Good GDP Data
This morning’s news about the second quarter GDP decline was actually good: the drop from the first to second quarters has been revised to only 0.7%, which compares with the original estimate of 1.0%.
So the second quarter contraction in the economy was less than originally thought, and less than most forecasters dared hope. Clearly the economy has begun to improve.
The major causes of the change between the original and this latest estimate were minor adjustments in exports and business investment, both of which were stronger than first measured.
Now what?
I think we can look forward with some confidence to the first cut at the third quarter which is due to be published on October 29th. Most analysts are predicting GDP growth of between 3.5% and 4.0%. The reasoning behind this apparent jump from contraction to expansion is, as we have mentioned here many times, that businesses have begun to re-stock shelves. That little spurt in inventory build up will be enough to support growth by itself. Add in the fact that most of the economy is no longer as weak as it was just six months ago, and it is easy to concoct a quarter, or maybe even two, of 3.0%+ growth.
The problem though is what happens deeper into 2010? Is this growth sustainable? Or will it fade?
And here the answers get very murky.
The is nothing in the data that suggests great strength is about to burst forth. On the contrary all signs point towards a very slow recovery riven through with significant risk. Anyone running a large number of computer simulations of the likely trajectory of the economy over the next two or three years will be faced by an unusually widely dispersed set of results. In other words: your guess is as good as anyone’s.
The problem boils down to business expectations.
This, naturally, flies in the face of economic theory, but, given the recent performance of that theory I think we are justified in ignoring the textbook entirely.
Business expectations are vital for a couple of reasons:
- They drive investment decisions: an optimistic outlook provides the basis for gearing up factories etc so as to meet higher sales; while a pessimistic forecast does the opposite and would entail more cut backs in order to preserve profit
- This means that unemployment would start to decline. OK this is really part of the first point, but it is so important I wanted to emphasize it.
It is here we hit a wall.
Businesses are being extremely cautious at the moment and are showing few, if any, signs of shifting from a defensive mode. Large scale lay-offs are still quite frequent – more so than makes sense were business about to ramp up; and business investment, while growing, is not exactly lighting the place up. Slow and steady appears to be the mantra.
Of course this all becomes self fulfilling. Weak prognostications beget weak investment beget weak outcomes, which justify and reinforce weak prognostications. Very Old Testament, but apt.
The odd thing is that the financial press – the Wall Street Journal etc – has gone from giddy statements about the return of growth, to ultra cautious statements and concern about a ‘double dip’ recession, without there having been any really radical change in the data. The flow of information seems to be what it was a few weeks ago, and what I expect it to be for the rest of the year: things have become a lot more stable, albeit still slow.
One last thing while we are on the subject of GDP: the amount of decline in the economy is not the amount we have to ‘make up’ in order to recapture our lost wealth. We need to get much more than that. The reason is, of course, that the recession interrupted an upward trend. Getting back to the start is insufficient, we also have to recapture the growth we have lost. The actual numbers are still in flux, but by the time we start climbing back the peak to trough decline will have been in the order of 3.7% t0 4.0%, given that under normal circumstances we should have had about a 3.0% growth during that same timeframe, the actual lost wealth is around the sum of those two or 6.7% to 7.0%. That’s a whole lot more difficult, even with the burst we are likely to see when the third quarter data is released.
The point of bringing this up is that it is the larger figure that we should bear in mind when we argue over stimulus packages etc. We are trying to get back to where we should have been, not to where we were. There’s a big difference.
Still, this morning’s announcement is clearly a step in the right direction.
The recession is over. Just what happens next is very uncertain.
