Category Archives: GDP & Productivity

Inflation in Obama’s First Term: The Lowest in a Half Century

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Inflation During Presidential Terms, 1953-2012

One of the most persistent criticisms of Obama and the economic policies followed during his term as president is that they would inevitably lead to high inflation, or indeed hyperinflation according to some.  The argument was that high deficits, driven by high government spending (even though government spending has in fact been coming down, see my previous blog postings here and here), plus the aggressive actions taken by the Fed to help the economy recover from the 2008 collapse, were boosting government debt and the money supply, and this would inevitably lead to soaring inflation.

The arguments have been made not only by conservative politicians and political pundits (see here and here for examples), but also by conservative economists such as John Taylor and Michael Boskin, both full professors at Stanford, who served in high positions in the administrations of Bush, Jr. and Bush, Sr. (respectively), and who also both served as senior advisors to Mitt Romney during his recent presidential campaign.  For examples of some of their non-academic writings on the issue (some co-authored with Congressman Paul Ryan), see here, here, here, and here.  John Taylor has indeed like to joke that the US is heading down the hyperinflationary path of Zimbabwe, and carries around a hundred trillion Zimbabwe dollar note in his wallet (as does Paul Ryan) to show people what may soon happen to the US.  And the forecasts that Obama’s policies will lead to soaring inflation continue.

The forecasts were that soaring inflation would soon be upon us.  But nothing could be further from the truth.  We now have data for the full four years of Obama’s first term, and can compare inflation during this period to that of other presidents.  The graph above shows that average inflation over the four years of Obama’s presidency was the lowest of any presidential term going back a half century to the 1961-64 term of Kennedy/Johnson.  It was substantially lower than inflation during Bush’s two terms, was also somewhat below inflation during Clinton’s two terms (when inflation was less than during Bush), and so on back to Kennedy/Johnson.

The inflation measure graphed above is the GDP price deflator.  This is the most broad-based measure of inflation for the economy as all goods or services produced or used in the economy are covered, weighted by the value of what was used.  One could alternatively have used the price deflator from the GDP accounts for just the personal consumption component of GDP, but the results would have been the same:  inflation by this measure was less under Obama than under any presidency going back to Kennedy/Johnson.  And similarly, one could also have used the consumer price index, the common measure of inflation of goods and services used by households, and again have found the same results.

Inflation during Obama’s first term averaged 1.5% a year (as measured by the price deflator for GDP, and also 1.5% a year as measured by the deflator for the personal consumption component of GDP).  Will it stay so low?  Hopefully not.  The Fed indeed now targets inflation to be about 2% a year, so average inflation during Obama’s first term has been below that target (although close to it in 2011 and 2012:  see the graph above).  With the economy still weak, some analysts have indeed argued that moderately higher inflation of perhaps 4 or 5% a year would help the economy to recover more quickly.  Prominent proponents of such a higher target include Professor Paul Krugman (see here and here) and Olivier Blanchard, the chief economist of the IMF (see here).

Inflation can thus be expected to rise above what it has been, and indeed there would be benefits were it to rise to a still modest level such as 4 or 5% for a period.  But inflation over Obama’s presidency up to now has been exceptionally low, and the forecasts by the conservative politicians, pundits, and even some economists that Obama’s policies would quickly lead to soaring inflation could not have been more wrong.

GDP Growth in the Fourth Quarter of 2012: Cuts in Government Spending Drove GDP Down

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Growth of GDP and Contri of Govt, 2007Q1 to 2012Q4

