Tag Archives: GDP

Possible Good News – A Gasoline Price Drop Would Help.

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Ronald White of tthe LA Times brings us this nugget via CalculatedRiskBlog:

Since I haven’t posted on gasoline prices in some time … from Ronald White at the LA Times: Gas prices expected to fall

“If oil remains low, the national average for gasoline will fall to $3.25 to $3.40 in the next two to three weeks as retailers slowly lower their prices to reflect their drop in cost,” said Patrick DeHaan, senior energy analyst for GasBuddy.com, a website that lists retail gasoline prices.

Another price decline would be good news, but it just takes us back close to the late February and early March levels – and March is when Personal Consumption Expenditure (PCE) growth slowed, and consumer sentiment fell sharply.
If this comes to happen, then it raises the chances of avoiding another drop in GDP  and another recession.  It’s the first positive contingency I’ve seen for quite awhile.  Most of the “if this happens…” around today are all negative: Eurozone collapses, Bank of America hits more losses, state and local governments continue to layoff workers, etc.  Of course, gas prices dropping depends on oil prices staying down, and that depends on the big banks and hedge funds not speculating in the oil markets to drive them up.

Is Debt-to-GDP a Good Measure?

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In a previous post, reader Sergei asks

Hello, I appreciate your article, however, I still wondering what is the meaning of the National Debt over GDP ratio? My numbers based on the US debt clock http://www.usdebtclock.org/index.htmlshow me that this ratio currently around 98%. Could you briefly explain what is the meaning behind this number?

Others might find the answer useful, so I’m making a post out of my response.

The “national debt” is the total money borrowed by the national government. It is the sum total of all the bonds and T-bills that have been issued and still outstanding by the U.S. government regardless of who owns (the lender or creditor) the bonds.  In some cases, one unit of the government such as Social Security owns the bonds which means in effect that one part of the government owes money to another part of the government.  In other cases, the central bank, The Federal Reserve, owns the bonds.  For details on the breakdown on the U.S. debt see here.

For centuries, nations have borrowed money and for centuries, there have been national governments that have found themselves unable to pay back the money or at times to even pay the interest on the money they borrowed.  These events are called “sovereign defaults”.   Economists are interested then in the is How much debt is too much?  Can the government bear the interest costs of the debt?  It is much the same kind of question that a bank asks about an individual when making a loan to an individual.  But there are important differences.

In doing this we are trying to compare the amount of debt to some measure of the government’s ability to make the payments.  The debt-to-GDP measure is simply a percentage number using total debt outstanding as the numerator and the size of GDP as the denominator.  We use GDP as a measure of the government’s ability to pay since a government’s income is taxes.  The taxes that can be collected depend on the total of all economic activity. After all, you can’t collect taxes of $1 trillion from an economy of only $500 billion, but it’s easily plausible to collect $1 trillion in taxes from an economy of $15 trillion. The higher GDP is, the more it is assumed the government has an ability to collect taxes and pay the interest.  Thus when the ratio is higher, it indicates that a lot of debt is outstanding and that implies (but only implies, not requires) a lot in interest payments.  So, it is assumed by many that a higher debt-to-GDP ratio means interest payments are likely a  greater burden and thus the chance of eventual default higher.

Using a debt-to-GDP ratio carries two major advantages over just using amounts of debt.  First, it allows us to compare two different countries regardless of their size.  For example, we can compare a small, little country like Greece which has a debt-to-GDP ratio that’s around 153% to a very large economy like say Germany which is around 84%.  Even though Greece has much, much less actual debt outstanding, it’s debt is a bigger burden on it than Germany’s debt is for Germany because Germany has a bigger economy and more ability to pay. Second, using the ratio allows us to compare debt levels of a country from different years.  Debt may be growing in dollar terms but becoming less of a burden because the country’s GDP is growing faster.  This was the experience of the U.S. since World War II.  In WWII debt-to-GDP reached 112%.  Ever since then, the U.S. has had an increasing debt because it almost always ran a budget deficit.  But the debt-to-GDP ratio declined from 1948-1981 because the economy grew so fast.

Why There’s So Much Attention to the Ratio In Recent Years

I’ll let noted economist Robert Shiller explain in his article in Japan Times (btw, this is an excellent, easy to read article – I recommend reading it):

A paper written last year by Carmen Reinhart and Kenneth Rogoff, called “Growth in a Time of Debt,” has been widely quoted for its analysis of 44 countries over 200 years, which found that when government debt exceeds 90 percent of GDP, countries suffer slower growth, losing about one percentage point on the annual rate.

One might be misled into thinking that, because 90 percent sounds awfully close to 100 percent, awful things start happening to countries that get into such a mess. But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90 percent figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30 percent, 30 to 60 percent, 60 to 90 percent, and over 90 percent.

And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.

There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.

The Problems With the Ratio

One major problem with the ratio is that people misunderstand it, as Shiller explains.  Many people think that a ratio of over 100% means the country is insolvent or bankrupt.  That’s false and a fallacy.  Many mainstream economists claim to be uncomfortable with ratios of over 90%, but that’s purely an arbitrary pick that reflects ideology more than economic experience.  Japan, for example, has been running a ratio of well over 200% for a decade with no signs of default.  In fact, investors think the Japanese government and economy are solid enough that the Japanese government borrows money at the lowest interest rates in the world.

