U.S. Economic Growth Rises to 2.8% In Q3, GDP-Based Inflation Indicators Remain Below Target

by: Ed Dolan

Today's advance estimate from the Bureau of Economic Analysis showed U.S. real GDP growing at a 2.8 percent annual rate in the third quarter of 2013, the fastest growth reported since early 2012. The estimate, which reflects economic activity from June through September, was not directly affected by October's government shutdown, although the data release itself was somewhat delayed. In addition to the growth estimates, the report includes a set of inflation indicators drawn from the national income accounts. These showed that inflation remained below the Fed's 2% inflation target.

The advance estimate, which the BEA bases on data from early in the quarter and extrapolations for later months, is subject to significant revision. For example, the advance estimate for Q2 was 1.7 percent. In the third and most recent estimate for the quarter, that was raised to 2.5 percent.

Details of the latest report indicate that some sectors of the economy were stronger than in Q2 and others weaker. As the following table shows, personal consumption expenditure, the single largest sector of the economy, contributed just 1.04 percentage points to Q3 growth compared to 1.24 percentage points in Q2. The contribution from gross private domestic investment was a bit stronger than in Q2, although the increase was entirely due to a faster rate of inventory accumulation.

For only the fourth quarter in the past three years, the government sector made a positive contribution to growth. The government contribution to GDP growth is measured by "government consumption expenditure and gross investment," an indicator that includes purchases of goods and services by units of government at all levels and salaries of all government employees, but excludes transfer payments like Social Security and unemployment benefits. The positive contribution of government to GDP growth was entirely due to stronger performance of state and local government. The federal government contribution to GDP growth was negative, as it has been in most recent quarters.

Exports contributed 0.6 percentage points to GDP growth in Q3, a bit better than the average for the past two years but down from the even stronger performance in Q2. As the next chart shows, exports were a leading source of growth early in the recovery, but faded in late 2012 and early 2013 as the global economy weakened. The fact that exports have rebounded in the most recent two quarters is a welcome development.

Imports also increased in Q3, but at a less rapid pace than in Q2. (Imports enter into the national accounts with a negative sign, so the -0.3 percentage point contribution of imports to quarterly growth means that more goods and services were imported in Q3 than in Q2.) As a result, net exports (exports minus imports) contributed a positive 0.31 percentage points to growth in Q3, in contrast to a negative contribution in Q2.

Today's report from the BEA also includes a set of estimates of inflation that provide a check on the monthly estimates compiled by the Bureau of Labor Statistics. The broadest measure of inflation, the GDP deflator, encompasses all goods and services. Another indicator, the deflator for personal consumption expenditures, covers the same goods and services as the Consumer Price Index from the BLS, but uses a different data set and methodology. As the next chart shows, inflation rose to a 1.9 percent annual rate according to both of these measures. Q3 inflation as measured by both the GDP deflator and the PCE deflator was consistent with the three-year trends shown as dashed lines in the figure. For comparison, the BLS estimate of consumer price inflation averaged 1.6 percent for the three months of Q3, and 1.7 percent for the core CPI, which excludes food and energy.

The question on everyone's mind will be how the Fed reacts to the latest GDP data. On the one hand, faster growth would seem to strengthen the hand of officials who think it is time to begin tapering the Fed's QE3 program of monetary stimulus. On the other hand, the PCE deflator, to which the Fed pays particularly close attention, is still below the announced 2 percent target. That will bolster the position of officials who think the time for tapering has not yet come.

The fact is, however, that the Q3 data will probably not play a decisive role in the Fed's decisions over the next few months. What officials will really be looking for are further clues as to the effects of October's shutdown, some of which will come as early as tomorrow's report on the October employment situation. Many observers are worried that the economy will be much weaker in the fourth quarter of 2013 than the third. If the outcome of the coming round of budget negotiations is an increase in fiscal drag, or worse, a stalemate that triggers another round of brinksmanship, then tapering could very well be off the table.

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