AS THE ECONOMY TURNS
TAKING A SOLID HIT
Dr. William Shingleton
January 30, 2006
The Bureau of Economic Analysis reported Friday that the American economy
took a solid hit in the fourth quarter of 2005, with the real growth rate
dropping from 4.1 in the third quarter down to the advance estimate of 1.1 in
the fourth quarter. [SOURCE: < http://www.bea.gov/bea/newsrel/gdpnewsrelease.htm>] Since the average growth rate over the last 20
years has been about 3.3 percent, this was not good news. However, before anyone gets too concerned
about the slowdown, we should be aware that the Bureau’s own note emphasized
that the fourth-quarter "advance" estimates were based on data that were
incomplete or subject to further revision.
The fourth-quarter "preliminary" estimates, which will be more
accurate and which will be based on more comprehensive data, will be released
on February 28, 2006. The other point to
notice, of course, is that the report was indeed about the fourth quarter of
2005 (October-November-December), so whatever the final word is, it will be
about something that has already happened and over which we no longer have any
influence.
The real growth rate is supposed to measure the rate of change in
something called GROSS DOMESTIC PRODUCT (GDP) after the major effects of
inflation have been rinsed out. The
rinsing is done using a PRICE INDEX, something we have discussed in earlier
reports. To get a real value, we take a raw
dollars and cents value, called the NOMINAL value, and divide by a price index. For instance, if prices have doubled from one
period to the next, we divide the numbers in the second case by two, which
allows us to compare the outputs in the two periods. The GDP data themselves are supposed to give
us some idea of the total output in the economy by adding together the dollar
value of all the cars, medical services, and basketballs we produce in a time
period. Since we have thousands of firms
producing hundreds of thousands of goods, it takes quite a bit of time to
assemble all of the necessary data. If
we wait until we are absolutely certain we have everything correct the data
will be useless because it will be too old, so we have this first “advance”
estimate to give us a peak. On February 28th
we’ll get a more accurate reading, called a “preliminary estimate,” and at the
end of March we’ll get the “final estimate.”
As if that isn’t enough, each summer until 2008, when only statisticians
and economists still care, they’ll go back and check everything out and give us
the “comprehensive revisions.”
If you read the fine print from the BEA, you’ll notice that they
give you two different numbers for the real growth of the economy, even if we
just stick to the January 27th data.
The number that picks up all of the press compares real GDP in the
fourth quarter to real GDP in the third (July-August-September) quarter. If we divide the new number by the old
number, we get 1.0027. That means that
the actual amount of increase in output from summer to fall was only 0.27
percent. They get the 1.1 they reported
by figuring that if the economy grew like this over 12 months, instead of just
three, the calculation would be (1.0027)*(1.0027)*1.0027)*(1.0027) =
1.011. In contrast, if we look at how
the economy has changed over the last twelve months, we would divide the real
GDP numbers from fall 2005 by the real GDP numbers from fall 2004. That would
give us a growth rate of 3.1 percent, which would be almost in line with the
twenty year average of 3.3 percent. The
difference is accounted for by the fact that the economy was moving along quite
nicely until the fourth quarter.
So how reliable are these numbers?
We’ll leave that for you to judge.
Since 1983, the average error, if we ignore the sign of the error, is
0.4 percent. This means that the 1.1
could be changed to anything from 0.7 up to 1.5 and it would not be anything
out of the ordinary. As a matter of
fact, if you know what a standard deviation is, the standard deviation is 1.0,
so when all the dust has settled on all of these revisions, we may have fallen
into a recession, with a negative growth rate of almost one percent, or we may
have come in almost on the mark of the 3.3 percent twenty year average, and
neither of those results would be much of a surprise either. That’s why reliable economic reports never
place too much emphasis on any one report, especially the early estimates.
If we assume that we can get anything useful out of all this,
let’s look at the pieces. What many
people do not realize is that the largest contributor to the American GDP is
consumer spending; the other pieces are not even close. Year after year, the American consumer’s
purchases account for roughly 70 percent of the total spending in the economy. Even with some new math, that does not leave
that much for the other categories.
Since consumer spending only grew at an annual rate of 1.1 percent in
the fourth quarter, that was the primary reason that the growth of the economy
slowed down. The specific element of
consumer spending that took the biggest hit was durable goods; items like refrigerators
and cars, that are supposed to last a while.
Durable goods purchases didn’t just stop growing as rapidly, they
actually went down 17.5 percent.
Basically, people cut back on their purchases of durable goods in order
to be able to afford to buy the other goods and services in their budgets.
There were three other drags on the economy. The growth of investment spending slowed from
8.5 percent down to 2.8 percent. Total
investment spending still went up; it just did not rise as quickly as it has
been doing. Since investment spending
tends to be the most erratic pattern in the system, one report about investment
spending decelerating probably doesn’t mean anything at all.
One important drag was the growth of gross imports, which jumped
9.1 percent. When we buy things from
other countries, the money leaves our spending stream, since money spent on
imported oil can’t also be spent on goods or services produced in the
Maybe you better sit down for this last one. The other drag on
fourth quarter spending was from government purchases, which was more than a
bit of a surprise. Total federal
government consumption expenditures and gross investment decreased 7.0 percent
in the fourth quarter, in contrast to an increase of 7.4 percent in the
third. For reasons we can’t really come
up with, defense spending decreased 13.1 percent, in contrast to an increase of
10.0 percent in the previous quarter.
Before you begin to worry that
If we want the economy to return to its three percent growth rate
we are going to need some help from consumers.
The three dollar gasoline of last fall and the higher heating costs of
this winter are going to combine to make us a more energy-efficient country. As people begin to decide how they are going
to be more energy efficient, they will start spending money, probably on
energy-efficient durable goods. For the
firms that have been planning for this scenario, sales and profits are going to
rise. If the price of energy goes high
enough, we may even have to order some more trains for moving people. In the
meantime, the American economy took a number of solid hits last fall and is
still standing, and growing. The
American economy is one of the marvels of the world.
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