BEA release of 1/30/13; Seasonally adjusted annualized rates       Percent Growth Contribution to GDP      Growth (% points)
2012Q2 2012Q3 2012Q4 2012Q2 2012Q3 2012Q4
Total GDP 1.3 3.1 -0.1 1.3 3.1 -0.1
A.  Personal Consumption Expenditure 1.5 1.6 2.2 1.06 1.12 1.52
B.  Gross Private Fixed Investment 4.5 0.9 9.7 0.56 0.12 1.19
 1.  Non-Residential Fixed Investment 3.6 -1.8 8.4 0.36 -0.19 0.83
 2.  Residential Fixed Investment 8.5 13.5 15.3 0.19 0.31 0.36
C.  Change in Private Inventories nm* nm* nm* -0.46 0.73 -1.27
D.  Net Exports nm* nm* nm* 0.23 0.38 -0.25
E.  Government -0.7 3.9 -6.6 -0.14 0.75 -1.33
Memo:  Final Sales 1.7 2.4 1.1 1.71 2.37 1.13
    nm* = not meaningful
$ Value of Change in Private Inventories (2005 prices) $41.4b $60.3b $20.0b

The Bureau of Economic Analysis of the US Department of Commerce released on January 30 its initial estimate (what it formally calls its “advance” estimate) of US GDP growth in the fourth quarter of 2012.  The result was terrible:  GDP is estimated to have declined by a slight amount (0.1% at an annual rate).  While it is possible that this estimate will be revised upwards as the second and third revisions are released next month and the month after (there has historically been an upward revision on average of 0.3% points from the advance estimate to the third, and there was a particularly large upward revision in the 2012Q3 figures between the advance and third estimates), fourth quarter growth will still likely be disappointingly low.

The primary cause of the stagnation of GDP in the fourth quarter was a sharp cut in government spending.  As shown in the table above, total government spending on goods and services (federal, state, and local) fell at an annualized 6.6% rate in the quarter.  This had the direct impact of subtracting 1.33% points from what GDP growth would otherwise have been.  But there will also be an indirect impact, as workers who would have been employed producing goods and services for government would in turn buy goods and services themselves with the salaries they would have received.  With a multiplier of just two, the impact of the cut in government spending in the fourth quarter was a subtraction of 2.66% points (2 x 1.33% points) from what growth would have been.

Most of the decline in government spending was due to a large fall in spending at the federal level, although state and local spending fell some as well.  Federal government spending fell at an annualized rate of 15%, all due to a fall in defense spending at an annualized rate of 22%.  These declines more than offset increases of an estimated 9.5% and 13% in total federal and in defense spending respectively in the third quarter, which had contributed to the relatively good GDP growth of 3.1% in that quarter.  The swings were likely due to end of the fiscal year spending (the federal fiscal year ends September 30) which was particularly sharp last year and therefore not picked up in the normal seasonal adjustment calculations.  The fall in the fourth quarter of 2012 (the first quarter of the fiscal year) reflected the continued budget uncertainty, as Congress threatens to slash the current budget drastically, either by design or through the automatic sequester cut-backs dictated as part of the agreement to get out of the debt ceiling debacle in 2011, that might be instituted soon (see below).

The fall in government spending in the fourth quarter was particularly sharp, but government spending has been falling in each quarter but two since the beginning of 2010.  The resulting fiscal drag has held back growth.  The figures are shown in the graph at the top of this blog.  The graph shows the rate of growth of GDP each quarter (in blue, at annualized rates) since the beginning of 2007, plus the direct contribution to this growth each quarter from government expenditures (in red).

Government spending rose each quarter in 2007 and 2008, the last two years of the Bush Administration, and this continued into 2009 after Obama was inaugurated.  The growth in government expenditures was particularly sharp in the second quarter of 2009 as the stimulus measures started, and this succeeded in turning around GDP.  GDP was falling at an annualized rate of 8.9% in the fourth quarter of 2008, and this carried over into the first quarter of 2009 with an annualized fall of 5.3%.  But then GDP stabilized and began to grow in the third quarter of 2009, and it has grown each quarter since until the fourth quarter of 2012.

But GDP growth since 2010 has been disappointingly modest, at rates of just 2 to 3% a year on average (with some quarterly fluctuation), as it has been dragged down by the falling government expenditures over this period.  As has been noted in earlier postings on this blog (for example here and here), the resulting fiscal drag can explain fully why this recovery has been modest in comparison to the recoveries seen in previous downturns in the US economy over the past four decades.

