October 27, 2018
Matt O’Brien had a good piece on yesterday’s GDP numbers noting that we are not seeing the investment boom promised by promoters of the tax cut. However, he argued that growth was likely to remain close to 3.0 percent based on the 3.1 percent growth rate reported in final sales to private domestic purchasers. In my GDP write-up, I was somewhat less optimistic about near-term growth prospects, pointing to the 1.4 percent growth rate in final sales.
The difference between these two measures is that the final demand measure pulls out inventory changes from GDP. The logic is that changes in the rate of inventory accumulation are erratic and no one thinks that the rate of inventory accumulation will expand infinitely relative to the economy nor the rate at which they are being run down will continually accelerate. For this reason, the final demand measure, which leaves out inventories, seems like a better measure of growth.
The final sales to domestic purchasers measure pulls out government spending and net exports, following a similar logic. Government spending is often erratic, jumping or falling in a given quarter, often due to the timing of purchases, especially with the military. Pulling it out can give a better measure of underlying growth. Net exports are also erratic, but we don’t expect the trade deficit to either continually expand or shrink relative to the overall size of the economy. Therefore pulling out the quarterly changes can give us a better measure of the underlying growth rate.
While the decision to pull government expenditures out of the GDP figure makes little difference in the most recent quarter (they grew at a 3.3 percent rate, almost the same as the 3.5 percent overall growth rate), the decision on net exports does. The increase in the trade deficit subtracted 1.78 percentage points from growth in the quarter. That is the explanation for the difference between the 3.1 percent growth rate in final sales to domestic purchasers and the 1.4 percent rate of growth of final demand.
The question of whether or not it makes sense to pull out net exports depends on what we think will happen with the trade deficit in the near future. The trade deficit will not continually expand relative to GDP, but there are good reasons for believing that it will continue to expand in the near future. Specifically, the dollar has risen relative to the value of the currencies of our major trading partners, making US goods and services less competitive internationally. Also, the US economy is growing faster than the economies of most of our major trading partners. This means the rate of growth of our imports from them will likely be faster than the growth of their imports from us. For this reason, the final demand measure may be close to the measure of underlying growth, since a rising trade deficit is likely to be a factor slowing growth at least for the next two or three quarters.
That doesn’t mean that I expect growth to fall to 1.4 percent in the fourth quarter. There is considerable interaction between inventory accumulation and the trade deficit since many of the goods sitting in inventories are imported. A slower rate of growth of inventories is also likely to mean a slower rate of growth of imports. So, if we see inventories added less to growth in the fourth quarter, we are also likely to see imports subtracting less from growth.
But the underlying point is that if we are in a period where the trade deficit is on an upward path, then we will see GDP growth that is less rapid than final demand to domestic purchasers. That is my bet for now.