Another very serious problem with the ratio is that when the ratio goes up, people assume it is because of deficit spending and borrowing.  In reality, most times when ratios go up it is because a recession or austerity program has shrunken the size of the economy and GDP.  For example, since 2007 the U.S ratio has gone up a lot.  But most of the increase has been because of the decline in GDP, not because of the stimulus spending program.

Finally, the last problem with measure is the very idea that it measures likelihood of default.  The empirical data on the relationship is weak.  Most importantly, default really happens when the debt-to-GDP ratio goes up AND the country borrows in somebody else’s currency (like small developing nations) AND the country has either fixed exchange rates or a gold standard.  These conditions apply to those nations that are part of the Eurozone – the countries that use the Euro as their currency.  These conditions also apply to many smaller developing nations.  These conditions absolutely DO NOT APPLY to large developed nations with their own currencies such as the U.S., U.K., Canada, Japan, Australia, Switzerland, and many others.

So, overall, the ratio is actually a pretty poor measure.  It’s useful in some esoteric technical econometric studies, but as a guide to whether the nation should cutting spending or not, it’s a horrible measure.

For the reader who is curious, data comparing different countries debt-to-GDP ratios can be had from the CIA Factbook here.

Economicshelp.org offers some graphics comparing these concepts for the U.S. historically:

There are different ways of measuring US National debt.

Firstly, there is the actual value of debt. This shows that (even adjusted for inflation) the value of debt has increased significantly over the years

  • In 1900, US debt was $43.6bn (2005 prices)
  • In 1945, US debt was $2347.41 bn (2005 prices)
  • In 2010, US debt was $12032.28 bn (2005 prices)

Though there were a few periods in the 1920s, 1950s and 1960s when the real value of debt was actually being reduced.

gross debt / public debt

from: wikipedia US Debt

The Public debt is the US debt held by private sector.
Gross debt includes debt that the government holds itself.

 

We Have A Debt-Ceiling Deal. The Economy Loses.

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Earlier this week the absurd and totally unnecessary debate in Washington over raising the national debt-ceiling came to an agreement, both houses of Congress passed it, and the President signed it.  Earlier this week I gave this metaphor for the deal, wondering why we need enemies with “friends” like our representatives in Washington.  Now that I’ve had a little more time to reflect, read some more on the details, comment on radio & TV about it, I think I was too easy on it.  It’s worse than it first appears.

This deal doesn’t “guarantee” that the U.S. government will reduce it’s deficit and maintain “solvency” (a non-concept for a sovereign country with a central bank).  Instead, this deal is more likely to guarantee that our economic non-recovery does, indeed, become at least a lost decade, if not a depression.  Right now I want to look at the economic impact of the deal.  In another post I’ll look at another casualty of the deal and the probably political-economy impact.

So what does the deal do specifically?  Well the details are fairly complex, even by Washington standards.  Right now the debt ceiling rises by $400 billion – enough to last for probably 3-4 months.  No real cuts will happen for maybe 60 more days.  Then starting in October 2011, which is the start of the government’s fiscal year 2012 budget (see here for definition of fiscal year), the action begins. Caps on spending start.  There are no tax or revenue changes in the deal.  It starts modestly with only $21 billion in spending cuts in 2012, although many of those cuts will be felt painfully by many citizens.  Students in graduate school in particular will feel the pinch in their pocket. Then in the remaining 9 years of the deal, there will be at least another $896 billion in reduced spending, amounting to about $100 billion less spending per year than currently planned.

This total of $917 billion in reduced spending is only the start though.  Congress is going to appoint a “special joint committee” of 12 members to recommend and additional $1.2-1.5 trillion in either spending cuts or tax revenue increases over the next 10 years.  (if you believe that committee with half Republicans will allow any revenue increases, I have a bridge in Brooklyn for sale).  If Congress doesn’t adopt those cuts, then Medicare payments, defense spending, and other discretionary spending would automatically by cut across the board. Either way spending gets cut another $1.2 trillion for the years 2013-2022.

This deal is supposed to raise the debt ceiling enough to get us through the end  of 2012 and the presidential election before the debt ceiling has to be raised again, sparing us this debate.  Don’t bet the your house on that though because House Republicans are betting they can keep this debate alive through then.  Basically Congress has created an elaborate mechanism in this law that increases the debt ceiling in several steps between now and the end of 2012.  But the way it’s done is that the debt ceiling keeps going up unless Congress votes to stop it (which the President would then veto).  It’s  a way for Republicans to keep talking about the debt and deficit, to keep recording “votes” against it, but all the time knowing that the debt ceiling will rise because it has to.  Pure politics at the expense of the country.

Right now the economy has over 9% unemployment.  Inflation is so low that deflation is actually the threat. The economy has effectively stalled or at least reached “stall speed”, threatening another double-dip recession.  This is not the time to be cutting spending.  To the degree spending cuts are necessary, they should happen when the economy is at or nearing full employment, not now.  At this time the economy needs all the spending it can find whether it’s from consumers, firms, or government.  And right now, firms and consumers are pulling back and keeping their wallets closed.  The government needs to step up and fill the gap.