The other major factor explaining the stagnation of GDP in the fourth quarter was the negative contribution from inventory accumulation.  The change in private inventories led to 1.27% points being subtracted from what GDP growth otherwise would have been.  But as was explained in an Econ 101 posting on this blog, it is the change in the change in private inventory accumulation which acts to contribute to (or subtract from) GDP growth in any given period.

One sees news reports that still get this wrong, with statements such as that inventories fell by $40 billion in the fourth quarter.  This is not correct.  As noted in the table above, inventories actually grew by $20 billion in the fourth quarter.  But they grew by more (by $60 billion) in the third quarter.  That is, the change (the growth) in inventories was $60 billion in the third quarter, while the change (the growth) in inventories was again positive at $20 billion in the fourth quarter.  But while they continued to grow, they did not grow as fast as before, and the change in the change in inventories was a negative $40 billion.  This subtracted 1.27% points from GDP growth.

As was noted a year ago on this blog when the figures for GDP growth in the fourth quarter of 2011 were released, an increase in private inventory accumulation in that quarter largely explained the relatively good growth rate of that quarter.  But I argued this would then likely be reversed, with inventories not growing as fast and perhaps even declining, which would act as a drag on growth in 2012.  The 2012 figures now out show that this in fact happened, with a negative contribution of private inventory accumulation to GDP growth in the first, second, and fourth quarters.

Other than the drag from cuts in government spending and the deceleration of inventory accumulation, the other components of GDP growth in the fourth quarter of 2012 were generally quite good.  Residential fixed investment grew at an annualized rate of 15.3%, continuing the strong growth seen already in the second and third quarters.  But residential fixed investment was only 2.6% of GDP in the fourth quarter, so the rapid growth on this small base only made a contribution of 0.36% points to GDP growth in the quarter.  In contrast, government spending in the fourth quarter was 19.3% of GDP (down from 19.6% of GDP in the third quarter).  [Figures on GDP shares directly from BEA on-line GDP tables.]

Non-residential fixed investment (basically private business investment in capital and structures) also grew at a good rate in the fourth quarter, at 8.4% annualized, reversing a small decline seen in the third quarter.  And personal consumption expenditure rose at a 2.2% rate.  Since personal consumption accounts for 71% of GDP spending, this 2.2% increase contributed 1.52% points to what GDP growth would have been.

The fourth quarter GDP report therefore would have been solid, had it not been for the sharp cuts in government spending in the quarter.  Accumulation of private inventories then responds, as businesses do not want to see inventories mounting up on the shelves when they cannot be sold and scale back production (or in the fourth quarter, still increase their inventories, but not by as much as before).

The danger to the economy now is that government spending will be scaled back even further, as a Republican controlled Congress insists on slashing public expenditures.  If nothing is agreed to, then the sequesters that Congress required in August 2011 as a condition for the debt ceiling increase (so that the US would not then be forced to default) will mandate a sharp scaling back in federal government expenditures.  While the deadline for this was pushed back to March 1 from January 1 as part of the fiscal cliff agreement at the end of 2012, there is still a deadline.  The nonpartisan Center on Budget and Policy Priorities has estimated in a recent report that should the sequester enter into effect on March 1, defense spending would be cut by $42.7 billion, or 7.3%, while non-defense spending would be cut by also $42.7 billion, or 5.1% for programs included other than Medicare (Medicare would be cut by 2.0%).

Such cuts, especially if they suddenly enter into effect on March 1, would be devastating to  the economy.  Note that while federal spending already fell by 15% at an annualized rate in the fourth quarter, this fall at a quarterly rate is just 3.6%.  The sudden cuts under the sequester would be far larger.

Almost all of the participants in this budget process, both Democrat and Republican, agree that the sequester is something to be avoided.  The sequester requirement was in fact set up precisely as something both sides would want to avoid, so that agreement would be reached on some other budget plan.  But Republicans are insisting on similarly large cuts in any budget.  They simply wish that the cuts would fall more on domestic programs affecting the poor and middle classes, and less on the military.  But economically the problem for GDP growth would remain if similarly sized cuts are forced through, and would indeed be worse (in terms of the impact on GDP, even ignoring the distributional consequences) if they are re-focused on programs for the poor and middle classes.

