The Great Recession Was Even Worse Than Thought

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.

What’s Up With Oil and Gas?

Calculated Risk sums up recent oil and gas prices nicely a few days ago (bold emphasis mine):

Oil and gasoline prices are probably the biggest downside risk to the economy right now. Oil prices are off slightly today, from the WSJ: Oil Prices Ease

The front-month July Brent contract on London’s ICE futures exchange was recently down 35 cents, or 0.3%, at $114.68 a barrel. The front-month July contract on the New York Mercantile Exchange was trading lower 43 or 0.4%, at $100.16 per barrel.

Looking at the following graph, it appears that gasoline prices are off about 18 cents nationally from the peak. This graph suggests – with oil prices around $100 per barrel that gasoline prices will fall into the $3.50 – $3.60 per gallon range in the next few weeks.

However that just takes us back to March pricing – and that was already a drag on consumer spending. I’ll have more on the overall economy later.

pricechart

The risk is real.  A continued high level of gas and oil prices threatens to slow down the U.S. economy.  Indeed the results of 1st qtr 2011 GDP and the May employment report tend to indicate the economy is slowing again.  How much of an effect?  Well James Hamilton of Econbrowser, one of the better academic econometricians and also one who follows oil prices closely points out that Americans buy approx. 12 billion gallons of gasoline each month. So when gas goes up by $1 per gallon like it has since February, that’s $12 billion less per month to spend on other things.  That translates to $144 billion per year or approx. 1% of GDP.  So, continuing this kind of back-of-the-envelope calculation, if gas prices continue to stay up near $4 per gallon, we can expect GDP growth to be 1 percentage point lower than it would have otherwise been.  As Hamilton points out, that by itself is not enough to put us into a recession, but it can slow things quite a bit.

But, Hamilton also points out that 10 of the last 11 recessions have been preceded by sharp run ups in the price of oil.  The likely impact of the recent increase in oil/gas prices will definitely include some immediate slowing in GDP growth.  I think we’ve already seen that.  But the more significant risks are still to come.   If prices stay up for the next year or more, then the effects will begin to compound.  Oil price increases have a multiplier effect, much like government spending and taxes.  When the price of oil goes up, the initial reaction is to cut spending elsewhere to continue fund our purchases of gas. After all, we gotta go to work and school.  But then, as purchases of other goods decline, layoffs begin in those other industries.  The increased unemployment in those other industries reduces total consumption spending even more and causes new rounds of cutbacks.  Hamilton points out that the last time we saw this rapid run up in gas prices in 2007-8, it wasn’t until many months later that the real devastating impact was felt.  Overall, it doesn’t bode well for fall 2011.

But why are oil and gas prices so high?  And why did they rise by approximately 25-30% at the end of February?  I think I’ll make that the subject of another post.

Tax Cuts and Economic Growth, Once More – the Corporate Tax Version

The issue of tax cuts and economic growth, which I’ve discussed recently here and here, looks like it’s going to be an important topic for some time now judging by this week’s announcement from Paul Ryan, one of the Republicans in the U.S. House of Representatives.  While all the attention in the media has been focused on the proposed changes to Medicare and Medicaid (I’ll get to those soon), that’s not really where the deficit reduction is supposed to come from in their plan.  When you look at the plan and their projections, it’s really a dramatic improvement in the health of the economy and employment that drives their projected budgetary improvement.  And what do they propose will instantly get this slow-growth economy to dramatically improve immediately?  Why tax cuts of course!  I’ll have more on the specifics of the Republican proposal soon, but for now I want to note the experience of our polite neighbors to the north with regard to this issue of tax rate cuts and economic growth.

In Canada’s case, they bought into the rhetoric of “tax rate cuts” will grow the economy ten years ago.  But the Canadians bought the corporate version.  Specifically, the cut corporate tax rates dramatically over the past decade.  The goal was to growt the economy.  This is the exact same strategy that Rick Snyder, Scott Walker and a host of other Republican governors are now trying to implement in different states in the U.S.  So it should be enlightening to see what happened when somebody else did it.  What happened?  Let’s turn to the Globe and Mail today (emphasis is mine):

Canadian companies have added tens of billions of dollars to their stockpiles of cash at a time when tax cuts are supposed to be encouraging them to plow more money into their businesses.

Corporate tax cuts are becoming a major issue in the federal election campaign. The Conservatives, arguing that they are the best custodians of an economy that remains fragile after the recession, say tax cuts are crucial to stimulate job creation and make Canada more competitive on the global stage.

But an analysis of Statistics Canada figures by The Globe and Mail reveals that the rate of investment in machinery and equipment has declined in lockstep with falling corporate tax rates over the past decade. At the same time, the analysis shows, businesses have added $83-billion to their cash reserves since the onset of the recession in 2008.

Infographic

In other words, the corporate tax rates did not increase corporate spending on investment.  In fact, the corporate tax rates actually coincided with lower corporate spending on investment.  It’s corporate spending on investment that is what generates and contributes to GDP growth.  So lower corporate tax rates simply functioned to increase profits but those profits are sterile.  They became piles of cash.  Cash that might be used to buy another existing company (and then layoff people) or just allowed to sit idly in the money and bond markets earning more interest.  What lower corporate tax rates do not do is create jobs.

So back to an earlier discussion – does this mean we should stop saying in principles classes that “tax cuts are stimulus”?  No.  It means we have to be more careful in what we say.  A better and more true statement is that:

Tax cuts for middle- and low-income individuals that result in more consumer spending, and tax cuts that are accompanied by deficits (meaning the tax cut isn’t offset by lowered govt spending) will stimulate an economy and grow jobs while tax rate cuts for corporations and high-income individuals won’t.

Unfortunately that’s 50 words long.  That’s way beyond the attention span or understanding of most politicians and media commentators.