San José State University
Department of Economics

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Thayer Watkins
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& Tornado Alley
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The End of the Recession or
the End of Reliable Economic Statistics?

The first estimates of the National Income Accounts statistics for the third quarter of 2009 became available from the Bureau of Economic Analysis (BEA)on October 27, 2009. There has been a great need by the Administration and the Fed to demonstrate significant improvement in the economy. There was no doubt great pressure on the Bureau of Economic Analysis to provide statistics showing such an improvement.

The result was a reported annual growth rate of 3.5 percent in real GDP; i.e., the Gross Domestic Product expressed in the year 2005 prices and corrected for seasonality. According to those first estimates economy actually grew by only 0.87 of 1 percent between the second quarter and the third quarter. Multiplication by 4 gives the 3.5 percent figure. The extrapolation of a one quarter change to an annual rate is not really justified in these volatile times. The reported growth in real GDP for the third quarter is surprising turnaround from the negative figures of the previous quarters. There are several things that are decidedly suspicious about this miraculous turnaround. These will be covered below.

The second estimates of GDP and the National Accounts statistics for the third quarter were provided by the BEA on November 24, 2009. Those estimate show the real GDP growing 0.69 of 1 percent (2.75 percent annual rate) between the second and third quarter.

On December 22nd the BEA published its third estimate, called the final estimate, of the third quarter GDP in 2005 value dollars ($2005). According to these estimates the real GDP grew by 0.55 of 1 percent over the second quarter level. This is 2.2 percent at an annual rate. This means that the first estimate was a 60 percent overestimate of the growth between the second and third quarters.

In 2005 value dollars the growth was $18 billion in U.S. production. That is $71.5 billion at an annual rate. The BEA does not publish margin-of-error figures for their estimates, but a margin-of-error of 0.25 of 1 percent is probably the right order of magnitude. Thus taking the difference of two values which are accurate to only ±0.25 of 1 percent ( ±$8 billion) produces a figure which is accurate to about ±$12 billion. Thus the growth in real GDP between the 2nd and 3rd quarter was $18 billion ±$12 billion and hence it is not at all certain that the economy actually grew.

On January 29th the Bureau of Economic Analysis (BEA) published its first (advance) estimate of the real GDP for the fourth quarter of 2009. According to that estimate the real GDP of the U.S. increased 1.4 percent over its level in the third quarter of 2009. The annualized rate would therefore be 5.6 percent. If the 1.4 percent quarterly continued for four quarters the increase would be the 5.7 percent growth the BEA publicized. This 5.7 percent growth rate is quite literally an incredible rate of growth. The 1.4 percent percent rate quarterly increase is in contrast to 0.55 of 1 percent in the third quarter and the decline of 0.185 percent in real GDP (0.75 of 1 percent annual rate) for the second quarter of 2009 compared to the first quarter. While the increases in real GDP in the third and fourth quarters, if they truly occurred, would be really good news for the economy, but there are some serious suspicions that the BEA may have succumbed to Administrative and/or Fed arm-twising to come up with a statistical end of the recession.

The graph below of quarterly growth rates over the past five years puts the 5.7 percent growth rate into perspective.

Sources of Growth

There are continuing weak spots in the economy. Businesses continued to sell off inventory without replacing it. In the third quarter the rate was $139.2 billion ($2005). As terrible as this is, it was an improvement from second quarter rate of 160.2 billion ($2005) per year. The investment in plant and equipment by businesses continued to decline. This quantity reflects business confidence about the future of the economy. In the fourth quarter businesses continued to sell off inventory without replacing it but the rate dropped to 33.5 billion ($2005). Most of the growth in real GDP for the fourth quarter came from the 105.7 billion ($2005) reduction in the disinvestment in inventory. The increase in real GDP between 2009III and 2009IV was 182 billion ($2005).

At this point the most instructive exercise is to examine where the 182 billion dollar increase in real GDP came from.

The Quarter-to-Quarter Changes in
the Components of Real GDP in 2009
(Billions of $2005)
Component1st Q
to 2nd
2nd Q
to 3rd
3rd Q
to 4th
GDP-23.971.5182.0
Consumption-20.263.645.9
Durables-15.551.0-2.4
Nondurables-9.87.621.3
Services2.811.825.8
Investment-101.817.7127.4
Residential
Struct.
-23.515.25.0
Nonresidential
Struct.
-32.8-19.49.1
Equipment
& Software
-11.03.327.9
Inventory-46.321.0105.7
Net Exports56.1-27.016.3
Exports-15.059.362.8
Imports-71.286.446.5
Government41.416.9-1.1
Federal27.219.80.2
State & Local14.712.2-1.2
Residual0.4-8.5-1.8

The total change for a component cannot be derived by adding up the changes in the subcomponents because of the methodology used by the BEA. The real value for a component is separately computed using the current value figure and a price index. The BEA explicitly warns that the totals of the subcomponents will not necessary equal the value for the component. For example, the changes in the subcomponents of GDP add up to 188.5 billion rather than 182.0 billion. The difference could be called the residual change, but it is not equal to the change in the residual. Likewise the subcomponents of private domestic investment add up to 147.7 billion, whereas the change in private domestic investment is 127.4 billion.

