January 31, 2007
Where did all that GDP growth come from?
The Bureau of Economic Analysis reported today that U.S. real GDP grew at an annual rate of 3.5% in the fourth quarter of 2006, more than most of us had been anticipating, and far better than the 0% growth that Nouriel Roubini had been predicting for 2006:Q4 as recently as November 28.
The unexpectedly good news didn't come from housing, which contributed -1.2% to the total figure, about the same as in 2006:Q3. Even though I've been suggesting that the low point in terms of the quantity of new homes sold may be behind us, I expect similar negative contributions from housing to the GDP totals at least through the first half of 2007, since construction can't pick up until the inventory of unsold homes returns to more normal levels, even if the number of homes sold continues its rebound.
Nor is there any confirmation of the hopes that some had expressed that business investment would pick up the slack from the housing downturn. Nonresidential fixed investment also made a negative contribution to 2006:Q4 GDP growth. I suppose if one is looking for the bright side in that unfortunate development, it might be the claim that there remains the potential, if not the reality, of a resurgence of investment spending to take the baton from consumers, who continue to be the big driver of the U.S. economy.
Inventory drawdown actually contributed -0.7% to the total, meaning real final sales grew at 4.2%, but production didn't keep up with sales. That again suggests some possibility that inventory rebuilding could make a positive contribution to some of the subsequent 2007 GDP figures.
There was also a modest fiscal stimulus, with the growth of government spending contributing 0.7% to the GDP total, and a surprising improvement in net exports. Rising exports accounted for 1.1% of the total, and falling imports contributed an additional half percent; (since imports enter negatively into GDP, a decline in imports means a bigger value for GDP). That's the first drop in real imports since 2003:Q1.
My GDP-based recession probability index declined slightly from 9.3% for 2006:Q2 to 9.1% for 2006:Q3-- the solid fourth-quarter growth makes it very unlikely that the anemic second and third quarter growth rates might have marked the beginning of an economic recession. This index is not a forecast of where the economy will be later this year, but is a backward-looking assessment of where the economy was as of 2006:Q3, using the latest GDP data to form that assessment. It is intended as an alternative to the announcements made by the National Bureau of Economic Research, which, although highly authoritative and reliable, often fail to be made public until years after a recession has started. Background on how the recession probability index is constructed and a review of its historical performance are available here.
Posted by James Hamilton at January 31, 2007 09:03 AMdigg this | reddit
Listed below are links to weblogs that reference Where did all that GDP growth come from?:
» Welcome to the Carnival of the Capitalists from Mighty Bargain Hunter
Greetings everyone! Thanks for coming to this week’s Carnival of the Capitalists! Without further ado, here we go! Fire your deadbeat clients to increase your profits. Elaboration on the Small Business Buzz. Free Money Finance has a post on m... [Read More]
Tracked on February 4, 2007 09:24 PM
I always find the idea that construction will rematerialize once inventories come back into balance rather silly. Just because one can sell a house for what it cost to build, or less as the case may be, doesn't mean there is any incentive to build more.
Posted by: Lord at January 31, 2007 10:58 AM
The surprise strength in real GDP came from low inflation, not unexpected growth in nominal GDP. Moderating prices in housing and energy in Q4 2006 were the main contributors.
Posted by: Sebastian at January 31, 2007 11:06 AM
Consumer debt and dissavings-fueled "growth" cannot continue indefinitely. There are two sure-fire impediments to this sort of behavior called bankruptcy and foreclosure if this jihad on fiscal sanity continues. Shop till you drop, indeed.
Posted by: Emmanuel at January 31, 2007 11:30 AM
Demand for consumption weakened, the "advanced" release is not a good indicator for growth in this case because it gave faulty inflation numbers that will have to be honed out in the future.
That will lead to a revisement down to 2.0-2.5 levels we have seen the last 2 quarters. It would be closer to 1 without the Oil drop(of course this is behind the consumption 'non-inflation' as well) and big government.
Contraction looks possible sooner rather than later(especially if Oil surges to 100-125 this summer).
Posted by: dryfly at January 31, 2007 11:30 AM
It does appear that the increase was primarily from consumption and the change in imports and exports. All three of these tend to imply inflation. This is reinforced by the recent increases in the spot price of oil and gold.
Increased consumption comes from the money illusion where inflation causes consummers to believe they have more exchange value than they actually have. Imports are also sensitive to a declining value of the dollar. But understand that this will not manifest itself for at least 6 months and so is partially dependent on what happens in those 6 months, but inflationary pressures are still an undercurrent in the economy.
The best thing that the FED could do to counter the potential inflation is to ease its constraints on business by cutting interest rates.
