August 28, 2008
Why Does It Feel Like a Recession?
The preliminary GDP release today provided a number of surprises. The first surprise was not that GDP was higher than the advance release (given the June trade figures reported earlier this month), but rather that at 3.3% it exceeded the 2.8% (SAAR) of the consensus . The second surprise is that the reduction in imports comprises an even larger proportion of the overall growth.
Let's turn first to the surprise. The change in the contribution due to net exports was anticipated, given the release of the monthly trade figures for June, which were unavailable at the time of the advance release. However, one big change was in the contribution of inventories. Apparently, they decreased by a smaller amount (-1.44 ppts vs. originally estimated -1.92 ppts). While this increases GDP in 08Q2, this might suggest a bigger reduction in output in the current quarter, as producers seek to match inventory stocks to anticipated output.
But let's return to trade. Figure 1 illustrates real GDP growth in ppts SAAR (blue bars), and the contributions from Net Exports (red line) and Imports (green line).
Figure 1: GDP growth q/q at annual rates (blue bars), contribution from net exports (red line), and contribution from imports of goods and services (green line). Source: BEA GDP advance release of 28 August 2008.
Interestingly, the change in trade sectors accounts for almost all of growth (in the advance, it accounted for more than all GDP growth). And while the proportions coming from export growth and import shrinkage are about the same, here I think absolute percentage point contributions are important. Reductions in real imports now are calculated to contribute 1.45 ppts, as opposed to the earlier estimate of 1.26 ppts. Of course, some of this reduction is due to the weaker dollar, as journalistic accounts have stressed. But unlike exports, imports are -- according to macroeconomic estimates -- highly insensitive with respect to exchange rates, and much more elastic with respect to income . So I suspect that real income is either actually stagnants or falling, or perceived to fall in the near future (I'm not so Keynesian as to think only current income matters). Figure 2 depicts the log real dollar exchange rate (calculated against a broad basket of currencies (blue), lagged two years, and both net exports to GDP and net exports ex oil to GDP ratios (red, teal, respectively).
Figure 2: Log real dollar exchange rate (Fed broad index) (blue, left axis), net exports to GDP ratio (red, right axis), net exports ex-oil to GDP ratio (teal, right axis). Source: BEA GDP release of 28 August 2008, Federal Reserve Board, and author's calculations.
the steep dropoff in the non-oil trade balance to GDP ratio suggests to me a big income (and perhaps wealth) effect, but I admit to not having conducted a formal decomposition into income and price effects.
Now we come to the issue that absorbed so much interest at the time of the advance GDP release. The divergence between real GDP and real Gross Domestic Purchases remains. Indeed it has expanded, from 2.4 ppts to 3.1 ppts. In Figure 3, I plot real GDP and Gross Domestic Purchases growth, and in Figure 4, the respective growth rates of the deflators.
Figure 3: GDP growth q/q annual rates (calculated using log differences) (blue line) and Gross Domestic Purchases growth (red line). Source: BEA GDP release of 28 August 2008, and author's calculations.
Figure 4: GDP deflator growth q/q annual rates (calculated using log differences) (blue line) and Gross Domestic Purchases deflator growth (red line). Source: BEA GDP release of 28 August 2008, and author's calculations.
Recalling the following definitions:
GDP = C + I + G + EX - IM
Gross domestic purchases = C + I + G
It's clear that the amount that we're expending on (from consumers, businesses, and government) is barely growing; given q/q annualized growth of 0.3 ppts (log terms), it's essentially zero. So the factories may be humming, but that's because exports are up, thereby illustrating how much continued growth in GDP depends upon the trends in the rest of the world.
Figure 4 illustrates why -- as noted earlier -- the GDP deflator does not jibe with what we as consumers see. It's because the prices for what we produce have diverged in a significant way from the prices for what we consume.
To me, this last outcome is not a surprise  (pdf). When a country consumes much more than it produces, then at some point, it has to repay some of the debt incurred. Repaying involves producing more than consuming. We're not even at that point yet -- we're merely moving toward producing more than we're consuming. How much longer the process will continue, and how far (i.e., will we actually run a trade surplus in the foreseeable future?) depends on a lot of things, including the desirability of American assets, and hence how much foreigners want to lend to us. So, as I say, two surprises, and -- for me -- one non-surprise.
