Many breathed a sigh of relief over the final revision of 2007 Q4 GDP. However, we took a closer look at some of the data to see what was happening beneath the surface.
Our advice to those who think we escaped recession in Q4 2007: Not so fast.
As you might have guessed, actual below-the-headline data was less encouraging than even that weak 0.6% final number.
Under Gross Domestic Purchases, the BEA wrote:
"Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- decreased 0.4 percent in the fourth quarter, in contrast to an increase of 3.3 percent in the third."
The smoking gun was under Real gross domestic purchases. These are purchases made by U.S. residents of goods and services wherever they are produced (domestic and imports). They decreased 0.4% in the Q4, a very significant drop when compared to the 3.3% increase in Q3. Add to that the Gross private domestic investment decline of 2.2% in Q4.
Given those huge swings, how was it possible that GDP in Q4 was still positive?
It all comes down to the current-dollar GDP (i.e., implied price deflater), which was lowered by a significant 0.3% more than was expected. Why does this matter? Real GDP (after inflation) is obtained by dividing nominal GDP by the GDP deflater (x 100). The smaller the deflater is, the less of GDP gains can be attributed to inflation. Had that not have occurred, GDP would very likely have been 0.0% -- or worse.
Given the impact of inflation on GDP, is there another measure that might provide a clearer picture of the economy's direction without the pernicious impact of rising prices?
It turns there is: Last year, Fed economist Jeremy Nalewaik suggested a different measure: GDI, or Gross Domestic Income. Nalewaik argued in a 2007 paper that GDI "has done a substantially better job recognizing the start of the last several recessions than has real-time GDP."
According to Nalewaik, GDP-based models did much worse at forecasting recessions than did GDI: The past four recession odds at their actual starting points were only of 52%, 40%, 45% and, for the 2001 recession, just 23% according to GDP data. The alternative measure of GDI did much better, signaling odds of a recession of 78%, 44%, 72% and, for 2001, 70%.
And what of today? Recent data shows an annualized GDI decline of 1% -- its largest drop since the 2001 recession.
While many people are debating whether or not the economy will fall into recession, the GDI data suggest that we are already in one -- and have been for several months.
GROSS DOMESTIC PRODUCT: FOURTH QUARTER 2007 (FINAL)
FOURTH QUARTER 2007
MARCH 27, 2008
Estimating Probabilities of Recession in Real Time Using GDP and GDI
Jeremy J. Nalewaik
Federal Reserve, December 19, 2006
Did Economy Really Escape Fourth Quarter Drop?
WSJ Real Time Economics, March 27, 2008, 2:02 pm
4th-Quarter Data Confirms Frailty of the Broad Economy
THE ASSOCIATED PRESS
Published: March 28, 2008