So bottom-line, what should we expect?  I’ve seen several estimates from folks with more sophisticated econometric models than I can access.  My own back-of-the-envelope calculations and intuition say the drag on the economy is significant.  In 2012, this deal is probably going to take up to another 0.4 percentage points off of GDP growth.  The real damage starts in 2013 with a reduction closer to 1%.  Remember we’ve only grown at 0.8% rate so far in the first half of 2011, so 2012 will be close to zero growth and 2013 will likely be negative unless some other source of growth and spending can be found.  Looking around, it’s hard to imagine where that could be.  Instead I see nothing but possible negative risks: Europe imploding in a currency and austerity crisis, China having to pull back to slow their inflation, the housing mess in the U.S. is still bad, U.S. banks aren’t as healthy as they claim.

The estimates I’ve seen are similar.  Economic Policy Institute says the debt ceiling deal with cost us 1.8 million jobs in 2012 alone. The same article reports:

Top economists and CEO’s have also weighed in against the deal and said that GOP concessions to the Tea Party will cost our economy dearly. Pimco CEO Mohamed El-Erian warned that the deal will lead to less growth, more unemployment, and more inequality. Nobel Prize-winning economist Paul Krugman called the plan “a disaster” and “an abject surrender” that will “depress the economy even further.”

The Center for American Progress’s Michael Ettlinger and Michael Linden argue that while the deal “goes straight in the wrong direction,” Congress can redeem itself by using the so-called “super committee” mandated by the bill to focus on job creation. The committee, made up of six Republicans and six Democrats, is tasked with finding an additional $1.5 trillion of deficit reduction over the next 10 years, and must report a plan by Thanksgiving.

It’s noteworthy that J.P.Morgan Chase Bank’s research department, as representative of Wall Street as any, says that overall with this deal, government budget policy in 2012 subtract at least 1.5% points from GDP growth rate in 2012.  Since  it takes at least 2% growth in GDP to keep unemployment stable and we haven’t even had a single quarter of growth at more than a 4% rate since the end of 2006, things look grim for employment.

The cutters and austerians have won.  They will make a wasteland of the economy in the name of fighting the deficit.

But What About National Debt-to-GDP Ratio? Not a Problem, Really

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In the comments to my post on the extraordinarily weak 2nd qtr 2011 GDP numbers a reader asks for my thoughts about debt-to-GDP ratio and “how can we afford more stimulus”?  Since my response will be a little long and others might be interested, I’ll post it here.

Reader AZLeader asks:

Here are some other GDP indicators I’d value your comments on…

Government spending now is somewhere around 28% of GDP, well above the 60 year average of 18.6% or so.

Spending as a % of GDP is indeed up, but it’s not primarily as a result of discretionary spending going up.  In other words, the so-called Stimulus spending bill didn’t do the damage.  The ratio is up in large part because the denominator (GDP) shrunk.  We lost a huge chunk of GDP.  That has a double effect on the ratio.  When the economy goes into recession and doesn’t recover it reduces the denominator by a big chunk.  But a recession also automatically increases government spending through automatic stabilizers.  Spending on unemployment compensation, welfare, Medicaid, SS disability claims, etc. automatically increases, thus increasing the numerator as well.

Krugman shows this graph from the St.Louis Fed using non-partisan Congressional Budget Office data that compares the changes in spending to changes in the potential GDP over 60+ years.  Potential GDP is the GDP that would be produced if we were at full employment.  It indicates our capacity to produce if we choose to put all our resources (labor) to work.  Any value that’s above 1.0 indicates that spending is rising faster than potential GDP. A value less than 1.0 indicates that spending is might be increasing in total dollars, but it’s increasing less than what the potential GDP is.  When the value is less than 1.0 it means that government spending is having a contractionary effect on the economy. As you can see, the issue in the last few years is that despite the increase in dollars of spending, it’s been peanuts compared to the damage done by the banks’ financial crisis and the ensuing recession with high unemployment.  This part of the reason why I’ve (and a lot  of others) have said the stimulus program was too little and too short.

Government deficit spending last year was about 10.9% of GDP, way over the sustainable comfort level of 2.6%.

There’s two issues here.  First, There’s nothing that says 2.6% deficit as % of actual GDP is “sustainable” and greater than that isn’t.  ”Sustainable” in the sense that we can operate at that level indefinitely might be less than 2.6% or it might be greater than 2.6%.  For private sector entities (you,me, households, corporations, state governments) there’s a real meaning to “sustainable”.  But that’s because ultimately our spending ability is limited by the combination of our earning and borrowing ability.  Borrow too much and eventually lenders say “I don’t think you can pay it back, so pay higher interest rates, the debt begins to spiral up, etc.”.  But for a sovereign national government that creates it’s own currency, borrows using bonds denominated in that currency, and doesn’t strap itself to some fixed exchange rate system (like gold standard), there is no financial limit to the borrowing.  All of the nations that are having debt crises now (or in the past) have either strapped themselves to somebody else’s currency (Greece & Ireland with the Euro, Argentina in 2000 with the dollar) OR they borrowed their money in somebody else’s currency (less developed countries borrow in $ not their own currencies) OR they have  a fixed exchange rate (under the old gold standard 80 years ago).