What are the prospects abroad? For Europe, I'll just refer to Jim's post. It remains to be seen what happens in East Asia. But while GDP is not yet shrinking (at least not according to the current data), there's still a good chance in the future, as the slowdown spreads across borders.
A lot more coverage at Economists View.
Update 9pm Pacific: Earlier remarks of a similar nature in WSJ RealTime Economics.
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Tracked on August 29, 2008 07:46 AM
Menzies - thanks on several fronts. The meme is running around that GDP is vastly over-stated because of the wrong price index. It seems to me that in some distant past post you guys explained the differences and how they worked but you appear to have at least skimmed it here. Can a request for an in-depth dissection be tabled btw ?
Without your background or level of sophistication I use YoY% changes in the real GDP to make my own poor assessments and find that in Q108 real GDP was up 2.5% while it dropped to 2.2% in Q2, despite the headlines. And congruently with your results by looking at the YoY changes in GDP components found the sum of all Consumption and Investment components was close to zero. While Trade accounted for the majority of the increase.
Posted by: dblwyo at August 28, 2008 05:59 PM
Oh BtW and FWIW in case anybody's interested in those assertions in chart form posted them earlier today in reaction to the headlines: http://tinyurl.com/5ela5n
Again probably doesn't met your standards but helps my simple mind grasp what's going on.
Posted by: dblwyo at August 28, 2008 06:00 PM
The increase in net exports makes a positive contribution to national savings, other things equal. This is one reason it feels like a recession. The US is not used to associating saving with feeling good. The dollar FX effect is a catalyst for exporting disinflation, which improves the overall GDP deflator. But the US consumer doesn't participate in this part of the deflator - a second reason it feels like a recession.
Posted by: JKH at August 28, 2008 06:18 PM
I love this article. It complements your "The Dollar and the Trade Deficit: How Does Productivity Fit In?", which I didn't see the point of at first.
For how long do you believe the US economy could grow while domestic consumption is flat or declining? Is it sustainable at all?
It has me wondering whether the US could even the trade imbalance without a long recession.
Posted by: Anonymous at August 28, 2008 06:23 PM
Excellent post, Professor: very clear, now, the effect from exports and imports, and the performance of production vs. consumption and the two deflators. Illuminating; thanks!
Posted by: jg at August 28, 2008 09:20 PM
Answer - because you want it to be.
Posted by: Rich Berger at August 29, 2008 06:17 AM
I am a marketing – not economics – consultant. So, unburdened by the need to quantify economic things as deliberately as you do, but burdened with the need to understand consumer behavior, let me offer the following thought:
As one who is old enough to have wasted countless hours sitting in gas lines during the Seventies, it seems that a (not the) key difference between the current economy and that of the Seventies is exactly that: There are no gas lines this time. I recall that the U. S. (with Federal government-imposed price controls) had gas lines in the Seventies while Europe (with no price controls) had none. Gas at $4.20 per gallon is infinitely better than NO GAS at $2.50. “NO GAS,” by the way, is what the sign said for months at my local Amoco station in those long-ago days. (Amoco doesn’t exist anymore, having been taken out when oil dropped to $10, a reflection of the natural cyclicality of commodities markets…but I digress.)
The key point – and the important consumer difference between now and the Seventies – is that no one is wasting hours (yes, hours) per day simply sipping a soft drink in the gas line that is snaking around three blocks of their neighborhood. To emphasize the point: when government doesn’t step in to try to “solve the problem,” or “help out suffering consumers,” or “achieve energy independence,” or some such excuse for legislative and judicial meddling, perhaps, just perhaps, individual businesses and consumers simply find a way to adapt to higher prices without tipping the economy into a full-blown recession. Put another way, perhaps, just perhaps, what really caused the recessions of the Seventies was NOT high gas prices, but our government’s response to them: price controls, leading to horrible shortages, wasting billions of person-hours in gas lines. How many of Safeway’s and Wal-Mart’s and GM’s trucks were simply idling in lines, generating carbon emissions, rather than revenue?
In addition to the direct cost of the wasted person-hours multiplied across millions of businesses there was, of course, the psychological impact of consumers wasting hours in gas lines. Consumers who are time-pressed because they spent two hours at the local Exxon station have neither the time nor the optimism to head out to the mall and start shopping. Instead, they might well go home, turn on the TV, and watch some pundit declare that high gas prices (not gas lines) have driven the economy into a ditch.
