Tag Archives: GDP

GDP Growth in the Fourth Quarter of 2011: Not a Very Good Report

Posted on by
BEA release of 1/27/12 2011 Q3% growth 2011 Q4% growth Contribution to GDP growth in 2011 Q4
Total GDP 1.8 2.8
A.  Personal Consumption Expenditure 1.7 2.0 1.45
B.  Gross Private Investment 1.3 20.0 2.35
   1.  Non-Residential Fixed Investment 15.7 1.7 0.18
   2.  Residential Fixed Investment 1.3 10.9 0.23
   3.  Change in Private Inventories nm* nm* 1.94
C.  Net Exports nm* nm* -0.11
D.  Government Consumption and Investment -0.1 -4.6 -0.93
   1.  Federal Government 2.1 -7.3 -0.62
   2.  State and Local Government -1.6 -2.6 -0.32
Memo:  Final Sales 3.2 0.8 0.82
        nm* = not meaningful

The Bureau of Economic Analysis of the US Department of Commerce released this morning its first estimate of GDP growth in the fourth quarter of 2011.  The headline figure of 2.8% growth of total GDP might look reasonably good (actually, it is less than is needed in the on-going recovery, with unemployment still so high; it would be a reasonable growth rate if the US were already at full employment).  But the underlying details that led to this overall growth are worrisome.

As has been noted before in this blog, the short run dynamics of the quarter to quarter change in GDP is heavily influenced by what is happening to the change in private inventories.  Keep in mind that it is the change in the change in private inventories that is one component of the change in GDP in any given quarter.  In the third (and final) revision to the estimated GDP accounts for the third quarter of 2011, the change in private inventories was essentially zero.  This was down from a positive growth in inventories in the second quarter, and hence the contribution to the change in GDP in the third quarter was negative.  I noted then that there was a good chance that inventories would return to some positive growth in the fourth quarter, and hence spur the GDP growth figure for the quarter.  And this they did.  According to this first estimate for the fourth quarter, 1.94 percentage points of the 2.76% growth in total GDP (rounded to 2.8% in the reports), was due to this bounce back of  private inventories.  That is, 70% of the growth (1.94 / 2.76) was due to the change in the change in private inventories.

Leaving out this change in the change of private inventories, the growth of final sales was just 0.8%.  This is substantially down from the 3.2% figure for the third quarter.  This is a disappointment.  If final sales do not grow by more than that now, in the first quarter of 2012, one can easily see private inventories being cut back, and overall GDP growth would then be negative.  If that happens for two quarters, one will have met the standard definition of a new recession.  Not good in an election year (or any year for that matter).

There were two main reasons why final sales grew so much more slowly in the fourth quarter of 2011 than in the third quarter.  One was that non-residential fixed private investment grew by only 1.7% in the fourth quarter, sharply down from the 15.7% annualized growth in the third quarter.  It was still positive growth, and hence contributed to overall GDP growth, but only by 0.18 percentage points vs. a contribution of 1.49 percentage points in the third quarter.

Offsetting this a bit was the encouraging figure that residential fixed investment (mainly housing construction) grew at a 10.9% rate in the fourth quarter.  This was the fastest growth for such investment in a year and a half.  But this quarter to quarter figure can bounce around substantially.  More importantly for the contribution to overall GDP growth, residential fixed investment has declined by so much (since 2006), that it is now a relatively small share of GDP.  It would need to triple (i.e. grow by 200%) to get back to where it was before.  And non-residential fixed investment is 4.6 times as large, so what is happening to non-residential fixed investment is much more important.

But the most important reason for the disappointing growth in fourth quarter GDP was an absolute decline in government expenditure.  Total government consumption and investment expenditure fell by 4.6% in the fourth quarter, with federal government expenditure falling by a sharp 7.3% and state and local government expenditure falling by 2.6%.  For 2011 as a whole, federal expenditure fell by 2.0%, while state and local expenditure fell by 2.3%.

With this drag caused by falling government expenditures, it should not be surprising that GDP growth was so weak, held up mainly by inventory accumulation.  And if inventories now revert (over time, the quarter to quarter changes average close to zero), the US could fall back into a recession.  Yet many Republicans and especially the Tea Party supporters continue to claim that the way to get strong growth is for government to contract.  They claim that such contractionary policies will be expansionary.  Yet one sees no evidence of this in the new figures.  If it were not for the accumulation of private inventories (items produced but then not sold), GDP growth in the fourth quarter of 2011 would have been extremely weak.  Contractionary policies are contractionary.

