Inventories, Exports and Government Spending Boost GDP

by Rick Davis, Consumer Metrics Institute

October 28, 2016 – BEA Estimates 3rd Quarter 2016 GDP Growth to be 2.91% 

In their first (“preliminary”) estimate of the US GDP for the third quarter of 2016, the Bureau of Economic Analysis (BEA) reported that the growth rate was +2.91%, up +1.49% from the prior quarter.   Most of the reported improvement in the headline number came from a +1.77% quarter-to-quarter gain in inventories, a +0.96% rise in exports, and a +0.39% uptick in governmental spending.

Offsetting the improvements was an aggregate -1.41% reduction in the headline number from softening consumer spending on both goods and services. Fixed investments remained in contraction at a -0.09% annualized rate. 

The BEA’s treatment of inventories can introduce noise and seriously distort the headline number over short terms — which the BEA admits by also publishing a secondary headline that excludes the impact of inventories. The BEA’s “bottom line” (their “Real Final Sales of Domestic Product”) was a +2.30% growth rate, down -0.28% from 2Q-2016. If we take the BEA’s “bottom line” at face value, economic growth actually softened during the third quarter. 

Real annualized household disposable income was reported to have grown by $127 in this report, to an annualized $39,103 (in 2009 dollars). The household savings rate remained unchanged at 5.7%. 

For this revision the BEA assumed an effective annualized deflator of 1.48%. During the same quarter (July 2016 through September 2016) the inflation recorded by the Bureau of Labor Statistics (BLS) in their CPI-U index was 1.84%. Under estimating inflation results in correspondingly optimistic growth rates, and if the BEA’s “nominal” data was deflated using CPI-U inflation information the headline growth number would have been somewhat lower, at a +2.60% annualized growth rate. 

Among the notable items in the report : 

— The headline contribution from consumer expenditures for goods decreased substantially to a +0.48% growth rate (down a material -1.03% from the prior quarter). 

— The contribution to the headline from consumer spending on services also went down to +0.99% (down -0.38% from the prior quarter). The combined consumer contribution to the headline number was +1.47%, down a significant -1.41% (nearly half) from 2Q-2016. 

— The headline contribution from commercial private fixed investments remained negative at -0.09%. Although this is up +0.09% from the previous quarter, it represents the fourth consecutive quarter of contraction in commercial fixed investments. 

— The contribution from inventories flipped to a positive number in this report, adding 0.61% (up a dramatic +1.77% from 2Q-2016 — after a string of five consecutive quarters of contraction). It is important to remember that the BEA’s inventory numbers are exceptionally noisy (and susceptible to significant distortions/anomalies caused by commodity price or currency swings) while ultimately representing a zero reverting (and long term essentially zero sum) series. 

— In no real surprise, the headline contribution from governmental spending was a positive +0.09% — up +0.39% from the prior quarter. This momentary growth was entirely due to increased Federal fiscal year-end (“spend every last budgeted dime — even if we can’t possibly use whatever it is that we are buying”) spending — a recurring annual phenomenon that is accompanied by an offsetting fourth calendar quarter (first fiscal quarter) reversal of that growth. 

— The contribution to the headline number from exports improved significantly to +1.17% (up +0.96% from the prior quarter). 

— Imports subtracted -0.34% from the headline number, down -0.31% from the prior quarter. 

— The “real final sales of domestic product” actually decreased to +2.30%, down -0.28% from the prior quarter. This is the BEA’s “bottom line” measurement of the economy and it excludes the reported inventory growth. 

— As mentioned above, real per-capita annual disposable income was reported to have grown $127 in this report. The household savings rate was unchanged, and it remains down from the first quarter of 2016. It is important to keep this line item in perspective : real per-capita annual disposable income is up only +6.61% in aggregate since the second quarter of 2008 — a meager annualized +0.78% growth rate over the past 33 quarters. 

The Numbers 

As a quick reminder, the classic definition of the GDP can be summarized with the following equation : 

or, as it is commonly expressed in algebraic shorthand : 

In the new report the values for that equation (total dollars, percentage of the total GDP, and contribution to the final percentage growth number) are as follows : 

The quarter-to-quarter changes in the contributions that various components make to the overall GDP can be best understood from the table below, which breaks out the component contributions in more detail and over time. In the table below we have split the “C” component into goods and services, split the “I” component into fixed investment and inventories, separated exports from imports, added a line for the BEA’s “Real Final Sales of Domestic Product” and listed the quarters in columns with the most current to the left : 

Summary and Commentary 

The headline number proclaims a miraculous return to a (nearly) “normal and healthy” 3% annualized growth rate. And luckily just in the nick of time — mere days before the next Presidential election. 

As pleasant as a rousing chorus of “Happy Days are Here Again” may be, a rational person might notice several cautionary items in the report : 

— The prior quarter’s growth in consumer spending took a major hit (it was nearly halved). This finding is consistent with most consumer sentiment surveys, and it is plausibly a consequence of the continued weak growth in disposable income. 

— It is possible that the “fear, uncertainty and doubt” (FUD) surrounding an especially uncivil election campaign contributed to consumer sentiments and the spending malaise. If so, that trend has certainly extended into the current quarter as well. 

— It is plausible that massive political media buys displaced normal commercial advertising in ways that impacted consumer spending. 

— Although the BEA is really proud of their “seasonal adjustments,” somehow the highly predictable (pre-election) Federal fiscal year-end spending shenanigans completely escapes them. This momentary “growth” in Federal spending has merely been brought forward from the 4Q-2016. 

— Most of the quarter-to-quarter improvements in the contributions to the headline number came from two especially noisy line items: inventories and exports. These line items are susceptible to significant distortions/anomalies caused by commodity price and currency swings — even as physical inventories or export transactions are relatively unchanged. 

— It could be argued that inventory growth after five consecutive quarters of contraction was simply an overdue reversion to a zero-sum trend line. Or, alternately, that they are just another indication of weakening end consumer demand. 

— The BEA’s own “bottom line” growth metric weakened on a quarter-to-quarter basis. 

We suggest that a more cynical view of this miraculous recovery might be warranted.