Posted by: DickF at January 31, 2007 12:57 PM
Two situations -
1) 100 homes are sold each month, on average, and there are 500 homes available for sale.
2) 100 homes are sold each month, on average, and there are 800 homes available for sale.
In which of these situations would you, the builder, who has a planning horizon of a few months to a few quarters, be willing to build houses? To my mind, the first case looks much more appealing. The question faced in an economy that sells over a million new houses every hear is not, in many cases, build or don't build. Rather the question is how strong a committment to make to building how many homes.
Home construction hasn't dematerialized, and won't have to rematerialize. Home construction has merely slowed. Builders are still willing to build now. Change business conditions for builders and you'll change the pace of construction. If you take a look at the data, you'll see a strong link between starts and the inventory/sales ratios in residential real estate.
Posted by: kharris at January 31, 2007 01:12 PM
Isn't the story here that imports did an about face? Instead of subtracting a percent or so as usual, imports added this quarter, making a difference of about the same difference there is between q3 final and q4 advance?
The continuing bad story, but no longer newsworthy but merely old and unfashionable news: the declining RI.
I need help cashing in the story of negative PCE, which owing to my near zero estimate of q4 GDP, I am not going to hazard any guesses.
Posted by: calmo at January 31, 2007 01:14 PM
The strength in the 4th Q was essentially driven by the drop in oil prices that drove inflation down and generated a rebound in consumer spending. the key question is what happens if & when oil prices quit falling and inflation rebounds.
The Goldilocks scenario is 3% real growth from 1% employment or hours worked and 2% productivity. this allows the unemployment rate, unit labor costs, inflation and rates to remain stable.
But this time we apparently got 3.5% growth from 2%hours worked and 1.5% productivity. this implies that employment growth is too strong and productivity is too weak for the Goldilocks scenario.
Posted by: Anonymous at January 31, 2007 01:38 PM
Noriel predicted no growth? I bet he'll be a bit ticked when he reads my link to the National Review which shows Kudlow called the 3.5% growth yesterday. Did he get an advance of the advanced estimate? Of course, Larry was saying yesterday that investment demand was strong. Seems his advanced copy didn't have the details.
Posted by: pgl at January 31, 2007 02:26 PM
Has macroeconomics become a waste? Why?
I'm grateful for all the money I earned as a macroeconomist years ago. I think, however, it is a waste. I started studying macro in 1961 with Dernburg and McDougall, perhaps the first textbook, and I believe that macro still is a little more than national accounting. There is no much difference in knowledge useful for prediction between a Ph.D. (I got mine in Minnesota before Sargent and Wallace) and anyone with some accounting knowledge and a computer. This applies also to predicting long term growth with Solow equation (sorry, identity).
Posted by: Edgardo at January 31, 2007 02:31 PM
The consumption part of it looks temporary and will decline a good deal next quarter. If the "res's" are still dropping, could make for a interesting quarter.
Posted by: Johnson at January 31, 2007 04:24 PM
Nouriel Roubini is officially a joke in my book. I really was pulling for him on the growth call for the last quarter and thought he made some decent points, even given what seems to be a very poor record of prediction. To his discredit, he's predicted about 15 of the last 0 economic catastrophes. When you combine his dour and aggressive tone with his string of huge misses, he deserves to be a professor of economics for the Daily Reckoning not NYU. I much prefer your even tone, professor. How can you take a guy like Roubini seriously? Don't economists snicker at the fact that he seems exclusively tied up in predicting economic horror shows?
Posted by: charts at January 31, 2007 07:02 PM
In re: new-home sales, since you bring it up again, I'll repeat the unanswered question I posed on your may-be-behind-us thread: "How do you reconcile stabilization of new homes sold with current rates of household formation? The back-of-the-envelope work I've done indicates the former still exceeds the latter. Are there still a lot of people who need vacation homes?"
Since I posted that on the 27th, the census released its vacancy survey. Say what you will about the data, but they do not say "housing has bottomed" to me. Viz. my chart of same.
On GDP, I am pretty happy. Prices are down, durables consumption is up, everybody wins except the dollar/yen, which seems to have been counting on a Fed hike. The PCE deflator isn't going to be minus-1 again any time soon, but it's not running away with the economy while real sales are there. Never bet against the consumer. Soft landing, here we come.
Posted by: wcw at January 31, 2007 07:19 PM
wcw, I am impressed with that optimism ("Soft landing, here we come.") but have my reservations. Prices are down you say (in ref to neg PCE?) and if housing continues the trend evidenced by the last 3 quarters of RI, I think we will see some real house price declines as those official wage increases are not swelling the house buyer pool. [So IMWoundedO, a continuing neg PCE deflator]
The problem: although imports retreated last quarter, (suggesting some patriotism? some thrift among those who declined the usually cheaper foreign product?) the bulk of the population cannot afford to consume at current levels without the same access to funds as the larger players (the HFs and LBO principals) whose wages are of course officially unmeasured but often reported in bravado style to keep the IRS amused.
