Friday, August 1, 2008

Economy has been slightly worse than we thought

A lot of the economic news yesterday focused on the government's advance second quarter GDP estimate of 1.9 percent annual growth. The growth figure represents decidedly mixed news. On the one hand, the number was positive, so output was advancing rather than declining. On the other hand, the rate was very modest, especially given that it came from the quarter in which the stimulus checks were distributed and the Fed's lower interest rates were in effect.

The gloomier news was further down in the report, where the government provided its annual revisions to the last three years of GDP estimates. These revisions are made when sources such as the annual economic and government finance surveys from the Census Bureau and tax return data from the Internal Revenue Service become available. The revisions shaved 0.2 percent from growth rates for 2005 and 2007 and 0.1 percent from the growth rate for 2006. The revised GDP growth rates for 2005-7 were 2.9 percent, 2.8 percent, and 2.0 percent, respectively.

To put the figures in context, consider the historical relationship between GDP growth and unemployment, known as Okun's Law, which suggests that growth rates of between 2 to 3 percent are associated with steady unemployment. Faster growth is associated with increasing joblessness, while slower growth is associated with falling joblessness. Okun's Law provides a helpful benchmark for identifying sub-par economic performance. Let's take the lower range number of 2 percent as that benchmark. The growth in 2005-6 was strong enough to bring down unemployment, while the growth in 2007 was not. The growth rates from the final quarter of last year and the first two quarters of this year were below the threshold associated with steady unemployment.

The revised quarter-by-quarter numbers further reveal that instead of slowly growing in the first and fourth quarters of last year, the economy actually stalled. GDP increased at an annual rate of 0.1 percent in 2007.I and decreased at a rate of 0.2 percent in 2007.IV.

The downward revisions also make the modest growth from the first two quarters of this year less impressive, as they represent growth from a lower base. Even with this, the estimated growth rate for the first quarter of this year was shaved down 0.1 percent.

As the rising unemployment rate and falling number of jobs from this morning's monthly jobs report indicate, the economy continues to under-perform. The bottom isn't falling out, but hardships are increasing.