Posted by: John Rosen at August 29, 2008 06:25 AM
I'm no economist, but I do have first hand experience "on the street-level" in regards to the economy. And I can say that business conditions haven't been this bad since Carter was in office. People are unwilling to spend, are extremely sensitive about what interest rate they pay, etc, etc.
My cost of doing business is increasing dramatically, causing me to make serious changes in strategy. Building materials are going through the roof. This in turn has caused me to raise prices for my customers, exactly at the same time my customers are becoming more and more sensitive about prices.
If I were to guess, I think the CPI is flawed, because the inflation I'm seeing is much higher.
Posted by: Curtis at August 29, 2008 09:52 AM
Rich Berger: I won't impugn your motives if you don't impugn mine. I'll just note that unlike some people, I don't own seven homes, nor do I get kicks out of seeing the price of homes go down. Further, I am an employee of a state university dependent upon state revenues, which are incredibly procyclical; I think you can do the math there. As a part time administrator, recessionary times only make more difficult the decisions I have to make regarding the allocation of financial assistance for our students. So, in order to keep the discourse to a constructive path, please keep your comments to critiques of the analytical framework, as opposed to critiques of the analyst.
Posted by: Menzie Chinn at August 29, 2008 12:10 PM
Professor, you might not own seven homes, but does your wife get paid $400K per year to be a 'community outreach' person? Did a convicted felon 'help' you buy your home?
Lots of fun economic facts on the other guy, too, Professor. I'd stay away from the political jibes.
Posted by: jg at August 29, 2008 12:17 PM
I do think my comment struck a nerve. I think there has been a concerted effort (not just by you but by others) to pick apart a good number and deflate it. The business section of my local newspaper reported the GDP number with a headline indicating effectively that "it can't last".
I don't own seven homes and I don't get a kick out of seeing prices go down (although that would make them more affordable for my kids!).
That being said, I did not mean to impugn your motives, only to suggest that you may have your own biases. I will admit that I am biased in favor of the free market, optimistic for the future and I do not blame the Bush administration for difficulties caused by high oil prices and credit market problems. I do not find them blameless in other ways, such as not keeping a lid on spending (although I do not lose sleep at night over the deficit or debt).
Posted by: Rich Berger at August 29, 2008 01:14 PM
I won't impugn your motives if you don't impugn mine. I'll just note that unlike some people, I don't own seven homes, nor do I get kicks out of seeing the price of homes go down.
When introduce partisan politics into the discussion like this it really takes away from your scholarship. I was enjoyed your article though I have disagreements, but when I read this it just put me off.
We could get into this: I don't own seven houses purchased legally like some, but neither have I used my political power to help a slum lord (who is on his way to jail) to get rich off of the poor people of Chicago, for campaign contributions and a house at half price.
But this is supposed to be an economic forum - or so I thought.
Sure Rich may have started it but just ignore him or just tell him to stop without the editorial comments.
Posted by: DickF at August 29, 2008 02:16 PM
Rich Berger: I could not tell from your remark, since you provided no basis for your judgment, so you will forgive my misinterpretation. But I am confused about your assertion of bias, since I would say my guesses about how the macroeconomy would evolve have been closer to the mark than the optimists (e.g., Administration, most of Wall Street).
DickF: When a statement of fact is interpreted as partisan, then indeed these are sad days. I believe you have just provided allegations that, to my knowledge, have not been proven in any court of law. But you have provided excellent advice.
Posted by: Menzie Chinn at August 29, 2008 06:34 PM
So, it "feels like a recession" because C+I+G is constant, but GDP increases since EX-IM > 0. Would it "feel like an expansion," all else equal, if C were higher because IM were higher (such that EX-IM were negative, making GDP lower)?
Posted by: Phil Rothman at August 29, 2008 06:38 PM
We all agree that the recent NIPA releases have been counterintuitive. Everyone thinks we are in a recession, and observes employment and real incomes going down. Yet the GDP numbers for the past four quarters do not seem commensurate with that.
You may have seen some popular bloggers (not just the hot-headed blog commenter) suggest that the GDP numbers are being manipulated for political reasons (e.g http://bigpicture.typepad.com/comments/2008/08/gdp-33.html and http://www.nakedcapitalism.com/2008/08/gdp-release-signals-further-decline.html).