What matters for “sustainability” is the ability of the economy to produce.  Does it have the  real resources to produce what the government is willing to spend on?  In this sense we see that even a 1-2% deficit-to-GDP ratio might be too high if we were at full employment and had no excess resources.  But the U.S. today has more than 10% of it’s labor force (even more since many would be workers aren’t looking) sitting on it’s hands doing nothing.

Another way of looking at the sustainability and desirability of deficit spending is to compare the interest rate the government has to pay to borrow now vs. the long-term growth rate of the economy.  If interest rates on government bonds were in the 6-8% range or higher (like in Greece and Italy), then large deficit spending might not be sustainable. But the U.S. is borrowing at near record low interest rates, less than 1% for a year.   Borrow at low rates, spend to invest in those things that grow your economy and get paid back later in larger GDP.

That brings me to my second point on “sustainability”.  The budget, government spending, is dynamic.  What GDP is the greatest determinant of what the deficit actually ends up being.  The budget discussions in Washington about 10 year projections are usually static projections.  They assume they can change the spending amounts while keeping the projected path of GDP the same.  Doesn’t work that way.  Running a large deficit relative to GDP, the kind of stimulus I think we need, will raise the deficit-to-GDP number immediately, but the ratio will then automatically decline. Again it’s the automatic stabilizers mentioned earlier.  As people go back to work and unemployment declines, the GDP rises faster.  Those people also pay taxes, so government revenues increase.  Spending in the form of unemployment comp, welfare, disability payments, Medicaid, etc all drop as people go back to work.  The deficit automatically shrinks relative to GDP.  This was how Clinton managed to produce a narrow government surplus at the end of this second term.  He eliminated the deficit completely.  It wasn’t by cutting spending. It was because the economy grew enough to reach full employment.

Government debt is just under 100% of GDP, the highest level in our economy that we’ve seen since WWII where it briefly spiked well above that.

Yeah, so what? Japan’s debt is around 200% of GDP and has been for over a decade.  Government debt is not like private debt.  It doesn’t have to be paid off. Government bonds are really just like government issued paper currency that pays interest.  This is why banks and investors love government bonds.  It’s a way to hold large amounts of cash and still earn interest.  A growing economy also needs a growing money supply and a growing supply of government bonds.  In the early part of this past decade (I forget the year), Australia was running a surplus for a few years.  It was paying down it’s national debt.  The bankers went to the Australian Treasury and the Australian central bank and asked the government to borrow and issue bonds anyway because they needed a larger volume of bonds in existence in order to run the banks.

Through “Intergovernmental Holdings” the U.S. government owns about 1/3rd of its own debt.

Yes.  $4.6 trillion, approximately 1/3,  of the $14.3 trillion total US government debt is “owned” by various other parts of the government.  The biggest chunk is the Social Security trust fund, $2.7 trillion.  The rest is in various other government “trust funds” such as Railroad employees retirement fund, government employees pension plans, highway building trust fund (paid by gas taxes), etc.  These funds reflect special taxes or fees that have been collected that are by law dedicated to a particular purpose, but the government hasn’t spent the money on that purpose  yet.  The accumulation of money in these funds (think of them as pre-payments of special taxes) must by law then be “invested” in the safest interest bearing assets available, which happen to be U.S. government bonds.  Let’s take a brief look at one of these funds: the Social Security trust fund.  The way SS works, dedicated SS payroll taxes are collected each month to pay for this month’s benefits.  (FICA taxes).  Obviously we want benefits to be relatively constant month-by-month.  Grandma wants to know just how much her check will be next month.  But the payroll taxes collected each month vary greatly. So, by the original law, SS Admin was supposed to make sure it always had enough liquid cash on hand to pay 1 year’s anticipated benefits.  This is the trust fund.  In the 1980′s the trust fund was too low – nearly depleted because benefits had been increased.  So payroll taxes were increased.  When the trust fund had fully recovered (circa 1991), the decision was made to continue to collect extra payroll taxes from workers in the 1990′s and early 2000′s in anticipation of the baby boom.  The current $2.7 trillion trust fund represents way more than the law said was necessary.  It represents the baby boomers having already pre-paid their own retirements.

These intra-governmental bonds cannot be traded on the public market, but they are regular debt obligations of the Treasury nonetheless.  To not pay these bonds is to renege on previous promises that people have relied upon.  It also might not be legal, although that is outside my experise.

In addition to the $4.3 intragovernmental holdings, there’s $1.6 trillion in government bonds held by The Federal Reserve.  These are ordinary bonds that The Fed bought from banks (that’s where banks get reserves).  Any interest paid on these bonds goes to The Fed who then sends it back to the Treasury as Fed profits.  This amount could easily be reduced by maybe 1/2 without consequences.

Given these constraints, where can we get the money to fund spending programs like the “stimulus” to create jobs and recover the economy?

As I attempted to describe above, it’s a fallacy to think of the government as having a financial constraint on it’s resources.  Government (again, a sovereign, fiat money, floating exchange rate, government that borrows in it’s own currency) faces no financial constraint.  Government is not like a household no matter how often misguided politicians say it.  You, I, households, firms, corporations, and state and local governments must obtain cash from either income or borrowing before we spend it.  Government does not face that constraint.  Government defines and creates the reserves that can become our spending money.  It has a monopoly on the creation of money.  And money today can be created as fast a somebody at the central bank can type (although we may not want to create it that fast).

