Summary
Tomorrow (7/29), the Commerce Department will release its advance estimate of second-quarter gross domestic product. So with this initial look at second-quarter data so close hand, why am I going back to the first quarter's numbers? Because as they were ultimately rendered after various revisions, they provide a wonderful example of how a little could go a long way in taking an initial result that was "disappointing," and transforming it into a final result that was "satisfying." Along the way, Wall Street bulls hyped the changes, leaving behind the impression of an economy perhaps stronger than it really was. And in the process, this helped the stock market to higher prices -- of course!
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Introduction
Tomorrow morning, the Commerce Department will release its first or "advance" estimate of second-quarter gross domestic product. Included in the report will be so-called "benchmark" revisions, covering data from the first quarter of 2002 through this year's first quarter, inclusive. Thus, reported results from 1Q2002 through 1Q2005 are likely to change at least a little bit, possibly resulting in some confusion.
So, with this release so close at hand, why am I going back now to have another look at first-quarter data? Because, the history of first-quarter data provides a solid example of how small changes along the way took an initial result that was not well-received, to a final release that Wall Street bulls hyped heavily as "proof" the economy remained in good shape. But I will run through a couple examples of where more than 100% of the revised growth came from; you can be the judge of just how sound it was.
One of the important messages I want to convey is that despite overall real GDP being a number in excess of eleven trillion dollars, relatively small changes from one quarter to another, calculated and expressed at annual rates, have a major impact on producing the growth figure that people see and the markets trade off.
The Chronology
On 4/28, the Commerce Department's "advance" estimate of first-quarter real GDP indicated an annualized dollar value of $11.078 trillion. This represented a positive 3.1% annual rate of change, versus the fourth quarter of 2004.
Fourth-quarter 2004 GDP had been reported at $10.994 trillion, so the initial estimate of first-quarter activity showed annual growth in gross domestic product of $84 billion. This illustrates the phenomenon mentioned above, since the $84 billion in growth was quite small, relative to the base number of $10.994 trillion.
The calculation for 2005's first quarter was 11.078/10.994, raised to the fourth power, which equaled an annual rate of change of 3.1%. In turn, the 3.1% reported result was a good deal weaker than the consensus forecast, clearly relegating it to the "disappointing" category.
On 5/26, the Commerce Department's second or "preliminary" estimate indicated a revised real GDP annualized dollar value of $11.089 trillion. This was only $11 billion more than the advance estimate, but it now represented a 3.5% annual rate of growth, an improvement of 0.4%, and something a good deal more appealing to Wall Street hypesters and their enablers in the usual venues of the financial media's regular propaganda loop.
The new calculation: 11.089/10.994, raised to the fourth power, which equaled an annual rate of change of 3.5%.
On 6/29, the Commerce Department's third or "final" estimate indicated a revised real GDP annualized dollar value of $11.096 trillion. This was a mere $7 billion improvement from the prior estimate, but this small amount was sufficient to kick the annualized rate of change to a rounded 3.8%, up another 0.3%.
The new calculation: 11.096/10.994, raised to the fourth power, which equaled a rounded annual rate of change of 3.8%.
Where the "Better Growth" Came From
Below are the usual tables/text I publish that examine what the major GDP components did to add to or subtract from growth. But first, I want to comment on just two phenomena that really helped do the trick!
In its first estimate, Commerce indicated an implicit price deflator, the primary inflation measure used to convert nominal into real GDP, that rose at an annual rate of 3.2%. By the time the final estimate rolled around in June, this measure had been revised down to 2.9%. There is virtually a one-for-one inverse relationship here, so this 0.3% reduction in the inflation measure accounted for about the same amount of upward revision in real growth. Thus, about 43% of the total 0.7% increase in real growth came from what I will describe as a "suspect" (euphemism) assumption of lower inflation.
It was the significant downward revision in the trade deficit, however, that was the really spiffy item. In GDP accounting, one dollar of negative "net exports" (the trade deficit) accounts for the loss of a dollar of real GDP.
The Commerce Department in its first report estimated net exports at a negative $663.2 billion. In Commerce's final report, this number had fallen to a negative $637.5 billion, for a total decline of $25.7 billion. Meanwhile, between the first and third releases, real GDP went from $11.078 trillion to $11.096 trillion, a total increase of $18 billion.
View the $18 billion increase in GDP against a $27.5 billion decline in the drag from trade and you see rather quickly where a lot more than all the change in growth came from. Do I think this magnitude of downward revision in the trade deficit was at least a little suspicious? You bet I do!