Perhaps in response to this, you and Prof. Hamilton, in this earlier posts, have done an excellent job of explaining the role the US's deteriorating terms of trade in some of the things people have a hard time believing. Yes, even though **consumer** inflation has been running over 5% per year, the implicit deflator for the goods and services the US produces can be much lower than that if import prices are rising faster that those of domestically produced goods and services. Yes, it is possible that the US could be producing more, while at the same time, the value of what the US can buy with what it produces goes down (i.e. lower real income).
BUT, unless labor productivity has vastly accelerated, I still do not see how we can have had 1/2 a year of declining employment with 1/2 a year of 2.1 per annum GDP growth.
I offer two things in the numbers that look fishy:
(1) The statistical discrepency. Over the past four quarters, the unexplained difference between Net National Product and National Income has swung (in nominal $s) from -$143 Billion to +$111.8 Billion, or 1.7% of GDP.
(2) The GDP inflation indexes **still** look funny, even before you consider the effect of foreign trade. Compare the NIPA domestic purchases price indexes over the year ending Q2 2008 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=38&Freq=Qtr&FirstYear=2006&LastYear=2008) with the June 2008 CPI report
Per CPI, consumer inflation for the year ending 6/30 was 5.5 %, while the reported PCE over the same period averages 3.65 % ((2.2 + 4.0 + 3.5 + 4.2)/4).
Do you think I am barking up the right tree with
(1) & (2)? And any thoughts about what could be causing those problems?
Posted by: gelboak at August 29, 2008 08:48 PM
Thanks for a good analysis.
I'm wondering about the deflators that you show in Figure 4. It seems they are inflation metrics of some sort. If so, it says the overall economy (GDP) has been deflating for 2 years, while gross domestic purchases has inflated in the past 3 quarters - mostly because of oil. If this is the message, then CPI is reflecting price trends in domestic purchases (as one would expect from a basket of goods and services), but it is not telling the big picture story of a deflating economy. This view synchs with my opinion that CPI is completely broken and bogus, but I'm not sure I am drawing the correct conclusion from your Figure 4. Your comment would be appreciated.
For the record, I don't have 7 houses, either, but I am able to count them. Last time I checked it was one. Also, I don't think that creationism should be taught in grade schools so that "alternatives can be compared".
Posted by: Mike Laird at August 30, 2008 06:35 AM
Wow, did this rather dry and technical post strike some nerves. FWIW and the record I've been pointing people to this post as a way to understand why the GDP numbers are not mis-representing inflation and urging them to understand the constructs instead of presuming conspiracies abound. Which many proudly level-headed and allegedly data-driven bloggers and commentators are doing. From Alan Abelson to Barry Ritholz to Jeff Saut....with all that in mind perhaps a deeper dissection is both in order and - suggestion - grist for some sort of oped by you and Jim, e.g. in a major paper. Or at least on some of the major blogs.
Setting all that aside where/how would one find the Gross Domestic Purchases data for dloading ? BEA provides a wealth of accessible data but none so labeled. I'm wondering if Net National Product and or Command-based Domestic Product are reasonable substitutes.
Thanks and keep up the good work. I for one see no biases but strict analysis here.
Posted by: dblwyo at August 30, 2008 07:04 AM
I posted the following on Big Picture this a.m.:
There are lots of reasons to question the data and its interpretation.
But thereï¿½s a tendency to conflate somewhat different dimensions of the problem.
E.g., some aspects frequently noted:
a) CPI hedonic adjustments
b) GDP ï¿½contra entriesï¿½ e.g. imputed rent as output and income
c) GDP financial sector profits, which probably exclude asset write-offs from underlying GDP income calculations
d) The GDP/GDI differential
e) The CPI/GDP deflator differential
The last of these should be the least controversial if interpreted probably. Most of the difference between CPI and the deflator should be attributable to the exclusion of import inflation from the GDP deflator calculation. Import inflation is currently extreme. CPI inflation, although probably understated for many reasons discussed, is made higher than what would otherwise be the case because of import inflation.
GDP includes only the valued added by the US economy in the further processing of imports. So the lower deflator number (leaving aside the other contentious CPI calculation issues noted above) means that the US economy is inflating in terms of total value added at a slower pace than imports per se (e.g. refining margins within the US inflating less than imported oil itself).