But there was good news on the inflation front, assuming one believes lower inflation is always good.  As part of the GDP accounts, the BEA also estimates the price deflators for the various GDP components (so as to go from the nominal measures to real ones, so one can then get real growth rates and changes), and in particular the price deflator for Personal Consumption Expenditures (PCE).  This PCE deflator is favored by many, including reportedly Alan Greenspan (although he in fact focused more on the core PCE deflator, which excludes food and energy prices), as the best estimate of what is happening to US inflation.  The PCE deflator rose by 1.8% in 2010 as a whole, and then at an (annualized) rate of 3.9% in the first quarter of 2011.

Conservative economists, such as John Taylor of Stanford and Allan Meltzer of Carnegie Mellon, as well as Republican politicians such as Congressman Paul Ryan and others, had complained of the Fed’s aggressive policies to spur the economy, and asserted that they would lead to high inflation in the US (see, for example, here and here).  John Taylor often invoked the hyperinflation in Zimbabwe as a warning of what could happen if monetary policy was not brought under control (see, for example, here).  The rise in the PCE deflator in early 2011 was promoted as evidence of inflation starting to rise.  Keynesian economists, such as Paul Krugman, argued inflation was not a concern, with the economy in a liquidity trap and high unemployment keeping down wages so that unit labor costs were falling or flat.  They argued that the rise in observed inflation in early 2011 was due to changes in volatile commodity prices such as oil, and that such changes are rarely sustained.

What has happened since early 2011 clearly supports Krugman and the Keynesians.  After  rising at a 3.9% rate in the first quarter of 2011, the PCE deflator rose at a 3.3% rate in the second quarter and a 2.3% rate in the third quarter.  And the newly released figures for the fourth quarter indicate an estimate of just a 0.7% rise in the fourth quarter.  While the fourth quarter figures are subject to change, the trend is clearly down, with an inflation rate that is indeed arguably now too low.  Such a low inflation rate makes it more difficult for the economy to adjust (as relative prices are then more difficult to adjust), plus the very low rate increases the risk of the economy declining into price deflation, where it can be very difficult to emerge (as Japan faced in the 1990s).

One final point:  One should not put too much weight on any figures on the economy for just one quarter.  Quarter to quarter figures can bounce around a lot.  And the figures released today are simply the first estimates of what the economy was doing in the last quarter of 2011.  Over the next two months, these initial estimates will be revised twice, as is always done.  Sometimes the revisions can be significant.

Still, some of the initial estimates are of concern, and should the trends continue into 2012, the economy will be in trouble.

Contribution to GDP Growth of the Change in Inventories: Econ 101

Posted on by

An update to this post, looking at the issue from a different perspective, is available here.

This is the first post in a series that I will label “Econ 101”.  Their purpose will be to explain some economic concept that might generally not be clear to many, yet often appears (and often incorrectly) in news reports or other items that readers of this blog might see.  This first Econ 101 post is on how changes in private inventories enter into the National Income and Product (GDP) accounts, where there is often confusion on the contribution of rising or falling inventories to the growth of GDP.

In the most recent (December 22) release by the government of the GDP accounts in the third quarter of 2011, growth in overall GDP was an estimated (and disappointing) 1.8%. But many news reports stated that private inventories fell, and that had these inventories not changed, GDP growth would have been 1.4% points higher, or a more respectable 3.2%.  Yet when one looks at the underlying GDP figures issued by the BEA (the Bureau of Economic Analysis, US Department of Commerce), one sees that the change in private inventories was essentially zero (and in fact was slightly positive).  If inventories did not fall, why did many commentators state that a fall in inventories reduced GDP growth in the quarter?

The confusion arises because while the GDP (Gross Domestic Product) accounts measure the flow of production (how much was produced during some period of time), and the flow of how much was then sold (e.g. for consumption or investment), inventories are a stock, and it is the change in the stock of inventories that enters into the GDP accounts.  GDP is the flow of goods and services produced in the economy, and these goods and services are then sold for various purposes, including private consumption, private fixed investment, government consumption and investment, and exports, with imports also a supply of goods that can be sold.  But goods produced in some period will not necessarily match goods sold in that same period.  The difference is accounted for by either a rise or a fall in inventories.  Hence the change in the stock of inventories, when added to final sales (with imports entering as a negative), will equal total goods and services produced, which is GDP.

From one period to the next, we are normally interested in how much GDP rose or fell in that period compared to the previous one.  And we are interested in seeing how much of that growth in GDP will match up with and can be accounted for by growth of consumption, investment, and other elements of final sales.  These demand components are important, particularly in the economy as it is now.  With high unemployment and production well less than capacity, production of goods and services is driven by the demand for them.  Hence one is looking at the change in consumption or fixed investment or government expenditures from one period to the next.  And as the balancing item between GDP production and final sales, one would now be looking at the change in the change in inventories.