Finally, it is worth noting that the price index figures also released by the BEA on January 30 as part of the GDP accounts still show no indication that inflation is any issue.  While conservatives have been asserting since Obama took office four years ago that high deficits resulting from his policies would lead to high inflation, that has not occurred.  The price deflator for GDP, the most broad-based index measuring inflation, grew by only 1.8% in 2012.  The price deflator for the personal consumption expenditures component of GDP (the price deflator that Alan Greenspan reportedly favored for tracking inflation) grew by a similar 1.7% in 2012.  These are both just below the target of 2% for inflation that the Federal Reserve Board favors.  (Inflation of zero is not desired by the Fed or others as it is then easy for the economy to slip into deflation, which makes management of the economy even more difficult.)

And inflation in the fourth quarter of 2012 was even less, at just 0.6% for the GDP deflator and 1.2% for the personal consumption expenditures deflator.  The prediction of both conservative economists and politicians that high deficits under Obama would lead to high inflation unless government expenditures were slashed drastically, could not have been more wrong.

GDP Growth in the Second Quarter of 2012: Even Slower

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BEA release of 7/27/12. Seasonally adjusted annualized rates       Percent Growth Contribution to GDP      Growth
2011Q4 2012Q1 2012Q2 2011Q4 2012Q1 2012Q2
Total GDP 4.1 2.0 1.5 4.1 2.0 1.5
A.  Personal Consumption Expenditure 2.0 2.4 1.5 1.45 1.72 1.05
B.  Gross Private Fixed Investment 10.0 9.8 6.1 1.19 1.18 0.76
 1.  Non-Residential Fixed Investment 9.5 7.5 5.3 0.93 0.74 0.54
 2.  Residential Fixed Investment 12.1 20.5 9.7 0.26 0.43 0.22
C.  Change in Private Inventories nm* nm* nm* 2.53 -0.39 0.32
D.  Net Exports nm* nm* nm* -0.64 0.06 -0.31
E.  Government -2.2 -3.0 -1.4 -0.43 -0.60 -0.28
Memo:  Final Sales 1.5 2.4 1.2 1.52 2.38 1.23
    nm* = not meaningful
$ Value of Change in Private Inventories (2005 prices) $70.5b $56.9b $66.3b

The initial estimates for US GDP growth in the second quarter of 2012 were released by the BEA of the US Department of Commerce on July 27, and indicated that a slowly growing economy was growing even more slowly than before.  GDP growth of 4.1% in the last quarter of 2011 (based on revised figures issued on July 27 as well), had slowed to just 2.0% growth in the first quarter of 2012, and then to an estimated 1.5% growth in the second quarter.  The figures are subject to revision, but it is unlikely that the basic story will change significantly.

This slowdown in growth in 2012 had in fact been predicted on this blog in a posting on January 27, when the initial estimates for growth in the last quarter of 2011 were issued.  While growth at the end of 2011 was relatively robust, it was noted there that much of this had occurred due to an increase in private inventory accumulation.  As has been explained in an Econ 101 posting on this blog, it is the change in the change in private inventories which contributes to GDP growth, and that change in the change in private inventories had been large in the fourth quarter of 2011.  Using the figures from the current BEA estimates, the change in private inventories was essentially zero in the third quarter of 2011 (a fall of just $4.3 billion at 2005 prices), but then rose by $70.5 billion in the fourth quarter.  This increase by a net $74.8 billion added 2.53% points to GDP in the fourth quarter, accounting for over 60% of the now estimated 4.1% growth in that period.  Without this (that is, if inventory accumulation had been at the same pace as before), GDP growth would not have been 4.1% but only 1.5% in that period (the growth of final sales).  Since over time the pace of inventory accumulation is relatively steady on average, even though there can be significant swings in any given quarter, it was predicted that GDP growth could well slow in 2012.