Itï¿½s a messy subject, but it doesnï¿½t really advance the case for CPI criticism by conflating that issue with what should be an understandable difference between the scope of CPI and the scope of the deflator. In particular, I donï¿½t think itï¿½s quite accurate to suggest that the deflator as an inflation measurement is the primary driver of understated inflation or overstated GDP. The other sources of the problem are closer to the truth of the problem, in my view.
Posted by: anon | Aug 30, 2008 10:30:13 AM
I agree Westburyï¿½s ï¿½import adjusted GDPï¿½ is a back-asswards way of looking at the problem, resulting in an absurd concept for GDP.
But the point he makes is that such an absurd GDP interpretation is in fact the logical consequence of what is an equally absurd inflation adjustment ï¿½ which is to attempt to deflate GDP with the CPI.
His final paragraph is more directly to the point, and is consistent with what I wrote above at 10:30.
Posted by: anon | Aug 30, 2008 10:46:11 AM
Posted by: anon at August 30, 2008 08:06 AM
dblwyo: You can find the data for gross domestic purchases, final purchases, etc. at the BEA website, tables 1.4.3, 1.4.4 and 1.4.5. (you have to use the "all NIPA tables" link to see these). You can see my take on the conspiracy issues in this post.
Posted by: Menzie Chinn at August 30, 2008 10:04 AM
Menzie - thanks found it, de-constructed it. Not your standards of elegance but in context of my weekly review of the economic data/information here:
It may appeal to some folks as an amateur's attempts to simplify it down. YoY growth rates in domestic purchases are quite weak and I was enormously surprised at how historically anomalous the deflator divergence was - ran the data all the way back to 1929 and this looks to be the biggest directional split ever. Which really says something about how borrowing on your house to get foreign funds and then spending them on foreign goods isn't economically healthy in the long-run.
Posted by: dblwyo at August 30, 2008 10:39 AM
Somewhat of an aside, but not irrelevant I think.
I'm perplexed by the almost complete lack of consideration of the role that the "informal" economy plays in analysis of GDP.
While estimates are admittedly imprecise, the size of the informal economy (those transactions that for various reasons aren't reported - ranging from criminal activities to barter/cash transactions to tax evasion) has been placed at between 5 to 10% of the total GDP. That is, I think, a substantial enough component to have a significant influence on what actually is happening in the domestic American economy.
Posted by: SecondTake at August 30, 2008 10:55 AM
please keep your comments to critiques of the analytical framework, as opposed to critiques of the analyst.
Well, it's your blog, but you baited us with the title.
Why does it feel like a recession to you? Because you're in Madison. If you were in Houston, or Northwest Indiana (where there literally isn't enough skilled labor to do all the work in BP's Whiting Refinery modernization, as profiled in the Wall Street Journal on Wednesday), you wouldn't feel that way.
Mittal's steelworkers are seriosuly considering a strike. How crazy is that? Times are good in many different sectors, and just because YOUR sector isn't doing well... well, it isn't the first time I've accused you of confirmation bias.
As for the content of the post (as opposed to the inflamatory title), I still don't see the currency adjustment where it's really needed: the Yen. 110 yen to the dollar is nothing to write home about. We were getting somewhere when we hit 96 to the dollar, but that was months ago.
The Euro isn't everything.
Posted by: Buzzcut at August 30, 2008 03:09 PM
Buzzcut: Actually, I was referring to journalistic accounts when posing the question. Wisconsin itself is doing okay, since it has an export oriented manufacturing base, and did not experience a substantial runup in housing prices.
Posted by: Menzie Chinn at August 30, 2008 04:28 PM
Looks like it will be very interesting reading should fly off the shelves....
Posted by: Sherry at August 31, 2008 10:23 AM
I am rather astounded that nobody has mentioned the obvious reason that so many think they feel like we are in a recession on this Labor Day (and have a happy one, everybody). Employment has been steadily declining all year long, which has an enormous impact on the psychology of the working public, "mental recession" and all.
There is an old and very useful term for what is going on: "growth recession," which I think was originally cooked up for exactly this situation, one in which the economy is not technically in a recession because GDP is rising, but in which that rise is insufficient to avoid a decline in employment.
Posted by: Barkley Rosser at September 1, 2008 02:17 PM