The term “the change in the change in inventories”  is a mouthful, and not often seen in news reports (indeed, I have never seen it used).  But that is what then leads to the confusion.  In the third quarter of 2011 (in the estimates released by the BEA on December 22), the change in private inventories was essentially zero, as noted above.  But there had been some positive growth in private inventories in the second quarter of 2011. Hence, the change in the change in inventories, going from something positive to essentially zero, was negative.  That is, if inventories had continued to increase in the third quarter of 2011 as much as they had in the second quarter, GDP growth would not have been 1.8% but rather would have been 3.2%.  The change in the change in inventories meant GDP growth was 1.4% points less than what it otherwise would have been.

The point can perhaps best be illustrated by some simple numerical examples.  Suppose for some fictitious economy, that GDP (the production of goods and services) is initially 1000 (in, say, billions of dollars), while the total of final sales (for consumption, fixed investment, and so on) is 950.  With production of 1000 and sales of 950, inventories will increase by 50.  Assume the stock of inventories at the start of the period is 500, so the stock will total 550 (50 more) by the end of the period.  The figures are as in this table:

Period 1 Period 2 Change % Change
GDP 1000 1050 +50 5%
  Change in Inventories  50  80 +30 3.0% points
  Final Sales 950 970 +20 2.0% points
Stock of Inventories:
    Start 500 550
    End 550 630
In the second period, suppose that production (GDP) increases by 50, or 5%, to 1050, while final sales only grow by 20, to 970.  The difference between production and sales must accumulate in inventories, so the change in inventories will now be 80.  Therefore, the change in the change in inventories will be 30 ( =80-50), and the contributions to the 5% growth in GDP will be 2.0% points from the change in final sales, and 3.0% points from the change in the change in inventories.  It is also worth noting that the stock of inventories has now grown to 630 by the end of the second period, which is substantially higher as a share of GDP or of final sales than it was at the start of period 1.  Hence, there is reason to assume that producers will likely scale back production (GDP) in the near future as long as final sales growth remains so sluggish, as there is likely little reason to accumulate even more unsold inventories on the shelves.
.
The second example will illustrate the case where inventories continue to rise, but at a slower pace than in the first period:
Period 1 Period 2 Change % Change
GDP 1000 990 -10 -1%
  Change in Inventories  50  20 -30 -3.0% points
  Final Sales 950 970 +20 +2.0% points
Stock of Inventories:
    Start 500 550
    End 550 570
In this example, final sales still grows by 20 to 970.  But producers here have scaled back production to just 990, or 1% below what it had been, with inventories now growing by just 20 rather than the 80 of the first example.  The change in inventories is still positive (at +20), but the change in the change in inventories is now negative, at -30.  The contributions to the -1% growth in GDP growth is made up of +2.0% points from final sales, and -3.0% points from the change in the change in private inventories.
As a final example, we will look at a case where the change in private inventories is negative.
Period 1 Period 2 Change % Change
GDP 1000 1050 +50 5%
  Change in Inventories -50 -20 +30 +3.0% points
  Final Sales 1050 1070 +20 +2.0% points
Stock of Inventories:
    Start 500 450
    End 450 430
Final sales once again grows by 20, although now from 1050 to 1070.  Sales is greater than production in each period, and inventories are drawn down by 50 in the first period and by 20 in the second period.  But while the change in inventories is negative in each period, that change is less negative in the second period than it is in the first.  That is, the change in the change in inventories is a positive 30, and this accounts for 3.0% points of the 5% growth in GDP.  It is also valuable to note that with inventories falling in each period, the total stock of inventories by the end of the second period is getting fairly low, so it is reasonable to expect that producers will aim to replenish inventories in future periods, with this then acting as a spur to growth.
.
Such swings in inventories are often important when economic growth is turning around, as at the start of a recovery from a downturn, or at the start of a downturn following a boom.  An example is seen at the end of the most recent recession, in the middle of 2009. The economy was in a state of collapse in 2008, the last year of the Bush Administration, and this fall carried over into the first half of 2009.  This downturn was then halted and reversed as a result of the policies implemented at the start of the Obama Administration. GDP was falling at a huge 8.9% annual rate in the last quarter of 2008, and at a still very high 6.7% rate in the first quarter of 2009.  Growth was then still negative, but at only a 0.7% rate, in the second quarter of 2009, and then started to grow at a 1.7% rate in the third quarter, and at a 3.8% rate in the fourth quarter.
.
The change in private inventories was negative in each quarter throughout this period. Specifically, private inventories fell by $200.5 billion in the second quarter of 2009, fell again by $197.1 billion in the third quarter, and fell again by a further $66.1 billion in the fourth quarter.  But the change in the change in private inventories was positive in the third and fourth quarters (while negative in each, they were becoming less negative), and this then accounted for a positive 0.2% points of the 1.7% growth in GDP in the third quarter, and a strong 3.9% points of the 3.8% growth in the fourth quarter (when final sales in fact declined slightly, accounting for a -0.1% contribution to growth in that period).
.
To summarize:  As everyone knows from their first Econ 101 class in Macroeconomics, GDP is equal to Consumption + Investment + Government Spending + Net Exports (Exports minus Imports), where total Investment is equal to Fixed Investment plus the Change in Inventories.  The change in GDP will therefore equal the change in Consumption + the change in Investment + the change in Government Spending + the change in Net Exports, where the change in Investment will equal the change in Fixed Investment plus the change in the Change in Inventories.
.

