The first revision for Gross Domestic Product (GDP) for the first quarter (1Q15) came out negative. The economy is contracting! Is it time to panic? The White House attributed the slowdown to weak exports, which are quite well known to be a problem. But is that all?
As we have commented on at length before, the GDP numbers are full of fudge, so it may be hard to know just what to make of them. A cynic would say, and probably does say, that they the Bureau of Economic Analysis (BEA) is making the numbers up as they go to make everyone happy.
Perhaps you are a bit too diabetic to handle all the fudge, either, but this problem is a bit more savory than sweet. It’s all about the seasoning – or, rather, the “seasonal adjustment”.
All of the numbers that are used to gauge our economy have built into them a seasonal adjustment. This includes all employment and output data. It’s absolutely necessary to do this if you want to rely on these numbers as an indicator of how things are going. Every January, for example, there is a mini recession as about 2.9 million people lose their jobs. This happens as holiday retail workers are laid off and construction grinds to a halt.
There is a similar effect in summer, when everyone goes on vacation.
In order to make the numbers all work out they are adjusted to even things out over the year. As long as the net over 12 months or four quarters is zero, it all comes out even. The problem, however, is that the last five years have seen downturns in the first quarter of the year that were simply not repeated in any other quarter. Here is GDP by quarter since 2010:
The BEA has decided that their seasonal adjustment must be wrong. That makes sense, but there are two problems: why is it wrong, and how will the cynics and conspiracy theorists respond to a change in the seasonal adjustment?
The reason for the harsh season is hard to say. It appears that because businesses are slow to make expansion plans new spending doesn’t kick in right away in January as it used to. GDP is measured by calculating expenditures on capital and consumer items.
One alternative measure that is being promoted looks at net income of businesses, which is \much smoother. By then simply looking at trends over the past year the data is automatically smoothed. It’s called GDP+ and it requires significantly less artificial seasonal adjustment overall. The Philadelphia Fed has been tracking it for a few years and is happy with the data.
As to the second problem, which is how the tin-foil hat crowd will receive all this …. Who really cares? We all know that any measure is going to be flawed so any measure that seems to work out is helpful.
We can see that by GDP+ the economy is still only growing at a bit better than a 2% clip, which with inflation at about zero is … still not good. It’s essentially treading water overall, but at least we aren’t drowning.
So what is the correct answer for GDP? That anyone who frets over these numbers is certainly kidding themselves no matter what. There is some reason to believe that either winters are getting harsher or businesses aren’t spending in the first quarter as they used to. Whatever the reason, we see it every year and it probably means the measurement is flawed, at least in terms of what it is supposed to do.
Should such heavily fudged numbers be used at all? In the end, it’s all better than nothing. But we can’t make such a big deal out of it. Between the seasoning and the plain fudgy, it’s a really odd flavor overall. But we can be sure that it’s not the only thing you should have in your diet of information.
A new number? Maybe GDP+ will catch on, but it’s hard to see it happening. The news still relies on the headline unemployment number, U3, rather than the much more reasonable U6. The heavily processed numbers will always have a place in popular media.
That’s one trend we can certainly rely on, season after season.