Think You Can Predict GDP Revisions? Think Again!

The focus group at our site "A Dash" rejected the original title for this piece, the more professorial "Understanding and Predicting Revisions in Government Data." Whatever the title, it is the same topic.  It will be uninteresting to the many who have already made up their minds.  It continues our theme about those who disparage information from many sources.

There is a quiet battle going on.  It is more important than most realize.  On one side are those whose every article seeks to "dumb down" the discussion.  They find something wrong with every data release.  These commentators, who almost universally lack the traditional training or credentials, use some "common man" argument, appealing to what most readers already believe.  What do they have at stake?  If correct, then their opinions are just as good as the PhD economists!  And with no cost in time or money to get the education!

On the other side there are the regular economists.  While they have plenty of room for disagreement, they are all committed to finding and interpreting the best data.

A Case in Point:  The GDP Report

Last week we observed that the reaction to the GDP report seemed overdone.  Our own viewpoint is that economic activity peaked in Q407.  If the decline is sufficiently significant in the opinion of the NBER, we shall see an official recession beginning with that date.  We have written on these lines several times.

When the advance report for Q208 was announced as 1.9% real growth, that seemed like a pretty good rebound.  Perhaps it is time to think about what may generate the next turning point, and when the market may anticipate the turn, a subject intelligently raised by Tim Plaehn at Investing Thoughts.

"Oh, no!" said the punditry (and a few respected commenters here at "A Dash."  Their basic contention is that the "deflator" used is unrealistic.  The deflator is an inflation measure geared to the basket of good in question.  The amateur economists prefer to use their own inflation gauges (Big Mac index, Martini Index, Oil index, gut feel -- whatever) instead of the various official choices).

They do this despite careful warnings and explanations describing each measure of inflation.  The use of this complaint is now so pervasive that a wide variety of reports are called into question including retail sales, personal spending, and GDP as well as the regular PCE and CPI announcements.

Popular media citations included sources we admire and follow like Rich Karlgaard and Felix Salmon.  (We probably owe Barry Ritholtz a link here also, since he has been a leader on this theme.  Perhaps Barry or someone else will supply it.  His articulate and powerful statements always capture the attention of many readers and the media.)

By contrast, there is are excellent explanations from our favored economists at Econbrowser.  James Hamilton, showing off his teaching skills, writes a post that anyone can understand.  He explains why the price of  imported goods are not and should not be a part of the GDP measurement.  It only takes five minutes to read, and it is time well spent.  His conclusion is as follows:

But wait a minute, Islandia's pundits decry. How can your crummy accounting claim that inflation was only 1%? Last year we bought 500 coconuts and 1 barrel of oil for $600, but this year if we tried to buy the same thing it would cost us $630. The inflation rate, they tell you, is obviously 5%, not 1%. You must have intentionally cooked the books, they charge, just to make the economy appear better than it is!

You patiently try to explain that imports aren't included in GDP, and that's why the numbers came out the way they did.

But they're not going to believe you.

We know that this does not make complete sense out of context, but maybe readers will be sufficiently intrigued to follow the link!

His blogging colleague, Menzie Chinn, has a more complex viewpoint.  While he thinks that revisions are likely, he does not agree with the criticism of the deflator.  More ambitious readers should take a look at his analysis.  His conclusion is as follows:

Thus, it seems to me that we should anticipate that over time, we should continue to see a disjuncture between the GDP deflator, and what we think should be the price level.

This is not to deny the possibility that the GDP deflator might be revised upward. That could happen. But my view is that a lot of the puzzlement abounding can be resolved by recognizing the difference by the GDP deflator and the gross domestic purchases deflator.

Our Take

We do not develop independent inflation forecasts nor GDP forecasts.  We are consumers of economic data.  We look for the best sources and recommend them to our readers.

Many traders and investors are also consumers of such data -- very poor consumers.  They do a poor job for two reasons:

1. They do not understand the technical aspects of the subject.
2. They believe that "gut feel" and popular perceptions are an adequate substitute for data.

Markets react to these perceptions.  It is a source of market inefficiency and an opportunity for those who take the time and trouble to understand.  This understanding does not require learning advanced economics.  It merely requires identifying the real experts on the subject.