Despite the fact that the changes in the subcomponents cannot be exactly related to the change in the component one still sees that a major part of the change in real GDP came from a decrease in the disinvestment in inventory. Thus supposedly the economy is booming because businesses are not selling off inventory without replacing it to the extent they were doing so. Net exports increased because exports increased more than the amount that imports increased. Thus supposedly foreign buyers are pulling the U.S. out of its recession. Those foreign buyers themselves are in recessions resulting from the decreases in imports by the U.S. Isn't that amazing? Also consumers purchases increased but not in durables goods.

Since so much of the supposed increase in real GDP came from the restocking of inventory it is worthwhile to look at two series compiled by the Bureau of Economic Analysis. The two series are final sales to domestic purchasers and final sales of domestic product. The figures are corrected for price changes.

Real Sales to Domestic Purchasers
and Real Sales of Domestic Product
(Billions of chained 2005 dollars)
QuarterFinal Sales
to Domestic
Purchasers
Growth
Rate
%/Q
Final Sales
of domestic
product
Growth
Rate
%/Q
2008IV13,654.913,193.5
2009I13432.7-1.6313,055.8-1.04
2009II13,401.4-0.2313,077.8+0.17
2009III13,477.2+0.5713,172.2+0.38
2009IV13,535.2+0.4313,200.2+0.56

These growth rates reflect an end to the recession and the beginning of a recovery but at creditable growth rates of about 0.5 percent per quarter (2.0 percent annual rate).

The Difference Between the End of a Recession
and the Recovery of the Economy

Before going into the details of the statistics, first let us consider the significance of the end of a recession. The end of a recession does not mean the end of hard times.

Below are given some of the statistics for the Great Depression of the 1930's. First consider the GDP.

From the graph we see the recession which started in 1929 ended in 1933. But the end of the recession did not end the depression. Note futhermore that in 1938 there was recession within the Depression. This was an anomaly. For all other years of the period after 1933 the real GDP was growing. One does not refer to the Great Depression of the first few years of the 1930's; one refers to the Great Depression of the entire 1930's. The reason for this is that the unemployment rate remained at depression levels for the entire 1930's, as is seen below.

Private investment, whose collapse from 1929 to 1933 was the immediate cause of the Depression, also began to recover in 1933. It was the decline in investment in 1938 which was responsible for the recession within the depression in 1938.

So the focus on ending the recession by presenting a rise in the real GDP is misleading. It is an essential first of recovery to end the decline in real GDP but in itself it does not mean much. But did the real GDP really increase?

Why the Numbers Just Do Not Add Up

From the title of this section it might appear that it would deal with some arithmetic problems of the third quarter figures, but that is not the case. This section deals with an aspect of the methodology for constructing the price corrected figures. First consider the set of numbers for the third quarter on consumer durable goods purchases as given in the second estimates. (All of the figures shown below are for the second estimates and serve to illustrate the point just as well as third estimates would.)

Durable Goods Purchases and Its Components
Third Quarter 2009, Seasonally Adjusted and
in 2005 Prices (Advance Estimates)
Billions of $2005
Durable Goods1127.2
Motor Vehicles
and parts
342.4
Furnishings and Durable
Household Equipment
258.2
Recreational Goods
and Vehicles
411.5
Other Durable Goods124.8
Sum of Above
Components
1136.9
Discrepancy9.7

The components of durable goods purchases total to $1136.9 billion yet the total durable goods purchases is given as $1127.2 billion. This is a discrepancy of $9.7 billion

Consider private domestic investment.

Billions of $2005
Gross Private
Domestic Investment
1496.8
Fixed Investment1641.1
Change in
Private Inventories
-130.8
Sum of Above
Two Items
1510.3
Discrepancy13.5

The components of private investment total to $1496.8 billion yet the total private domestic investment is given as $1510.3 billion. This is a discrepancy of $13.5 billion.

