breakdown is called “private domestic final purchases” or PDFP). Here’s their take from Friday:

“In recent quarters, weaker foreign demand has dampened business investment, and low oil prices have weighed on energy-related investment, both of which have typically led to slower PDFP growth. In the second quarter, though, these drags on growth were offset by strong consumer spending, resulting in a solid pace of PDFP growth. The gap between PDFP and GDP growth this quarter is more than accounted for by movements in inventory investment. Overall, PDFP rose 2.2 percent over the past four quarters, above the 1.2-percent growth in GDP over the same period.”

So, while I don’t love the deceleration in top-line GDP (Figure 1 above) one bit, I’m not wetting the bed over it, either. The pace of employment and even wage growth, including real wage growth, remains solid. Quarterly GDP is a noisy indicator beset by various factors like inventories that tend to lower the signal-to-noise ratio. The advance report, meaning the first of three releases, is subject to significant revisions. Unusually low energy prices are climbing back a bit and the dollar is weakening, both of which could boost production in coming quarters (net exports were a plus in q2, adding 0.23 ppts to real GDP growth).

If you want to worry about something I have two excellent candidates for you. First, slow productivity growth. I’ve already written a bunch about the deceleration in output-per-hour, and one point I’ve made is that as the job market tightens and labor costs rise, that could create some pressure on firms to squeeze out inefficiencies that they could afford when there was lots of labor market slack (I’ve called this the FEPM: full employment productivity multiplier). We’ll see, but these things turn very slowly.

Second, if, in fact, GDP really does slow down enough to threaten recession, then we’ve got a serious problem. The Fed won’t be able to lower rates much because they’re already quite low. And the fiscal authorities—the Congress—simply can’t be trusted to quickly legislate the needed discretionary spending.

So it will all be about the automatic stabilizers. They’ve proven to be very helpful, for sure—Unemployment Insurance, food stamps, and Medicaid all performed admirably in the last recession (they all benefitted from ramped-up discretionary assistance from the federal gov’t as part of the stimulus). But unless the downturn is very shallow, both of the recessionary-fighting forces may well prove inadequate to the task.

In other words, stay tuned…

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12 comments in reply to "That second quarter GDP report: should we be worried?"

  1. Bob Palmer says:

    Disappointing Productivity:

    One contributing factor is a tightening labor market. Historically when we approached full employment, productivity slowed. No reason to expect this recovery to be different.

    Another factor may be our transformation into a service dominated economy. Service productivity grows more slowly than productivity in other sectors, so comparisons to prior periods when service was a smaller component suffer.

    To increase overall productivity we must squeeze more productivity out of our low-wage, low-productivity service sector. But cultural bias will make that hard to do. Imagine a future DisneyWorld without human employees. Sound like a fun vacation? Or imagine this conversation in a future saloon: ‘Hey, wow, did you see the legs on that waitress . . . er, robot ???’

  2. rjs says:

    check this graph out; large shrinkage in inventory growth 5 quarters running:

    that’s not sustainable…

  3. Beth says:

    Without adequate investment in supplies (public research, public services and other public investments) our country (plant & equipment) and people (human resources), how exactly is the economy supposed to actually expand and/or stabilize? Capitalism doesn’t work that way. I can’t honestly think of an economic system which works that way. Worst fiduciaries ever are entrenched in, or are occupying, the US Congress.

  4. Philip George says:

    Here’s something else to worry about: falling rate of domestic private investment.

  5. Smith says:

    Great article on gender wage gap, mentions in passing study
    Starting in the third to last paragraph, it brings out research showing longer hours don’t create gains. Uhmm, that sounds like a mechanism for lowering productivity. If you have seen anyone pointing this out, let me know. The slack labor market and cultural norms allow a pliant workforce to be pushed this way to working extra without compensation. The recent raising of overtime exempt eligibility minimum thresholds did not reach previous inflation adjusted maximum level. This is also related to decline of manufacturing, both in absolute and relative share of the economy (because factory work lends itself to overtime rules).

    Here are two links provided in the article above

    This I got from a realclearpolitics link.

    Also, as I’ve repeatedly pointed out, DNWR, downward nominal wage rigidities, means the gender wage gap helps keep men’s wages stagnant, but DNWR also masks the effect. Is there a study on this? Anyone else propose this effect? I don’t know.

  6. John San Vant says:

    GDP accelerated fairly well off the 1st quarter. Government involvement was another big drag. Put that with inventories, and it contracted the bulk.

    Residential Investment is another factor which will reverse. Many homebuilders have told me they have been sitting on “loans” for a year now, sucking in profit at the current rate rather than start new projects. That is ending. They will have to start building for new profit. That means a recession isn’t coming anytime soon. Respect the cycle guys. They are long and winding now.

  7. Kevin Rica says:

    How long can we sustain consumption growth in excess of real disposable personal income?

    Households are depleting assets or assuming more debt.

    Sooner or later, this ends badly.

  8. Smith says:

    I’m not getting why inventory and productivity aren’t closely tied. The story would be inventory goes down, so less stuff is made, but people aren’t fired as quickly or not at all at first. Hence productivity rate is affected in a downward direction, same head count, less stuff. When inventories remain stable, productivity gets natural increase from new technology. When inventories bounce back from depletion, productivity is goosed. This might explain some short term effects. But productivity seems stuck in neutral. The simple common sense explanation might be slack in the economy, never a rush to keep up with expanding sales, growth is dealt with by hiring more people. It’s not just capital investment that suffers, it’s all the little ways that productivity might increase from growing markets and a tight labor market that keeps productivity low. Meanwhile, business owners still profit more from lower labor costs than they lose from either lower sales or less robust productivity gains. Possibly. Below also are links to look at in Fred.

  9. Bob says:

    One more insight into worrisome declining productivity.

    Share buybacks by corporations were $391 billion through July of this year. Last year share buybacks were around $1.3 trillion. Shares purchased in buybacksare canceled or returned to the treasury, leaving a smaller number of shares outstanding to split the corporation’s profits. That will increase a corporation’s reported earnings per share by more than the increase in corporate profits.

    But buybacks are partial liquidations. Money spent on a buyback gives a one time zutz to EPS and then is gone forever. Were the money kept in the corporation and invested in productive additions, it would increase both productivity and future earnings, compounded.

    Buybacks are financial engineering. Low interest rates make buybacks attractive. But buybacks are one of the reasons productivity isn’t growing.

    For more see Gretchen Morgenson 2016/08/14

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