GDP versus final sales

Bob Barbera tells me there is information in the data on "final sales to domestic purchasers." Final sales to domestic purchasers is GDP minus net exports and inventory investment. It measures demand for goods and services from US households, businesses and government, regardless of whether those goods and services are imported or domestically produced. GDP, by contrast, measures demand for US-produced goods and services, regardless of whether that demand is from foreigners or US residents. Here's a graph of quarterly growth rates of real GDP and final sales:

The GDP numbers show a weakening of growth, from 5% in 2009Q4 to 3.7% in 2010Q1 to 2.4% in 2010Q2 (the latter number likely to be revised further downward). But the final sales figures show the opposite: growth in demand accelerated from 0.2% in 2009Q4 to 1.3% in 2010Q1 to 4.1% in 2010Q2.

What does this mean? It means that the slowdown in GDP growth is due to a dramatic rise in imports - the BEA's report on 2010Q2 GDP says that import growth reduced GDP growth by 4 percent in the quarter. People - most importantly, businesses - are buying, but they're buying imported goods rather than domestically-produced goods. The result is little feedback to domestic employment. If I had to guess, I would guess that the problem is that weakness in the housing sector means lower than normal demand in sectors heavy on domestic production. Business investment in equipment and software has been leading growth the last few quarters, and much of this stuff is probably imported.

GDP is up at last!

The Bureau of Economic Analysis reports GDP growth was 3.5% in 2009Q3, considerably higher than the consensus forecasts. Lots of commentary here.

My take, which is largely informed by conversations with Bob Barbera, is that people are being far too pessimistic about the strength of the recovery. For example, here's Bruce Kasman and Jan Hatzius debating whether growth in 2010 is going to be slow at 2%, falling to 1.5% by year's end (Hatzius), or fast at 3.5% (Kasman). If growth is even as slow as 3.5%, that would be very surprising given how fast the economy recovered from the last two deep recessions: in the first five quarters of the recovery from the 1974-75 recession GDP growth averaged 5.4%; in the first five quarters of the recovery from the 1981-82 recession it averaged 6.0%. Forecasters are thinking we're going to have a recovery more like those of 1990-91 and 2000-01 (2.9% and 1.8% respectively), but I don't know why that would be the case. Yes, there are impediments to strong growth in the current recession that didn't exist in the 1974-75 and 1981-82 recession - notably, households have to work through a big debt overhang and the financial sector is still very weak. But there are also forces that should accelerate growth, among them extraordinarily stimulative monetary and fiscal policy. Once growth begins, I would anticipate that all of the accelerator effects that made the downturn so scary - low growth --> problems in housing sector --> problems in financial sector --> credit crunch --> low growth - will begin to work in the opposite direction. The financial sector that looks so weak today won't be looking weak at all a year from now. The threat of massive foreclosures and a crumbling commercial real estate market will recede as growth solidifies. I think it would be prudent to have another round of fiscal stimulus focusing on aid to states, but I don't see grounds for pessimism overall.

As for 2009Q3 GDP, Bob has an interesting take. He says (I'm paraphrasing here) that the inventory numbers the BEA computed are almost certainly too low. They have inventory investment at -$130 billion in Q3 versus -$160 billion in Q2. Bob says - and he's right, I've looked at the numbers - that the US economy has never had such a string of large inventory reductions as the BEA is reporting. And these numbers are essentially a guess anyway - at this point, BEA has the inventory numbers for July, partial numbers for August, and nothing for September.

A more realistic estimate of inventory investment is that rather than improving from -160 to -130 (a +$30 billion addition to GDP in Q3), the improvement was 2 to 3 times that (so inventory investment should be between -100 and -70). Eventually inventory investment has to be positive; this will take a few quarters, but the process has to move faster than the BEA is proposing.

The implications for our estimate of Q3 growth: the $30 billion improvement added 0.94 percent to growth in Q3. Doubling or tripling that gives us an additional 0.94-1.88 boost to growth. Now about a third of the higher inventories, if it occurred, would be due to higher imports, so you have to reduce it proportionately. This would give us a net impact of 0.63-1.25%. That is, Q3 GDP growth should have been between 4.1% and 4.75%.

If Bob's right about the inventory numbers, then when Q3 GDP is revised next month it will be revised substantially upward. If he's wrong about the inventory numbers for Q3, that just means that we're headed for a stronger inventory adjustment in the next quarter or two - we could see 4%+ growth in 2009Q4 and 2010Q1.

After that, it's kind of a race between the momentum of the recovery versus the headwinds in the form of state and local spending, financial stress, etc. I'm betting on the momentum of the recovery.