Such discrepancies do not exist for the current dollar figures. The reason for their existence is that the total and the component values are adjusted separately for price changes. That is to say, a price index is computed for each component and for the total separately. Thus the total does not have to equal the sum of the components. This is true for real GDP and for its components; i.e.,

Billions of $2005
Gross Domestic Product13014.0
Consumer Purchases9265.1
Gross Domestic
Private Investment
1496.8
Net Exports
of Goods and Services
-130.8
Government Purchases2583.4
Sum of Above
Four Items
12997.0
Discrepancy17.0

Thus the sum of the components is $12,997.0 billion is $17.0 billion short of figure of $13,014.0 billion reported for the real GDP for the third quarter of 2009. Such dicrepancies are reported as Residuals, however the reported residual is -$12.8 billion rather than -$17.0 billion. The residuals for the first and second quarters of 2009 were -$1.1 billion and -$2.9 billion, respectively. Thus thereeee was a substantial jump in the level of the residual for the third quarter. If the residual is taken away the real growth for the third quarter is 0.74 of 1 percent instead of the reported 0.87 of 1 percent. This reduces the annual growth rate from 3.5 percent to 3.0 percent.

The increase in real GDP reported for the third quarter compared to the second quarter is $112.5 billion. Because of the independent price adjustment one cannot find this increase as exactly the sum of the net changes in the detailed components. Nevertheless it is possible to get an approximation of the increase by examining the changes in the components.

The Sources of the Increase in Real GDP

The largest single element in the increase is the increase in Motor Vehicles and Parts. This was $29.0 billion in the third estimate. The figure for the this increase was $36.2 billion in the first or Advance estimates. The 25 percent downward adjustment reflects the uncertainty in estimate.

The $29.0 billion increase in purchases of Motor Vehicles and Parts accounts for 0.2 of 1 percent of the annual growth rate. Undoubtedly this increase in Motor Vehicles and Parts purchases was largely due to the Cash for Clunkers program. Note that this is purchases rather than increase in production. If motor vehicles were purchased from dealers' inventory and not replaced there would be an offsetting decrease in inventory investment. If the motor vehicles purchased were foreign produced then there would be an offetting increase in imports. The statistics are in terms of Gross Domestic Purchases rather than Gross Domestic Product. In principle these should be equal but in practice there is usually a significant discrepancy.

There was also an increase in Recreational goods and vehicles of $16.4 billion. In the previous quarter this component had decreased by $4.7 billion. So supposedly in the midst of the recession consumers who had previously been reducing their purchases of Recreational Goods and Vehicles suddenly started started buying more. If this increase in purchases of Recreational Goods and Vehicles is not really there the annual grow rate would be reduced by 0.13 of 1 percent. The Cash for Clunkers program is a noncontinuing stimulus. When its effect disappears in the fourth quarter will the talk be of the beginning of another recession, given that the talk now is of the end of the recession? And did the Cash for Clunkers really stimulate the economy? The new car dealers could have sold off their existing inventory without replacing it. The phenomenon of selling off inventory without replacing it has been a major source of the recession. In the second quarter of 2009 this selling off of inventory without replacing it amounted to $160.2 billion at an annual rate. In the third quarter this disinvestment in inventory continued but at a rate of $139.2 billion. Clearly businesses did not perceive the recession as having ended. They are continuing to unload inventory and welcome any so-called stimulus measure such as Cash for Clunkers that help them do so. The supposed reduction of the disinvestment in inventory from $160.2 billion to $139.2 billion is the source of $21.0 billion of the reported $71.5 billion increase in real GDP. Without it the growth rate would be decreased by 0.16 of 1 percent. No measures of accuracy are provided for the statistics. Is the level of disinvestment $139.2 billion ± $1 billion or is it ±$10 billion? Or, perhaps ±40 billion. The statistical unreliability of the estimate of the level of disinvestment in inventory makes it unwise to count on it for a major share of the increase in real GDP.

The most important factor in most recessions is the level of investment in plant and equipment. In fact, essentially all of the decline in real GDP of the recession can be attributed to this element of demand. Between the third quarter of 2008 and the third quarter of 2009 real GDP, according to the present official statistics, declined by $351.6 billion. Over that same period Nonresidential Fixed Investment (investment in plant and equipment) declined from $1579.2 billion to $1269.0 billion, a decrease of $310.2 billion. From the second quarter to the third quarter of 2009 this element of demand continued to decrease, at an annual rate of $19.4 billion. Somehow the supposed end of the recession is not being perceived by business.

The official GDP statistics do not cover major investments in research and training. These items have been reduced sharply and may be continued to be cut back as a result of businesses wanting to show as much profit as they can under current conditions. Thus the decline in investment may be larger than the official statistics show.

