August 17, 2011
The NYT reported on the fact that the large revisions to GDP that the Commerce Department reported last month changed our view of the state of the recovery. (Although it is not accurate to term the 1.8 percent growth rate originally reported for the first quarter as respectable. This growth rate is not even sufficient to keep pace with the growth of the labor force.) The data are often subject to large revisions which can substantially change the assessment of the economy from the originally reported data.
However, it is wrong in arguing that the picture would be improved by relying on the income side measure of GDP. There have been two instances in which the income side measure has diverged sharply from the output side measure. One was associated with the growth and later collapse of the stock bubble in the 90s and the beginning of the 00s. Income-side GDP exceeded output side when the bubble was growing and then trailed it in the quarters following the bubble’s collapse.
The second major divergence was in the middle of the last decade. We saw the exact same pattern around the growth and collapse of the housing bubble. Income-side GDP growth exceeded output side when the bubble was growing, it fell behind output growth when the bubble burst.
It seems likely that the issue here is that some of the capital gains generated by the bubbles are being misclassified as ordinary income. (Capital gains should not appear in GDP.) In fact, regression results strongly support this case.
To get this outcome, all we need is an assumption that some percentage of capital gains are always misclassified as ordinary income. When capital gains rise relative to GDP, as they do in a bubble, the amount of misclassification rises, causing income-side GDP to exceed output-side GDP. The story is reversed when the bubble bursts and capital gains plummet.
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