Let’s consider what actually happens when the government spends.  The Treasury writes a check and sends it to a contractor, or SS beneficiary, or someone.  That check is drawn on an account at The Fed Reserve bank.  Let’s suppose you get the check.  You got income from the government. You take the check to your bank, let’s say it’s Chase.  You deposit it in your checking account.  You go out and spend the money by using your debit card to buy dinner, thereby helping to create a job and employ a waiter and kitchen staff.  But what happens at the bank?  Chase takes your check and sends it to The Federal Reserve. The Federal Reserve takes the government check and credits Chase’s account at The Fed.  This creates bank reserves.  The Federal Reserve has no limit on how much bank reserves they can create.  They can create all they want.  In the barbarous old days of the gold standard (before 1971), The Fed would have had to make sure it had enough gold on hand before issuing any reserves.  No such limit now.

So why doesn’t the government just spend endlessly with no limit?  Well, there’s no financial constraint on the government spending, but there’s a real resource constraint.  When the government attempts to increase deficit spending it is in effect placing orders for work to be done, things to be produced, and people to be employed (you do the same thing when you spend).  As long as there are unemployed resources to be put to work, the deficit spending is OK.  It stimulates more activity.  But if there are no idle resources then increased deficit spending will produce inflation because the government would be bidding against everybody else for resources.  At nearly 10% unemployment we have plenty of idle resources and that’s why there’s no threat of inflation despite the worries of those who don’t understand the gold standard ended 40 years ago.

There’s one other aspect of deficit spending that’s important.  This is not the result of theory, but rather is pure accounting.  I’ll just give a very brief mention of it here, but there’s a full tutorial here by Randall Wray.  A one page view of this idea is here.  Basically, government deficits are the mirror of the private sector.  There’s three “balances” that must add up to zero.  There’s the government spending vs. taxes balance, called the budget deficit.  There’s the question of whether the private sector (all households and firms together) are accumulating financial assets.  This is called “net private financial wealth”.  It’s the difference between what our private incomes each year and our private spending.  If we spend less than our income, then we are accumulating net financial assets, or in plain language, we’re putting money away in our bank accounts and investment accounts.  There’s a third balance which is the external capital account balance.  Basically it’s like the private net financial asset accumulation except it records how much foreigners are accumulating U.S. denominated financial assets.  If imports are greater than exports (trade deficit), then foreigners are collecting U.S. financial assets, typically government bonds.

Now there’s no way the private sector can create net any new financial assets. If I loan money to you, yes, I create a financial asset on my books.  But you’ve created an exactly offsetting private debt on your books.  In aggregate, the private sector cannot create new financial assets.  That’s because financial assets are things like money, currency, and bonds.  And they can only be  created by government. They can also be gotten from foreigners by selling more exports than imports, but that ain’t gonna happen anytime soon.  By accounting, these three balances must equal zero.  This means that when the government runs a deficit it creates net financial assets that the private sector can accumulate.  If the government creates a surplus.

In simple language, this means that, assuming we run a trade deficit, that a government deficit means the private sector can accumulate financial assets.  If the government runs a surplus, though, it means the private sector must go deeper into debt itself.  See the answer to question 1 here for another explanation. There’s a dramatic historical graph that beautifully illustrates this relationship over the last 60 years.  Unfortunately, I can’t put my hands (mouse, really) on it right now.  When I find it again I’ll update.  The point is that government surpluses, the kind that the Tea Party and many Republicans claim they want as being responsible, can only happen if the private sector as a whole goes deeper into debt.  It’s private debt that got us into the Great Recession/Financial Crisis, not public debt.  In fact, the Clinton surpluses were a small part of it because to create those Clinton surpluses the private sector had to go deeper into private debt – which we did. It was called mortgages, corporate debt, credit cards, student loans, etc.

A long response, but I hope it was worth it and helps.

The Great Recession Was Even Worse Than Thought

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In yesterday’s release of the 2nd quarter 2011 GDP numbers for the U.S., the BEA also revised some past numbers.  This is not an unusual event.  It’s routine. But the news and revisions this year were disturbing and sobering.

First, a little about how GDP numbers are reported.  In this day and age of instant info when stock markets report numbers within seconds, we tend to think we should get all our data that quickly.  But it’s a really tough job.  Think about it.  GDP is the total market value of all the goods and services produced in a period of time.  For the U.S., that’s a lot of stuff.  There’s over 300 million of us buying things, making things, providing services, etc. The BEA has to add all that up.  Actually it’s got to find out what we did before it can add them up.  Some of the activity must be estimated.  Hard data on a lot of production isn’t even available until months or even years afterward.  In addition, to estimate real GDP from nominal GDP (nominal is what’s observable at current prices), they have to collect immense data on prices of nearly everything.  Looked at this way,they do a pretty good job.

So what happens is that each quarter they release three “estimates” of GDP and growth rates.  The first version is released at the end of the month after the quarter closes. This is the “advance” estimate.  That’s what we got yesterday, on July 29, for the quarter ending June 30.  Next month in late August they will issue a  revision of this number based on more and better information. Then in late September comes the “final” estimate based on even better analyses.  Then they start over in October with the 3rd quarter “advance” estimate, etc.  But in July each year, the BEA takes the opportunity to revise any of the data for the previous year, and at times for several previous years.  There’s nothing sinister here, just more time allows a better, more precise estimate.  And that brings me to yesterday’s news.

