The first estimate (‘flash’ estimate) of 4th quarter 2009 Real GDP growth came out Friday. The headline number, a 5.7% annual growth rate certainly looks good and has gotten a fair amount of attention. Unfortunately, the number is highly deceptive.
First, this is only the flash estimate. It will be revised next month and the month after that. Remember at the end of October 2009 the flash estimate for 3rd Qtr real GDP was 3.7%! Everybody declared it proof the recession was over, time to move on to cut spending, etc. Then in November the number was revised down to 2.7% and eventually just before Christmas we got the more accurate number of 2.4%, of which 1.4 points were cash for clunkers, a discontinued program. I fully expect this 5.7% estimate to be revised downward in Feb and March. It may not be cut as much as the 3rd qtr number was, but nonetheless.
More importantly, it’s always important to look at where the growth or increase comes from and then ask whether it’s sustainable. In this case, the growth overwhelmingly came from changes in private inventories. Students in my classes should remember that GDP = C + I + G + (X-M). In other words, GDP is the sum of consumer, investment, and government spending and net exports. Further, we can “explode” the I component, investment spending, into other sub-categories such as: spending on new equipment, business software, residential investment (RI) in new housing, new commercial buildings, and changes in inventories. When I grows significantly, it is always critical to see what is driving the increase in I spending. If it’s new plant, equipment, or software then it probably portends expansion of businesses. Businesses are expecting the economy to grow and are investing for the future – good. This isn’t what happened this quarter. Similarly, increases in RI are usually good since RI actually represents a part-investment, part-consumer good: new housing. Increases in RI have historically been indicators of future growth in GDP. In this case, we had a very modest increase in RI, but it doesn’t look sustainable since we still have a huge inventory of unsold houses nationwide – more houses than we need (at current prices).
As Calculated Risk notes below in this post, changes in inventory accounted for 3.4 of the 5.7% of growth this past quarter. What happened? Well, essentially it reflects three things happening. First, businesses in general overreacted a bit in the 1st, 2nd, and 3rd qtrs of 2009 and cut inventories a bit too far in anticipation of an even worse recession. This partly happened because financing (banking crisis) wasn’t available for inventory. To the extent the recession did not prove as disastrous as anticipated (we stopped falling in the summer), businesses began to rebuild inventory in 4th qtr. Not likely to repeat in 1st qtr 2010. Second, cash for clunkers program seriously depleted inventories of new cars, auto makers cranked up to replenish inventory in 4th qtr . Again, not likely to repeat in 1st qtr. Finally, it appears that businesses may have cranked up inventories a bit too high hoping for a good Christmas selling season. Christmas wasn’t a disaster, but it wasn’t real strong, either. This actually bodes poorly for 1st qtr.
So overall, while 5.7% is better than a lower number, I don’t think it indicates good times returning. If good times were truly returning, we should see more than 6% growth AND it should be driven by large increases in C (personal consumption) and the RI and plant & equipment portions of Investment. We just aren’t seeing that yet. This means that the economy is still on life support (also known as G). Unfortunately, the deceptive headline growth numbers have too many in Washington talking about prematurely ending the life support.
As expected, GDP growth in Q4 was driven by changes in private inventories, adding 3.39% to GDP.
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 5.7 percent in the fourth quarter of 2009, (that is, from the third quarter to the fourth quarter), according to the “advance” estimate released by the Bureau of Economic Analysis.
The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, and personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, increased.