That is what happened.  GDP growth slowed to a pace of just 2.0% in the first quarter of 2012 and to an initial estimate of just 1.5% in the second quarter.  There are many other changes going on of course, but the swings in the change in change in inventory accumulation can have a significant impact in any given quarter.  In the first quarter of 2012, the pace of inventory accumulation slowed to $56.9 billion.  This was still positive (inventories grew), but was a slower pace than the $70.5 billion accumulation in the fourth quarter of 2011.  That is, inventories were still growing at a fairly high rate in the first quarter of 2012, but by not as rapid a rate as they had in the last quarter of 2011, so this subtracted from GDP growth.  It subtracted 0.39% points from what GDP growth otherwise would have been (see the figure on Contribution to GDP Growth in the table above).  The initial estimate for the second quarter of 2012 is that private inventories grew by $66.3 billion, which was an increase from the $56.9 billion pace of the first quarter, and so contributed 0.32% points to GDP growth.  But will this continue?

Inventories are held only because of an expectation that the goods will be sold, and businesses do not wish to hold too much in inventories.  Inventory accumulation must be financed, and goods can deteriorate in value if not soon sold (this is especially the case for anything where technology changes rapidly, such as the latest electronic gadgets).  Rapid accumulation of inventories is indeed normally a sign that goods are not being sold as rapidly as the producers of these goods had expected, so a rapid rise in inventories is often a disturbing sign.  Production is still going on, and hence GDP is being generated, but a rapid accumulation of inventories will often then lead producers to cut back on production, and GDP growth will slow or even become negative.

This could happen now.  Private inventories have grown by a total of almost $200 billion in the last three quarters together (at constant prices of 2005), and have not grown by so much over a three quarter period since 2006.  Should producers decide to limit production so that total inventories stay where they are now in the next quarter (and succeed in doing this, as there is unpredictability in what sales will be), inventory accumulation will drop back to zero.  This is not unusual:  As noted above, inventory accumulation was essentially zero (in fact slightly negative) in the third quarter of 2011.  But if this happens, GDP growth would fall by 2.0% points (given the current pace of inventory accumulation) below what it would otherwise be, and could easily push GDP growth into negative territory.

Because of these swings in inventory accumulation from quarter to quarter, it is wise to look at what is happening to final sales.  This will often provide a better picture of what is happening in the basic underpinnings to short run growth.  As seen in the table above, final sales have grown at rates of 1.5%, 2.4%, and 1.2% in the most recent three quarters, respectively.  On average, GDP growth will tend to match these rates over time.  They show that the economy has been fundamentally weak over this period.

And the concerns are not just with what may happen to inventories.  Aside from inventory accumulation, the other elements making up GDP growth all show a weakening in the second quarter of 2012 compared to what their growth had been in the first quarter.  Private consumption expenditure only rose by 1.5% (at annualized rates) in the second quarter, compared to growth at a rate of 2.4% in the first quarter.  Private fixed investment only grew at a 6.1% rate, vs. a 9.8% rate in the first quarter.  Of this, non-residential fixed investment grew at a 5.3% rate vs 7.5% before, and residential fixed investment (a bright spot in the first quarter) slowed to a 9.7% rate of growth vs. 20.5% before.  Net exports (the net between exports and imports) subtracted from growth, and once again, government expenditure contracted and acted as a drag on growth.  As has been discussed before in this blog, if government expenditure had been allowed to grow during the Obama term by as much as it had during the same period under Reagan, the economy would likely now be at full employment.

There is therefore little to be encouraged by in these initial estimates for growth in the second quarter of 2012.  With Europe already in a double-dip recession, as they have foolishly pushed fiscal austerity policies despite their high unemployment, there is a good chance that US growth will slow to below 1%, and quite possibly even to something negative, in the second half of 2012.  Regardless of who should be blamed for this, it is likely that Obama will be the one blamed.