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NOTE: For a historical perspective on GDP methodology, etc., see John Williams' excellent work at: "Gross Domestic Product".
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General Observations Regarding
the Revised First-Quarter Numbers
* The three-month period ended March 2005 was the 14th consecutive quarter of reported real GDP expansion.
* Comparing the final (third) estimate of first-quarter numbers with the Commerce Department's final estimate of last year's fourth quarter, real GDP was up $101.9 billion or about 0.927%. Add one, then raise the result to the fourth power, and you get the rounded annual rate of change of 3.8%.
Nominal (Pre-Inflation) Comparisons
* Versus 2004's fourth quarter, 1Q2005 nominal GDP rose $196.9 billion, or at an annual rate of 6.7%. The respective numbers: 1Q2005 = $12191.7; 4Q2004 = 11994.8 billion.
* Versus 2004's first quarter, 1Q2005 nominal GDP rose $719.1 billion, or 6.3%. The respective numbers: 1Q2005 = $12191.7 billion; 1Q2004 = $11472.6 billion.
Real (After-Inflation) Comparisons
* Versus 2004's fourth quarter, 1Q2005 real GDP rose $101.9 billion, or at an annual rate of 3.8%. The respective numbers: 1Q2005 = $11096.2 billion; 4Q2004 = $10994.3 billion.
* Versus 2004's first quarter, 1Q2005 real GDP rose $398.7 billion or 3.7%. The respective numbers: 1Q2005 = $11096.2; 1Q2004 = $10697.5 billion.
* Four of the six primary GDP categories added to real growth in the "final" versus "preliminary" 1Q2005 estimates of economic activity. In order of their dollar contribution, these were:
(1) Residential fixed investment (housing, +$3.1
billion),
(2) Net exports (+$2.5 billion), by virtue of a
narrowing in the trade deficit by that amount),
(3) Nonresidential fixed investment (capital
spending, +1.8 billion),
(4) Government spending (+$1.6 billion).
* Two primary GDP categories subtracted from growth. In order of their dollar contribution, these were:
(1) Inventory change (minus $1.6 billion),
(2) Personal consumption expenditures (minus
$0.7 billion).
The following table breaks out in greater detail many of the numbers discussed above.
--------------------------------------------------
FINAL ESTIMATE OF FIRST-QUARTER 2005
REAL GROSS DOMESTIC PRODUCT (Released
6/29 -- Billions of 2000 Chained Dollars
at Seasonally Adjusted Annual Rates)
--------------------------------------------------
1Q2005 4Q2004 Change/
Final Final Impact
------------------------
Real GDP 11096.2 10994.3 3.8%
Inventory Change 66.8 47.2 +$19.6
Real Final Sales 11027.9 10945.5 3.0%
--------------------------------------------------
Components of GDP
-----------------
Personal Consumption 7815.8 7747.0 3.6%
Nonres. Fixed Investment* 1301.3 1288.3 4.1%
Resid. Fixed Investment 586.3 570.6 11.5%
Net Exports -637.5 -621.1 -$16.4
Government Purchases* 1954.8 1954.0 0.2%
--------------------------------------------------
Implicit Price Deflators:
Gross Domestic Product 2.9% 2.3% --
Gross Domestic Purchases 2.6% 2.9% --
--------------------------------------------------
*MEMO ITEMS
-----------
Government Purchases
--------------------
Total 1954.8 1954.0 0.2%
State & Local 1224.9 1225.1 -0.1%
Federal 729.9 728.8 0.6%
National Defense 491.3 490.7 0.5%
Nonresidential
Fixed Investment
----------------
Total 1301.3 1288.3 4.1%
Structures 240.8 242.3 -2.5%
Equipment & Software 1075.3 1059.5 6.1%
Info. Processing
Equip. & Software 630.1 599.5 22.0%
---------------------------------------------------
MAJOR GDP COMPONENTS -- CHANGES BETWEEN
"FINAL" AND "PRELIMINARY" 1Q2005 ESTIMATES
(Billions of 2000 Chained Dollars at
Seasonally Adjusted Annual Rates)
---------------------------------------------------
1Q2005 1Q2005
Final Prel. Change
----------------------------
Real GDP 11096.2 11088.8 7.4
Inventory Change 66.8 68.4 -1.6
Real Final Sales 11027.9 11018.8 9.1
---------------------------------------------------
Personal Consumption 7815.8 7816.5 -0.7
Nones. Fixed Invest. 1301.3 1299.5 1.8
Resid. Fixed Invest. 586.3 582.7 3.6
Net Exports -637.5 -640.0 2.5
Govt. Purchases 1954.8 1953.2 1.6
---------------------------------------------------
REAL GROSS DOMESTIC PRODUCT (SEASONALLY
ADJUSTED ANNUAL RATES, 2000 CHAINED DOLLARS)
--------------------------------------------
Year Q1 Q2 Q3 Q4
----------------------------------------
2005 3.8% -- -- --
2004 4.5% 3.3% 4.0% 3.8%
2003 1.9% 4.1% 7.4% 4.2%
2002 3.4% 2.4% 2.6% 0.7%
2001 -0.5% 1.2% -1.4% 1.6%
2000 1.0% 6.4% -0.5% 2.1%
1999 3.4% 3.4% 4.8% 7.3%
1998 4.5% 2.7% 4.7% 6.2%
-----------------------------------------
MEMO ITEM: Annual change in real GDP
before and after the "comprehensive
revision" published by the Commerce
Department on 12/10/03.