The BEA revised GDP numbers back to 2003.  Most of the numbers from 2003-2007 were pretty much unchanged, but from 2007 there’s a significant revision, a significant downward revision. The change shows that the Great Recession (what I prefer to call the Lesser Depression or Workers’ Depression) in 2007-2009 was much worse than previously reported. Instead of losing close to 5% of GDP in the recession, we lost close to 6% of GDP.  Calculated Risk shows the revisions graphically:

The following graph shows the current estimate of real GDP and the pre-revision estimate (blue). I’ll have more later on GDP.

Real GDP

The revisions also mean (as the graph shows) that we aren’t back to where we were in 4th quarter 2007 yet.  In other words, it’s almost four years after the recession began and we still have an economy that’s producing less goods and services than we did back then.  Keep in mind that our population is close to 3.5% larger now than it was then.  Kind of explains the bad the feelings you’ve been having, huh?

Another implication of the revision is that it clearly shows that the government policy response has been grossly inadequate.  The Obama stimulus program, which was clearly too small to deal with even the recession as we thought it was then, was definitely much, much too little.  Given what we now know of the size and scope of the recession, the government stimulus program needed to be at least twice, perhaps three times, as big as it was.  And, it needed to be more focused on stimulating demand through actual spending instead of having 40% of the money be tax cuts that wouldn’t be saved and wouldn’t help the economy.

Finally, a perusal of the graph shows us two things.  First, we lopped off a big chunk of the economy in 2007-09.  That’s lost opportunity.  It’s lost income. And it’s the 10%+ unemployment rate.  But more disturbing is the fact that the so-called “recovery” since then, a recovery that hasn’t gotten us back to the beginning, is itself running out of steam.  The curve is flattening in 2011.  That’s because the rage in Washington by both Republicans and the President has been for budget-cutting.  Budget cutting is contractionary fiscal policy.  They’re trying to slow down the growth of an economy that’s pretty much already run out of steam.

GDP for 2nd Qtr: Economy In “Growth Recession” – Very Bad News

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The Bureau of Economic Analysis released the “advance estimate” of 2nd Quarter 2011 GDP growth.  The numbers are bad.  Worse than most analysts expected.  I’ll let BEA explain:

Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- increased at an annual rate of 1.3 percent in the second quarter of 2011,
(that is, from the first quarter to the second quarter), according to the "advance" estimate released by the
Bureau of Economic Analysis.  In the first quarter, real GDP increased 0.4 percent.

A 1.3 percent annualized growth rate is very bad.  Yes, it’s a positive number which indicates real growth and not decline, but it’s not enough to keep people even, let alone putting unemployed people back to work.  What’s worse, the BEA, as part of it’s annual revision process in July of year, revises the past numbers based on better data and better information than what was available at the time.  They revised their estimate of real GDP growth in first quarter 2011 down to 0.4% annualized rate from the previously estimated 1.8%.

Putting both quarters together it means the U.S. economy has grown at a 0.8% growth rate for the first six months of 2011.  As said earlier, yes, that’s a positive number so it indicates “growth”.  But that’s growth in the total or aggregate size of the economy.  During those same six months our population grew at a 1% annualized rate.  So do the math.  The pie is 0.8% bigger but there’s 1% more mouths at the table.  It means less per person.

I’ve mentioned before how economists have an inadequate vocabulary when it comes to describing the condition of the economy.  We tend to use only the terms “recession”, which means decline or negative growth, and “recovery” which technically means “not a recession” or any positive growth rate.  But not all positive growth rates have positive results.

There’s an unofficial term used in economics called a “growth recession”.  A growth recession is when real GDP is growing – the rate is above zero – but it’s too small to really make an improvement in living standards or improvement in employment.  That’s where we’re at now.  We’re in a “growth recession”.  Technically GDP is still growing, but it’s so slow and so weak that unemployment will actually rise.

Today’s news on GDP in first and second quarters has taken many most analysts by surprise.  But it really shouldn’t be a surprise.  The Obama “stimulus” spending program started in 2009, which was way too small to begin with, is being phased out. With it federal government spending in the first six months has actually declined.  The biggest culprit in the weak GDP numbers though is consumption spending by households.  It has come to a virtual standstill at the end of June.  Why?  Well, unemployment is rising again – no jobs, no money to spend.  Unemployment compensation has been cut in many states and many long-term unemployed have run out of benefits.  Again, that cuts spending.  And in Congress, Republicans with Obama’s help have been pushing a cut-spending, cut-deficits agenda.  In economics this is called “contractionary fiscal policy”.  And that’s what we’re getting – a contraction of GDP.  No surprise really.

 

GDP 1st Qtr 2011 – Revised

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I missed posting this a few days ago.  Bureau of Economic Analysis says first revision of the GDP estimate for 1st quarter 2011 was essentially unchanged from the initial “flash” estimate provided at the end of April.  The U.S. economy grew at approx. 1.8% annual rate.

