The Third-Quarter GDP Revisions - Better, But Not By Much

Includes: UDN, UUP
by: Bob McTeer

The second estimate of third-quarter real GDP growth rate was 2.7%, up from 2.0% in the initial estimate. On the surface, that is a substantial improvement, but a look at the components makes it less so. In fact, the entire increase was accounted for by an increase of 0.77% in inventories, which are often hard to interpret. Inventory increases are desirable if businesses are responding to stronger demand, but undesirable if they reflect unanticipated slumping sales. In the current environment it’s hard to say which that is, but I’m inclined to believe they were at least partly involuntary.

The net change in the GDP estimate from the first to the second estimate of the third quarter reflects changes in several variables in addition to inventories. The foreign trade sector -- imports and exports of goods and services -- often changes significantly from quarter. Increases in exports add to GDP, while increases in imports subtract from GDP because they were counted in other components of spending. While exports add and imports subtract, smaller increases in each have the opposite effect in estimating GDP from one quarter to the next.

In the latest estimate, the Bureau of Economic Analysis said "Real exports of goods and services increased 1.1% in the third quarter, compared with an increase of 5.3% in the second. Real imports of goods and services increased 0.1%, compared with an increase of 2.8%." In other words, exports provide a boost, but a smaller boost than the quarter before; imports provided less of a "leakage" than the previous quarter.

So, while the trade deficit remained large (not a good thing), its slight shrinkage in the third quarter boosted real GDP by one percentage point, down from a net boost of 2.5 percentage points in the second quarter. Not only did the boost to GDP shrink from the second to third quarters, the slowing of the growth of both imports and exports is a reflection of a weak world economy.

One significant development in the third quarter numbers is that government spending increased for the first time in several quarters. Total government spending increased by a 3.5% annual rate in the third quarter, after declining in nine out of the past 10 quarters. The decline in state and local government spending was a small 0.4% in the third quarter, making it the 12th consecutive quarter of decline. Federal government spending increased at a 9.5 percent rate in the third quarter after declining six out of seven previous quarters. The decline in government spending in recent quarters has received very little public attention.

Personal consumption spending increased 1.4% in the third quarter, about the same as the 1.5% increase in the second quarter. Real nonresidential fixed investment, however, declined 2.2% after increasing 3.6% in the second. Residential fixed investment increased 14.2%, compared with an increase of 8.5%. These large numbers are welcome, but do come off of a low base.

The implicit GDP price deflator was up at a 1.4% rate in the third quarter, 0.1% less than in the advance estimate and above the 0.7% increase in the second quarter. Excluding food and energy, the index was up 1.1% in the third, compared to 1.4% in the second.

Bottom line: While the headline number looks better, the components take some of that luster away.