GDP Revised Downwards

I don’t think there was too much surprise, except, of course, amongst the Wall Street stock market shills, in today’s announcement that third quarter GDP was lower than first reported. Growth was trimmed from 2.5% to 2.0%. The biggest shift down came in the form of a much reduced business inventory number. Apparently businesses had a hard time restocking shelves. Or they chose not to. Which one of these two explanations you prefer will depend on your overall view of the economy’s health. The first reflects the view that business is having a hard time keeping up with demand, or, perhaps is facing decent demand but had supply chain problems. The second explanation is more pessimistic and reflects the view that business is still being cautious in its expectation for sales growth, and so is content to allow inventories dwindle in order to avoid their carrying cost.

This being economics, there is a middle ground also: it is quite possible that business is both cautious and facing supply chain issues. This is the position I am still taking. We should not forget the variety of natural calamities that afflicted the world earlier in the year: from the Japanese tsunami to the flooding in Thailand, they all have crimped the delicate flow of materials upwards through the supply chain. The Thai floods in particular are still recent enough to be causing some disruption, and provide a good explanation for the involuntary component of the inventory decline.

Having said that I still think that businesses are generally being careful about avoiding a build up in inventories. The ongoing lack of strong demand is the dominant theme in business planning for year end and the start of 2012, and so inventory levels are being watched with more care than usual.

If we adjust GDP to eliminate the effects of inventories we arrive at a statistic called real final sales, and this tells a slightly more robust story. Real final sales grew at a 3.6% pace in the third quarter suggesting that consumption and investment were relatively healthy after all. This pace was a considerable improvement over the second quarter’s anemic 1.6%. So clearly there has been some acceleration. Early reports indicate that the pick up has carried over into the fourth quarter also – retail sales were fairly strong in October. Unfortunately this pace is unlikely to be sustained since it came on the back of a reduction in savings rather from rising wages.

So what do we make of today’s revision?

Not a whole lot.

Until incomes get on a steady upward track we can expect to experience a repeat of the recent choppy pattern in the numbers. Rising final sales give us some hope that the economy is growing well enough to avoid falling back into recession. But there are still no signs of a definitive break out to stronger sustained growth. Third quarter growth of 2.0% is better than the first half of the year, and the best rate of growth since late in 2010, but it is still pathetic in the context of either historic averages or a sufficient pace to reduce unemployment any time soon.

So I am sticking to my view that we are muddling along in a sideways stagnant pattern, with GDP likely to average around 2.5% through the end of 2011 and into 2012. That’s not good, but it’s better than nothing.