U.S. GDP Growth Revised Up To 2.5 Percent On Stronger Exports; Inflation Falls

by: Ed Dolan

The Bureau of Economic Analysis reported Friday that the U.S. economy grew at an annual rate of 2.5 percent in the second quarter of 2013. The advance estimate for Q2, released last month, had shown a 1.7 percent growth rate. Higher exports and lower imports were a major factor behind the stronger growth estimate. As the following chart shows, Q2 growth appears to have picked up from its slower pace in Q4 2012 and Q1 2013. The Q2 data are subject to further revision in a third estimate that the BEA will release next month.

The next table breaks the latest growth data down according to the contributions of each major sector of the economy. The contribution of consumption expenditure was essentially unchanged at 1.21 percentage points, a little slower than the average growth of consumption over the previous eight quarters. Investment contributed a little more to growth than previously reported, but the upward revision was entirely attributable to higher nonfarm inventory investment. Inventory investment is an ambiguous indicator. Higher inventory investment can indicate either that firms are optimistically stocking up in anticipation of stronger future sales, or that goods they had planned to sell were unexpectedly piling up in warehouses and store shelves because of disappointing demand.

The most welcome news in Friday’s report was the stronger performance of exports. As the next chart shows, exports were a bright spot for the U.S. economy during the early phase of the recovery. In 2011, the growth of exports began to slow, falling almost to nothing by the second half of 2013. In the first quarter of this year, export growth was negative for the first time since the end of the recession. Somewhat surprisingly in view of the weak economic performance of many U.S. trading partners, export growth in Q2 was been the strongest in more than two years. Furthermore, the BEA now reports that imports grew less rapidly than previously thought, erasing the negative contribution from net exports shown in last month’s advance estimate. (Imports enter into the national account with a negative sign, so the revision from -1.51 percentage points to -1.11 percentage points reflects a smaller volume of imports.)

In contrast to the strong contribution of exports, the government sector has been a negative contributor to GDP growth since the expiration of the 2009 fiscal stimulus package, as the next chart shows. (The chart shows government consumption expenditure and gross investment, a measure that excludes transfer payments like Social Security and unemployment benefits. Transfer payments do not directly impact GDP.) In recent quarters, the fiscal drag from a shrinking government has been tapering off. The advance estimate actually showed a slight positive contribution from state and local government, but the BEA has now revised that back to a small negative.

In addition to data on real GDP, the national income accounts also include several measures of inflation. The broadest of these is the GDP deflator, which is the implicit price level derived by dividing nominal GDP for each quarter by that quarter’s real GDP. Another inflation indicator, which the Fed watches closely, is the deflator for personal consumption expenditures. The Fed prefers to state its 2 percent inflation target in terms of the PCE deflator rather than the more widely publicized consumer price index. As the next chart shows, indicators from the national accounts show inflation running well below the 2 percent target, and continuing to slow.

Participants in financial markets will be watching the GDP data not just for indications of the direction of the economy, but also for what they may suggest about the Fed’s plans to taper off its current program of monetary stimulus. Friday’s data tell a mixed story. The Fed operates under a dual mandate, which requires it to consider both inflation and trends in the real economy, such as employment and real GDP growth, when setting its monetary policy. This strong report on growth, by itself, strengthens the case for tapering, but the weak inflation figures have the opposite effect.

For what it is worth, stock prices were up and bond yields were down in the first hours of trading after the data were released. The suggests that market participants think the Fed well be more impressed by the sluggish inflation than by the positive GDP numbers, and will therefore be less inclined to taper.