If that floor in housing does not appear soon, that soft landing just might be quick sand IMO.
Posted by: calmo at February 1, 2007 07:18 AM
Soft landing? It seems to me to be more like a long slow bleed....until the emperor's heart stops beating.
Posted by: vorpal at February 1, 2007 08:07 AM
Roubini's forecast of a recession will prove itself correct later this year. Lovely Chicago PMI, ISM, and GM/Ford U.S. sales numbers, those were.
Household debt to disposable personal income is at 131%, now, the same level for Japan in '89.
Deseasonalized San Diego employment is down, November to December.
The end is here (or really near).
Posted by: jg at February 1, 2007 12:26 PM
"In re: new-home sales, since you bring it up again, I'll repeat the unanswered question I posed on your may-be-behind-us thread: "How do you reconcile stabilization of new homes sold with current rates of household formation? The back-of-the-envelope work I've done indicates the former still exceeds the latter. Are there still a lot of people who need vacation homes?" "
Household formation can be measured by population growth divided by persons per household (2.5) to a first approximation. A better estimate allows for the correlation between headship ratios and age cohorts such that even with constant population housing starts would increase over time.
Consensus estimate for household formation in the USA right now is 1.4 1.5 m. The rest of housing demand is made up of demand for second houses and the replacement of old houses. There is no theory that I am aware of that specifys second (holdiday) home demand, however price appreciation expectations and tax incentives are obvious parameters.
We also need to subtract demand for mobile homes from the above to get total underlying housing demand. Estimates of underlying housing demand in the USA range from 1.8 m to around 2.2 In my 20 years of experience (makes me cynical) the estimate of underlying demand is a lagged function of actual starts.
Posted by: David Leitch at February 1, 2007 04:15 PM
Wow - two dryfly's... amazing. What's the chance of that. The Posted by: dryfly at January 31, 2007 11:30 AM was not 'me'... not that I have a copyright on the handle. Just more attack of the 'sockpuppets' I guess.
Anyway - Dr Hamilton, I followed this over from Dr Chinn's & he said there was a 'kick from external accounts'... is this all oil & currency driven rebalancing? Or is there some 'dark matter' in there?
Regardless - from a 'Pareto' perspective - the net change in GDP looks to be mostly driven by growth in consumption, just like the previous four quarters. So what does a 'typical' recession profile look like? Or even better, what does the profile look like heading into recession?
Will a drop in consumption likely lead us into recession or will the other drivers go negative so much as to swamp consumption growth... at least initially. Do you have historical data on this?
Posted by: dryfly at February 1, 2007 08:17 PM
Dryfly, the interesting and annoying thing about recessions is they all look different. But with the current anemic investment situation, a significant drop in consumption would in my opinion mean a recession. As for why the improvement in net exports, it looks to me like oil is only part of the story. I'm intrigued by Spencer's suggestion on Menzie's thread that it's related to the drop in inventories.
Posted by: JDH at February 1, 2007 09:01 PM
First of all I always enjoy your thoughtful analysis.
It would seem to me that a good deal of the real growth is a bit of a numbers game. I agree the economy is stable, and I also believe the Fed is still overly restrictive.
In Bill Gross's January Investment Outlook he targeted nominal GDP of 5% as the perfect world. Here is an excerpt
" But it is nominal, not real GDP that reflects the return on a nation?s capital, and nominal GDP that points towards our ability to pay our bills. Since almost all yields reflect a real plus an inflationary component, it stands to reason that the ability to pay debts expressed in nominal terms should be viewed in a similar fashion when analyzing growth. By so doing one can understand, for instance, why a deflationary environment can be so deadly to a modern-day, debt-ladened economy. It might be growing in real terms, but if nominal growth sinks below the zero line then the servicing of debts becomes onerous and can lead to liquidity traps that implode financial markets."
Sorry to clip and paste, but I would really like to hear your opinion on how much you really think inflation or lack therof is a contributing factor.
Posted by: drbrightside at February 5, 2007 07:55 PM
Whoops! Put away that Champagne --
New BEA inventory data makes that original 3.5% GDP number likely to get revised downards toward 2.75%, or if JP Morgan is correct, 2.5%.
Posted by: Barry Ritholtz at February 12, 2007 02:52 AM
It's even going lower than that! I am beginning to think there is not much truth to anything coming out of Washington.
Posted by: Gregory at February 14, 2007 06:16 PM