While the overall growth rate was unchanged, there was some shuffling among the categories.  The revised numbers indicate that consumption spending (C) was weaker than initially thought, accounting for only 1.53 points of GDP’s 1.8 percent growth rate as opposed to the original 1.91.

Offsetting this lower estimate of Consumption spending was a larger than originally thought increase in Inventories (part of I, Investment spending).

This is not a good sign.  It says that consumers are slowing their spending more and that as a result firms ended the quarter with more inventory than expected.  That tends to signal an economy slowing more than businesses had expected.

There’s a lot of headwinds and “aftershocks” that are hitting the economy now. Among them:

  • continued high oil and gas prices
  • slowed production and sales in the auto industry due to supply chain bottlenecks from the Japanese nuclear meltdown, earthquake, and tsunami
  • continuing cuts in government spending at all levels.  State and local governments in particular are cutting a lot.  Congress and the President have evidently decided this year that it’s more important to cut government spending and borrowing (despite less than 3% interest rates) no matter how much it slows the economy and raises unemployment.  Together state, local, and federal government cuts in spending reduced GDP growth rate by 1.09 points.  In other words, if we had simply continued spending at the existing rate instead of cutting, we could have had at least a 2.9% GDP growth rate.
  • Europe is having a lot of difficulties with their ill-designed monetary union and their ill-advised austerity policies.  Europe is slowing dramatically and some countries are falling back into recession.  Not good for overall global growth or U.S. exports.
  • China is struggling to contain it’s inflation and may need to slow down it’s growth rate.
  • and most significant, unemployment and wages continue to play out a depression for workers. 

The Ephemeralization of GDP Via GPS

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When you get down to it, Gross Domestic Product (GDP) is really a pretty lousy measure given how we try to use it.  But it’s about all we have so far.  Timothy B. Lee offers a fantastic example using Google and GPS.  A GPS is one of those “Global Positioning Systems” – those systems that tell drivers in a robotic voice where to turn to get to where they’re going so they never have to really look at maps again.  (I’m personally not a fan of GPS, but that’s a different tale).

But before we get to the example, let’s review some basics about GDP.  GDP is used by economists as the most common measure of the overall welfare or economic well-being of an economy.  Technically, GDP is a count of the “market value of all goods and services produce for final consumption (usage) by an economy within some time period, usually a year.”  We generally consider increases in GDP a good thing and decreases a bad thing.  Why?  Because more goods are supposed to mean more value and more well-being for people.  To figure out how to add up all the different goods, we add up the money value of the goods when they’re sold.  Otherwise, if we tried to add up actual physical quantities, we would have a horrendous mother-of-all-adding-apples-to-oranges problem.  How do you determine how many bottles of Coke are the equivalent of an open-heart surgery? You can’t.  So, we add up the money values.  But that depends on prices that the goods are sold at.

So what happens when innovation takes the price of good or service down to zero?  We still get the goods/services and utility they bring, but we they show up as zero in GDP calculation.  What happens when we invent a magic wand? Here’s Timothy B. Lee’s example:

Today these magic wands exist. For example, a couple of years ago, Google waved a magic wand that transformed millions of Android phones into sophisticated navigation devices with turn-by-turn directions. This was functionality that people had previously paid hundreds of dollars for in stand-alone devices. Now it’s just another feature that comes with every Android phone, and the cost of Android phones hasn’t gone up. I haven’t checked, but I bet that this wealth creation was not reflected in GDP statistics. And it’s actually worse than that: as people stop buying stand-alone GPS devices, Google’s innovation will actually show up in the statistics as a reduction in GDP.

So what’s the point? Should we scrap using GDP?  No.  We need GDP measures.  It’s useful. But we always need to be mindful that there’s more behind the cold statistics.  There’s always a human story and an economic reality behind the numbers. Making policy through pure reliance on the reported numbers without understanding the economic reality behind them is a mistake.  It’s like a doctor that treats only the blood test results and not the patient.

There’s lots of ways GDP can mislead.  This type of innovation-leading-to-zero-cost is only one.  GDP also misses valuable services that aren’t sold in a market, like the meal your spouse or roommate cooked yesterday, or the way your mama & papa took care of you as a little kid, or even the tomato you grew in your backyard and ate on your sandwich.  GDP also just measures goods and services.  It doesn’t tell us whether the additional toys made us any happier.

Still, despite it’s defects GDP is the best we have.  At least for now.  Maybe some brilliant reader or student will figure out a better way to measure national welfare some day.  It’s happened before like when Colin Clark, Simon Kuznets, and Richard Stone developed our current methods of calculating GDP.  But for now, we have to make do.

Downbound Again: GDP in 1st Quarter

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Yesterday the “flash” estimate for GDP growth in 1st quarter 2011 was released.  Not good. GDP only grew at a 1.8% annual rate, down from the 3.1% we experienced in the 4th quarter of 2010.  This is very disappointing, but not really surprising. Before I comment, I’ll let CalculatedRisk report and show one of his great graphs.

From the BEA:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 1.8 percent in the first quarter of 2011 (that is, from the fourth quarter to the first quarter) according to the “advance” estimate released by the Bureau of Economic Analysis

GDP Growth RateClick on graph for larger image in graph gallery.

This graph shows the quarterly GDP growth (at an annual rate) for the last 30 years. The dashed line is the current growth rate. Growth in Q1 at 1.8% annualized was below trend growth (around 3.1%) – and very weak for a recovery, especially with all the slack in the system.

