What if 4% turns out to be 2%?
The latest numbers on GDP growth show an encouraging upturn. After a dismal drop in first quarter output, GDP grew by 4% in the second quarter, which many economists consider a convincing sign that more prosperous times are ahead.
But GDP numbers are notoriously fickle, and that robust second-quarter number could turn out to be hollow. “It is obvious the economy is not growing at a 4% clip,” economist Jeffrey Rosen of Briefing.com wrote recently. “Unless things suddenly surge forward, 2014 economic growth will likely be the lowest yearly gain since 2011.”
Second-quarter growth numbers were strong largely because of an unusual expansion in inventories. But that doesn’t reflect actual growth in the economy, because inventory growth means companies are just replenishing stockpiles. Another component of GDP that more closely reflects actual spending is "real final sales" of things like cars, computers and services, which grew by just 2.3%. “What that’s telling you is, we’re not growing at 4% but probably closer to 2%,” Rosen said in an interview.
GDP numbers are obviously important, and they’re one of the indicators the Federal Reserve is watching closely as it considers when to start raising interest rates. Stronger-than-expected economic growth might lead the Fed to hike rates sooner, in order to stem inflation that can occur when the economy overheats. That's partly why financial markets fell in the aftermath of the second-quarter GDP news last week. But if the economy turns out weaker than the second-quarter number shows, the Fed could wait longer to raise short-term rates -- now near 0% -- which Fed watchers generally expect to happen for the first time in mid-2015.
GDP numbers undergo revisions that can significantly change the economic insights they provide. The first estimate of first-quarter GDP, for instance, showed growth of just 0.1%. The government’s Bureau of Economic Analysis revised that downward to a 1% drop in growth, then to a larger 2.9% drop, before revising it back up to a 2.1% decrease. Swings of two or three percentage points are unusual, yet they reflect the push-pull nature of a recovery that has been subpar for five years.
The 4% number for second-quarter growth was a first estimate that might be revised lower (or higher) as the next two sets of numbers come out, on Aug. 28 and Sept. 26. It’s not hard to build a case for a downward revision. Job growth has been pretty good lately, but wages have barely been keeping pace with inflation, which means the typical worker isn’t getting ahead. The housing recovery seemed to be picking up steam last year but has stalled for the time being. People are saving more, which is smart at a personal level but hurts the economy in the short run, since consumers spend less.
Fed Chair Janet Yellen has the tricky job of tightening monetary policy in time to minimize the risk of inflation, without jeopardizing a creeping recovery that has shown many false starts. Since the recession ended in 2009, there have been two other instances when quarterly GDP growth exceeded 4% -- the fourth quarter of 2011 and the third quarter of 2013 -- only to drop sharply in following quarters. Yellen has to guess whether 4% growth is here to stay, and do it before all the numbers are in. It’s a moving target with a history of moving in the wrong direction.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.