----------------------------------------
1929-2002 1959-1992 1992-2002
---------------------------------
After 3.4% 3.4% 3.2%
Before 3.4% 3.4% 3.2%
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Real Vs. Nominal, A Continuing Whiff of "Stagflation"
* The current release showed another decline (-0.1%) in the GDP implicit price deflator, versus May's release. However, the number remained high enough to keep in play concerns about "stagflation."
* According to the Commerce Department report of late June, the implicit price deflators for GDP and for gross domestic purchases came in at respective revised rates of 2.9% and 2.6% during the first quarter, versus rates of 2.3% and 2.9% during last year's final quarter. These GDP measures continue to report inflation at levels appearing well out of touch with reality.
* At least the last two quarters' inflation rates that apply to gross domestic product have been more sensible than the 1.4% and 2.0% rates that were reported for last year's September quarter. Those results were particularly difficult (as in "impossible") to justify. But maybe not really so difficult, considering the then-approaching national election. If you know what I mean!
Here are how the key GDP inflation measures have performed over the last nine quarters:
2003 2004 2005
---------------------- ---------------------- ----
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q
----------------------------------------------------
[1] 2.9% 1.1% 1.3% 1.4% 2.7% 3.2% 1.4% 2.3% 2.9%
[2] 3.9% 0.4% 1.6% 1.2% 3.4% 3.5% 2.0% 2.9% 2.6%
--------------------------------------------------------
Implicit price deflators for:
[1]GDP; [2]gross domestic purchases.
--------------------------------------------------------
Bear in mind the critical point made earlier -- that there is virtually a one-for-one inverse relationship between the GDP implicit price deflator and real GDP. A given decline in reported inflation translates into a similar increase in real gross domestic product. Therefore, understating inflation automatically overstates real growth.
The table below breaks out these relationships over the last 13 quarters. As a graphic example of the inverse relationship between inflation and real growth, note in the numbers below that the reported decline in inflation during last year's third quarter accounted for far more than 100% of the increase in real growth between the second and third quarters.
------------------------------------------------
NOMINAL AND REAL GROSS DOMESTIC PRODUCT
(SAAR, 2000 Chained Dollars); RATIO OF REAL
TO NOMINAL; IMPLICIT PRICE DEFLATORS FOR
GDP AND FOR GROSS DOMESTIC PURCHASES
------------------------------------------------
Year Q1 Q2 Q3 Q4
------------------------------------------------
2005 Nominal 6.7% -- -- --
Real 3.8% -- -- --
R/N 0.57 -- -- --
===========================================
GDP Def. 2.9% -- -- --
PCE Def. 2.6% -- -- --
------------------------------------------------
2004 Nominal 7.4% 6.1% 5.5% 6.2%
Real 4.5% 2.8% 4.0% 3.8%
R/N 0.61 0.46 0.73 0.61
===========================================
GDP Def. 2.7% 3.2% 1.4% 2.3%
PCE Def. 3.4% 3.5% 2.0% 2.9%
------------------------------------------------
2003 Nominal 4.9% 5.3% 8.8% 5.7%
Real 1.9% 4.1% 7.4% 4.2%
R/N 0.39 0.77 0.84 0.74
===========================================
GDP Def. 2.9% 1.1% 1.3% 1.4%
PCE Def. 3.9% 0.4% 1.6% 1.2%
------------------------------------------------
2002 Nominal 4.4% 4.2% 3.9% 2.7%
Real 3.4% 2.4% 2.6% 0.7%
R/N 0.77 0.57 0.67 0.26
===========================================
GDP Def. 1.0% 1.8% 1.3% 2.0%
PCE Def. 0.8% 2.8% 1.4% 1.9%
------------------------------------------------
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