The graph really puts into context just how slow and disappointing this “recovery” has been.  The recession of 2007-09 (the blue shaded area) was worse than the recessions in the early 1980′s.  But look at how fast the economy was able to recover from those earlier recessions. Growth rates in 1981, 1983, and 1984 were well over 6% and at times over 8%. The economy truly “recovered” the ground lost in the recessions before settling down to the long-term growth trend (the dotted line).  In contrast, we are almost two years into this poorly-named “recovery” and we are struggling to even get up to the long-term growth rate.  We haven’t really recovered at all.

It’s worse, though.  The signs are pointing down.  To recover, we needed to have better than 4th quarter growth.  But instead, things are slowing down.  And they are slowing down despite having gotten some significant stimulus at the beginning of the first quarter.  Remember last December Congress and President extended the large Bush-era tax cuts for the top-bracket income earners.  Republicans told us it was necessary to grow the economy and create jobs.  We also cut the payroll tax for this year only for Social Security as an attempt to stimulate the economy.  The Federal Reserve implemented Quantitative Easing II program throughout the first quarter, promising us it would stimulate the economy. Yet despite these efforts to stimulate the economy, the economy is actually slowing.

Why?  Let’s look at the data.  There’s lots of culprits, but the most significant ones are drops in Investment spending and drops in Government spending. Again, Calculated Risk reports from the  BEA news release yesterday (emphasis mine):

• Investment: Nonresidential structures decreased 21.7 percent… and real residential fixed investment decreased 4.1 percent.

• Government spending subtracted 1.09 percentage points in Q1 (unusual)

Basically it’s two big things.  First, Investment spending is decreasing overall, not increasing.  The exceptions were increases in inventories (business probably expected more sales than they got) and sales of software grew.

The second one is the disappointing one.  Government spending dropped so much that it subtracted 1.09 percentage points from the growth rate.  In other words, instead of the weak 1.8% growth rate, we could have had at least a 2.9% growth rate if only we had kept government spending unchanged.  Instead we have been cutting government spending like mad.  The federal government’s 2009 stimulus bill is over. The spending’s gone and now total spending is declining.  More significant is that state and local governments are cutting spending big time.  And state and local governments are cutting business taxes so that they have cut to spending even more.

It’s really not a surprise.  We’ve known for at least 75 years that cutting government spending is contractionary – it slows the economy.  Yet our so-called leaders in Washington persist in cutting right now at a time when the economy needs help, not hindrance.  All the first quarter numbers have proven is that, yes, contractionary fiscal policy (cutting spending and cutting the deficit) is indeed contractionary.  Well duh.  What is amazing is how so many politicians and businesspeople and bankers keep claiming that somehow, someway, if we cut spending and the deficit, some magic “confidence fairy” will inspire the entire economy to grow despite a lack of demand.

As Brad Delong put it:

Contractionary fiscal policy is contractionary.

With overall government spending on the decline and with severe aftershocks from the Japanese earthquake and rising oil prices, we’re down-bound again.  Buckle up.

4th Qtr 2010 GDP Revision

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First revision to the 4th qtr 2010 GDP results are out.  I’ll outsource the reporting and commentary to Mark Thoma and Ryan Avent:

Fourth quarter GDP was revised downward:

A disappointing day, by Ryan Avent: …let me draw your attention to two stories… First, America’s fourth quarter GDP growth has been revised down:

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.8 percent in the fourth quarter of 2010, (that is, from the third quarter to the fourth quarter), according to the “second” estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.6 percent…

The downward revision to the percent change in real GDP primarily reflected an upward revision to imports and downward revisions to state and local government spending and to personal consumption expenditures (PCE) that were partly offset by an upward revision to exports.

And Britain’s economy shrank by more than initially thought:

Britain’s economy shrank more than initially estimated in the fourth quarter, complicating the task of the Bank of England as a split deepens among policy makers on whether to withdraw stimulus.

Gross domestic product fell 0.6 percent from the previous three months, compared with an initial estimate for a 0.5 percent drop, the Office for National Statistics said today in London. The statistics office said its “best estimate” for the impact of cold weather on the data remains 0.5 percent. The slump was led by construction and investment.

The American data helps explain labor market figures that looked unusually bad given growth. In both cases, the fiscal and monetary authorities should be asking themselves whether they’ve overestimated the performance of these economies and their ability to handle big, and largely unnecessary, short-term budget cuts.

Though certainly better than lower growth, a 2.6% growth rate is not much progress. It’s basically treading water, though barely. To “recover” what was lost in the recession, including lost jobs, we need to grow much faster than that. Unfortunately for the millions of unemployed, problems at the state and local level are far from over, there are other headwinds working against growth as well (e.g. the prospect of higher oil prices, the end of the stimulus package), but policymakers have moved on to other things. And worse, the main topic presently, cutting the budget, works against the employment and output growth.

The comment I’ve seen on the overall trend is lifted from “Goldilocksisableachblonde” in from Thoma’s blog:

“It’s basically treading water…”

In aggregate , that’s accurate. When you break it down by income groups in the population , you’ve got a bunch who are treading water , a few walking on water , and the rest are drowning.