Gross Domestic Product is a measure of the nation’s economic activity. The statistic measures the sum of the nation’s production for both the private and public sectors. A nation with an increasing GDP in real terms is considered to be growing, while one with a declining GDP in real terms is in recession. (NOTE: By real economists mean adjusted for inflation and population).
The Federal Government’s second estimate of GDP for the 1st quarter of 2014 was released, showing that the economy actually shrunk by 1 percent during the first 3 months of the year. This is much lower than the original estimate of basically no growth and comes off of a very slow 1.9 percent growth rate for 2013. While GDP is supposed to be a measure of production, the government actually produces a statistic based on consumption figures, and as everyone knows, consuming something is totally different than producing it. For example, based on how GDP is calculated, if we were to dig up all of the interstates in the country and pile the concrete up to produce pyramids, we would be consuming and therefore growing the economy, so there are obvious problems with the statistic. Even so, one can garner some idea of how the economy is preforming and it is actually measured by the government using consumption expenditures. In the 1st quarter overall consumption fell by 1 percent, although consumer spending was up by over 3 percent. This higher consumer spending was offset by steep reductions in investment spending (what actually grows the economy), and higher net imports.
As we identified last month a big part of the change in consumer spending is not real. Based on the revised data, the contribution to the quarterly change from consumer spending on physical goods was nearly flat (adding just 0.16 percent to growth). But spending on health care services added 1.01 percent. In other words, based on how the Bureau of Economic Analysis reports GDP, 1st quarter figures would have been down by 2 percent were it not for the increased costs resulting from the “Affordable” Care Act.
The real scary story from the 1st quarter GDP figures was a decline in physical investment. Some of this may have been due to weather conditions, but winter is accounted for in the statistics. Business investment was down by 1.6 percent and investment in housing was down by 5 percent, after a 7.6 percent decline the prior quarter. Obviously the real estate market will not be pulling the economy out of the slow growth pattern as had been suggested by many pundits. The one good sign from the overall GDP figures was that inventory adjustments accounted for a large part of the reduction in overall economic activity (reducing growth by 1.62 percent). Since inventory growth is not real economic activity, reductions in inventories are not real declines. Taking all of these adjustments into account means that overall economic activity was relatively flat, with the big reduction in inventories being offset by the ACA tax increase.
Businesses and industries should be concerned about slow GDP growth because the overall level of income available to customers tracks this number. The economy is starting to generate some job growth, but if GDP does not rise along with jobs, it would indicate that the economy has topped out and is heading for a recession sooner rather than later. Considering the fact that both fiscal and monetary policy are still in effect fighting the last recession, a new downturn would be particularly difficult for Keynesian tools to fight, suggesting that the next downturn could be just as long and drawn out as the current one.
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