New Home Sales Remain Abysmal, But The Potential Should Be Recognized

Posted on by

New home sale figures for October, recently released, remain abysmally low at just 307,000 sales at an annual rate.  They have fluctuated within only a narrow range over the past year, with no clear trend and no signs to be encouraged by.  What is more interesting is the longer term context.

New home sales in the US fluctuate a good deal, but around a rising trend of 1.0% a year (calculated from a regression over the 1980 to 2010 data).  They reached a fairly stable level of approximately 900,000 housing units a year between 1998 and 2001.  But there was then a bubble between 2002 and 2006, reaching a peak of almost 1,300,000 in 2005, and then crashing to a bit over 300,000 in 2010 and 2011, where it now seems to have leveled off.

Only 300,000 new home sales a year is abysmal and a major drag on the economy.  It is only one-third of the 900,000 level of the early part of the last decade, and less than one-quarter of the levels reached in the bubble years.  But it should also be noted that people need homes, and that that need grows over time due to population growth.  The trend 1.0% growth found in the data is consistent with this.  And with new home construction now far below trend, it will be a significant spur to the economy if and when housing construction recovers.  Brad DeLong has made a similar point in his blog a number of times.  Here is one such post.

Keeping things simple and conservative, let’s assume that new home sales will, for the purposes here and over periods of time, on average equal the number of new homes constructed.  All are eventually sold, with very few exceptions.  And while there are figures available for new housing starts, these are consistently higher than sales for reasons that are not clear, but may reflect homes never completed.  Using the 900,000 units sold a year between 1998 and 2001 as a reasonable norm, and for simplicity not even allow for a rising trend in this figure, one can calculate the excess over the bubble years 2002 to 2006 (the area in blue in the graph) and then the shortfall that has developed over 2007 to 2011 and continues (the area in red).  Based on the figures underlying the graph, the excess during the bubble was 1.1 million units, while the shortfall in the subsequent bust through 2011 was 2.2 million units.  There is therefore now a net shortfall in housing supply of 1.1 million, as the excess over 2002 to 2006 has been more than worked off.  And as long as new home sales and construction remain at only 300,000 a year, that shortfall (relative to a 900,000 per year norm) will be growing by 600,000 housing units a year.

This suggests that a major pent-up demand for homes has built up.  It has not been resolved due to continued problems in the housing market and especially in the housing finance market, with many mortgages underwater and hence do not move, mortgages that remain hard to get by potential new buyers, an overhang of houses not sold, and a foreclosure process that has not worked well.  The market remains close to frozen.

But if these housing market problems could be resolved, so that construction could revert to its previous norms, the stimulus to the economy would be huge.  Assuming simply a return to construction of 900,000 units a year (and hence ignoring what would likely be an overshooting of this for a few years to make up for the net shortfall of recent years), implies construction of an additional 600,000 units a year.  At the average new home price of $221,800 in 2010, the aggregate value of such homes would be $133 billion per year.  This is just short of 1% of GDP.  Most of this would add to GDP as there is some, but only limited, “leakage” through some inputs that are imported (housing lumber, fuel for trucks, etc.).

But there will also be indirect multiplier effects, especially in the current depressed economy.  A reasonable estimate of the multiplier on housing construction would be 2 to 3.  A return of new home construction to previous levels would therefore add 2 to 3% of GDP. With actual GDP currently about 5% below potential GDP (estimate for end 2011 by the Congressional Budget Office, page 12), such an addition from housing construction would bring the economy about half-way back to where it needs to be.  But this will not happen until the market for homes and for home mortgage financing begins to function reasonably well.