Tuesday, July 22, 2014

GDP: Looking Back at Q1 and Looking Forward to Q2

Tyson Smith, Regional Economist

Last month, the Bureau of Economic Analysis (BEA) revised down its first quarter 2014 Gross Domestic Product (GDP) estimates. GDP measures the total value of all goods and services produced in the economy during a given period, and is one of the broadest indicators of economic activity. According to the BEA, the U.S. economy shrank 2.9 percent in the first three months of the year.

Since then, economic journalists like Andrew Flower and Ben Casselman at FiveThirtyEight.com have written extensively about the GDP estimates and the contraction’s potential impact. The question is: how much weight should we put in a single quarter of negative GDP change? The opinion among journalists, economists and financial experts is mixed. While there are few people willing to assert that the “sky is falling”, the news is certainly unwelcome considering the multi-year sluggishness of the recovery.

The Pessimistic Assessment:

First, let’s state the obvious; an expanding economy is better than a contracting one. While GDP is not a flawless measure of national economic health, it does correlate with increases in consumer spending, business investment and individual wealth. What makes this downward revision particularly alarming is the size of the contraction. The original estimate had GDP down 1 percent then, in June, the BEA moved it even further to negative 2.9 percent.

“Negative quarters are rare outside of recessions,” explains Casselman. “There have been only two other non-recessionary quarters since World War II when the economy shrank at a rate over 2 percent.” In both of those cases, the negative quarters immediately preceded a recession.

The following chart shows how the fall in GDP last quarter compares to recent history. The decrease is the largest of any outside of the recession. However, it is worth noting that GDP fell over 1 percent in the first quarter of 2011 and bounced back substantially thereafter.

The Optimistic Assessment:

Even though the first quarter GDP was noticeably weak, there are several reasons to believe that the downswing was an outlier and not a trend.

Consider that GDP estimates can be erratic from quarter-to-quarter. Quarterly swings of 2 percentage points or more are not unusual, occurring over 60 percent of the time since 2000. Furthermore, quarterly estimate can change dramatically with each round of revisions. The reported 2.9 percent decrease resulted from a revision of the initial GDP press release. The data will go through yet another revision as part of the “normal” quarterly process (historical revisions and benchmarking can have an even greater variation than the initial adjustments).

Many economists also believe that disruptive weather played a significant role in the sluggish first quarter. Much of the Northeast and Midwest were pummeled by snowstorms and freezing temperatures during the first three months of the year. The consequences revealed themselves in some of the data, prompting the downward revision. In part, declines in personal consumption and business inventories can be attributed to the harsh winter conditions, as consumers are less likely to go to the mall or the auto dealer in inclement weather. However, weather interferences represent short-term difficulties, and do not reflect fundamental problems in the economy.

Lastly, other economic indicators fared well during the first quarter and have performed even better since. Employment, wages and job openings have all increased during the first half of 2014. The national job market has been accelerating at pre-recession rates, adding 288,000 jobs in June.

The Local Perspective:

How does the first quarter contraction translate locally? The BEA does not release state-level quarterly GDP estimates, but several indicators suggest Utah’s economy continued to outperform the U.S. average and avoided any setback in the first quarter.

The first positive sign is that Utah’s annual GDP growth normally trends higher than the U.S. average. The chart below shows Utah’s year-over GDP growth outperformed the nation in 13 of the last 16 years. One would expect a similar trend for quarterly GDP data (despite the variable nature of quarterly estimates).

Also, Utah had a relatively normal winter, avoiding the effects of extreme weather. Utah would not have experienced the same disruption in production and consumption as the nation’s eastern states.

Lastly, Utah’s economy has outperformed the national economy since the onset of the recovery four years ago. During 2014’s first quarter, Utah employment grew 3.2 percent compared to 1.7 percent in the U.S., demonstrating that the national GDP setback did not translate into slower Utah job production.

Looking Forward:

The initial second quarter GDP estimate will be released on July 30th. Most analysts expect a rebound, with GDP up 3 percent. Wholesale inventories – which negatively impacted first quarter’s data – rebounded in May, pointing to GDP growth.

We don’t know how the economy performed in the second quarter. The weak first quarter caused analysts to pull back their 2014 annual growth estimate, but many signs suggest that the rest of 2014 will be much better economically than the first three months.

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