The other element of private investment is residental construction. The level of new residental construction has been falling steadily over the past few years. From the first quarter of 2009 to the second quarter of 2009 residential construction fell by $23.5 billion at an annual rate. Now suddenly in the third quarter of 2009 it supposedly increased by $15.2 billion. How surprising that developers looking at the declining real estate prices and the inventory of existing housing on the market due to the foreclosures should suddenly change their minds about the real estate market for new houses.

Consumer spending for nondurables increased in the third quarter by $8.4 billion. This is somewhat of a surprise since in the second quarter spending for nondurables decreased by $9.8 billion. Did consumers have more real income in the third quarter? No, they in fact had less real disposable income in the third quarter, $36.9 billion less in terms of 2005 value dollars. Out of this 0.37 of 1 percent smaller real disposable income they bought $6.6 billion more in food and $11.8 billion more in services. This increase in purchases of consumer services came largely in financial services and insurance ($5.7 billion). In the second estimates there was an increase in expenditures for healthcare of $7.9 billion. In the third estimate this increase fell to $0.4 billion.

Altogether consumers bought $63.6 billion more in goods and services (about 0.5 of 1 percent) out of 0.37 of 1 percent less real disposble income. This reflects a surprising confidence on the part of consumers.

In the international scene the level of exports from the U.S. increased by $59.3 billion but the level of imports increased even more, $86.4billion. The net result was a decrease in net exports by $27.0 billion.

For the government sector the picture is mixed. State and local governments, struggling with budget problems stemming from the recession, reduced their purchases by $2.5 billion. This is a turnaround since in the second quarter their purchases had increased by $14.7 billion.

The Federal Government, on the other hand, increased its purchases in the third quarter by $20.2 billion. Most of this came from purchases associated with the military ($14.1 billion), denoted in the accounts as Defense. The nondefense Federal purchases also went up, by $5.6 billion.

Conclusions

The end of the recession, if it did end, came as a result largely of actions on the part of the Federal government; the Cash for Clunkers program and increases in direct government purchases, two thirds from defense and one third from nondefense. The other elements of the increases in demand range from the surprising to the implausible. These involve consumers buying more but having less real disposable income. Developers are supposedly building more new housing. In the recent past the building of new housing was quite reasonably being cut back. In the third quarter against reason and caution this building suddenly blossoms. Businesses, on the other hand, are not perceiving the end of the recession. Investment in plant and equipment continues to decline and businesses are selling off inventory without replacing it. The end of one-shot stimulus program will probably result in a decline in demand and a further fall in real GDP. The situation is similar to the tax rebate program in 2008. The tax rebates stimulated demand a bit in the second quarter of 2008 but with the fading away of that effect the level of real GDP declined slightly. That decline added to the depressing effect of the financial crisis which occured in September of 2008 due to the scuttling of Fannie Mae and Freddie Mac.

The Advance (first) estimates of the National Income Accounts raised suspicion that the Bureau of Economic Analysis succumbed to arm twisting by the Administration and/or the Fed to provide a rosy picture of the economy. In all previous releases by the Bureau of Economic Analysis the embargo on releasing the information before the official date was maintained. For the October 27th 2009 release the nature of the figures was being presented days ahead of time. Usually the embargo is maintained to give the Bureau the opportunity to make any last minute adjustments in the figures. This time that consideration did not seem to matter. Perhaps because the results were dictated by the Administration rather that found by the Bureau.

The reported annual growth rate of 2.2 percent is a bit more believable than the previously reported 3.5 percent and 2.8 percent, although it still seems still a bit high. The 3.5 percent growth rate was exactly what someone would choose for propaganda impact. A lower figure would be dismissed as insufficient to have any impact on unemployment. A higher figure would have been just too implausible. Three point five, not too hot and not too cold; just right. The 2.2 percent growth figure will probably be further reduced in future revisions of the figures.

The suspicious nature of the third quarter growth rate shows up in its comparison with growth rates of the recent and more stable past.

There is a definite likelihood that the real GDP will decline for the fourth quarter of 2009 after the one-shot stimuli measures fade into the past. The real source of the recession is the decline in business investment in plant and equipment. As of now investment in plant and equipment is still declining, although not at the free-fall rates of the begining of 2009. Disinvestment in inventory is still occurring. The real end of the recession will come when invesment in plant and equipment stops declining and the selling off of inventory without replacing it stops. These elements of aggregate demand are a matter of business confidence. The Obama Administration does not inspire a great deal of confidence with its mania for "getting things done." Some of those things have negative impacts which offset the impact of the positive things. The recent call for banks to lend more to business sounds like the creation of subprime business loans. The problem is not that banks are not willing to lend to business; the problem is that businesses have little incentive to undertake new investment projects.


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