Friday, July 29, 2011

GDP: less growth, more inflation

As this chart from Calculated Risk shows, today's historical revisions to GDP subtracted a lot—a little more than $200 billion—from real GDP. The recession now looks worse than before, and the recovery looks weaker. Real GDP has still not recovered to its 2007 high. Although growth in 2010 was revised upwards, growth this year has proved to be much weaker than previously thought. On a minor note, my original forecast in late 2009 that GDP would grow by 3-4% in 2010 has now been vindicated, since according to today's revisions, GDP expanded by 3.1% in 2010. But so far, first-half 2011 growth (0.8%) is much slower than the 3-4% I expected last December.

Much of what was subtracted from real GDP was added to inflation (i.e., nominal GDP didn't change very much, but its composition did). The first of the above two charts shows quarterly annualized changes in the GDP deflator before today's revision, and the second shows them after the revision, including the second quarter number. Previously, we had two quarters of deflation, with six quarters of inflation that was either very close to zero or negative. Now we see only one quarter of deflation, and only two that were close to zero or negative. For the first half of this year the GDP deflator has risen at a 2.6% annualized rate. The CPI rose at a 3.8% rate over the same period, so between the two we have clear signs of accelerating inflation.

This has to be a very surprising and even shocking result for establishment economists as well as for the Fed. As the above chart shows, real GDP is now over 12% below its long-term trend. This huge "output gap" should have been extremely deflationary, according to traditional Keynesian analysis, but that hasn't been the case at all. The Fed has been in a near-panic for the past three years, believing that the extreme weakness (aka "resource slack") of the economy posed the very real threat of a debilitating deflation, but deflation has proved to be only a fleeting phenomenon. If current trends continue, the Fed is soon going to be worrying about too much inflation, not too little. 

Once again these developments underscore supply-siders' belief that growth can only come from hard work and risk-taking. Monetary policy can't create growth out of thin air, and neither can fiscal "stimulus" spending. The swimming pool analogy is very apt: fiscal spending "stimulus" is akin to taking water out of the deep end of a pool and pouring it into the shallow end—it achieves nothing and is simply a waste of effort. Real growth only occurs when people work more and/or someone figures out how to make the same amount of work produce more output.

If there is a silver lining to this gloomy GDP cloud, it is that fiscal and monetary policy "stimulus" have now been soundly discredited. Congress does not have the power to pull spending levers in order to speed up the economy, and the Fed can't speed up the economy by keeping interest rates at artificially low levels. In fact, fiscal and monetary policy errors of the sort we have lived with in recent years only serve to weaken the economy. Too much debt-financed spending only wastes the economy's scarce resources, while simultaneously boosting expected tax burdens. This in turn reduces the after-tax rewards to hard work and risk-taking, which explains why corporations have been so slow to invest their growing stockpiles of cash. Too much easy money only boosts speculative activity (which shows up as higher commodity and gold prices) while undermining the dollar and reducing investment.


brodero said...

This was a dismal report...most
estimates had nominal GDP for 2nd qtr coming in at 15.143 trill.....
they marked 15.003....that change is fairly dramatic and we cause strategists to mark down their year
end S&P 500 targets....

Mark Gerber said...
This comment has been removed by the author.
Mark Gerber said...

Oustanding summary Scott! I have doubted the official line on inflation (GDP deflator, CPI, etc.)for some time because I could see the makeup of the economy is changing as domestic consumption of services drops relative to goods without a corresponding reduction in the weighting of services in the inflation metrics. Therefore, the services components generate a larger disinflationary factor in overall inflation computations than they should. With the revisions today, it appears that everyone will now have to wake up to this reality -- maybe even the Fed as you opine.

The Smoky Mountain Hiker said...

Scott - on the top chart: is there any coincidence that the gap between original and revised GDP numbers has expanded during the current administration versus the prior. In other words, is the BEA basically lying to give cover to Obama when the initial headline numbers are published?

The gap is quite stark. If you don't believe that's the case, do you have any other explanations?

Scott Grannis said...

Smoky: I strongly doubt it. For one, fudging GDP data is an extraordinarily complex exercise. Two, GDP data are routinely revised over the years as a matter of course. Three, if Obama had pressured BEA to fudge the data, wouldn't he have preferred to show strong numbers in his third year of office rather than his first two? Right now the news looks like his worst nightmare as we approach the 2012 elections season.

Benjamin Cole said...

I disagree, as usual, with Scott Grannis on the dangers of inflation. What is he talking about?

Look at any of the inflation charts. Draw a trend line through them. We are headed to Japan.

The core CPI YOY is now at 1.6 percent, and that may overstate the case (Don Boudreaux of George Mason in 2006 penned editorials that the CPI overstates inflation. But that was when Bush jr. was President.

Unfortunately for the USA, we are following exactly the Japan formula for getting out of a deep recession--one they have followed for 20 years (and which never worked the wholw time).

Large fiscal deficits, and interest rates trapped at zero bound. A temporary QE program was tried in the mid-2000s, and John Taylor gushed about the positive effects. They stopped and went back to perma-gloom.

If we stay on present course, expect real estate and equity values to sink for decades.

Charles said...

Productivity growth was overstated and inflation was understated. Nobody is revising employment statistics so there is not a lot of substance here. People are overreacting.

Deflation seems a little less threatening to people who worry about their money getting more valuable.

John said...

The next recession will be known as the Tea Party Recession. Have any economic indicators improved since they took control of the House?

William said...

Keynesian analysis' belief. Political Conservative vs. Progressive. One religion vs. another religion. The're basically just DOGMA.

Reality and truth lie somewhere in between. I prefer experimentation and seeing what works.

Given the uncertainties of the 2008 collapse of the credit / speculative / derivatives bubbles, I think that TARP and bailout of two automobile companies was worth a try. Unlike conservative prophesies to the contrary, they have worked pretty well and cost the Federal government very little. I also believe that the Federal Reserve's experiments in various asset purchases were worth a try and have not resulted in horrible inflation as yet. Although I am in the camp that inflation will increase I don't believe that it will be run-away inflation in the near future. By the way, every major nation that I can think of including China responded much the same as the US congress and the US fed - except maybe the auto bailout.

I would once again point out that the private sector is not so great at allocating resources. All one has to do is look at the internet / bubble and the housing bubble.

Please educate me as to how the hundreds of billions of dollars spent on over-priced internet and telecom IPOs or condominiums in the SW helped our economy - other than to make some bankers incredibly wealthy.

In my view, there is no simple answer to our problems - and never will be.

John said...

Cool-headed analysis, William. Refreshing. Reminds me of a poem by Yeats, which says, in part:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.

Benjamin Cole said...


Check out this chart of commercial real estate values:


Commercial real estate is now selling for 2001-2 prices.

That's in nominal dollars.

So, how do we have a great inflation if commercial real estate is worth 2001 levels, and the S&P 500 is at 1999 levels, and unit labor costs are flat?

The problem with QE is that Bernanke, just like the japanese, did not stick with it.

Vaulty McNut said...

Does this GDP print make last month's employment report make more sense? Thanks for your great work.

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