I hate to put a damper on the party, but the some of the reporting on the economy is getting a bit out of hand. The Post gave us an example, with a piece on the revised fourth quarter GDP numbers headlined, "Robust Economic Growth in the third quarter raises hopes that a boom is on horizon." That's not what Mr. Arithmetic says.
First, just to be clear, the third quarter numbers were definitely good news. Five percent GDP growth is a solid economic performance by any measure, so there is no doubt that it is a big step forward by any measure. The economy is clearly growing, and likely at a reasonably respectable rate. The issue is whether the term "boom" is appropriate.
As this article and other reporting notes, the third quarter follows a strong second quarter of 4.6 percent growth, which in turn followed a first quarter where GDP shrank by 2.1 percent. The piece dismisses the drop in first quarter GDP as the result of bad weather. This is surely true, but the strong growth in the subsequent two quarters is clearly related to the drop in the first quarter. The growth in these quarters was a reversal of the decline in the first quarter.
If we take the average growth over the last three quarters, we get a 2.5 percent annual growth rate. This isn't bad, but it's hardly anything to write home about. If we assume the economy has a potential growth rate (the rate of growth of the labor force plus productivity) in the range of 2.2-2.4 percent, then with the 2014 growth rate we are filling the gap in output at the rate of between 0.1-0.3 percentage points a year. CBO estimates that the gap between potential GDP and actual GDP is still close to 4 percentage points. This means that at the 2014 growth rate we can look to fill that gap in somewhere between 13 and 40 years. Perhaps we should put a hold on that champagne.
Looking at specifics of the third quarter numbers, there are several items that are virtually certain to be reversed in whole or in part in the fourth quarter. Top on this list was the jump in military spending that added 0.66 percentage points to growth in the quarter. Military spending is highly erratic and sharp jumps are almost always followed by sharp falloffs in subsequent quarters. This means that instead of adding 0.66 percentage points to growth, we are likely to see military spending subtracting something like 0.66 percentage points from growth in the fourth quarter.
A smaller trade deficit also added 0.78 percentage points to growth. We will almost certainly see a larger trade deficit in the fourth quarter (October's deficit was considerably larger than the third quarter average), which means that the trade deficit will be subtracting from growth in the fourth quarter. Equipment investment, which added 0.63 percentage points to growth in the quarter is also likely to go the other way in the fourth quarter. The data for October and November show that shipments are running below the third quarter average, before adjusting for inflation.
The takeaway is that we should see decent growth in the fourth quarter (consumption spending was very strong in November), but it is likely to be much closer to 2.0 percent than 5.0 percent, so folks may want to put that boom talk on the shelf for the moment. One final point, we continue to hear celebrations of the 0.4 percent growth in the average hourly wage reported for November. As noted previously, these data are highly erratic. The November number was primarily a bounce back from weak growth the prior two months. The annual growth rate for the three months (September, October, and November) compared with the prior three months was just 1.8 percent.
Folks can believe that wage growth was really weak in September and October and then bosses suddenly coughed up big pay increases in November, or that the monthly data was mostly driven by measurement error and that there has been little change in the actual rate of wage growth over the last three months. Mr. Arithmetic and I believe the latter.