So Why Does It Feel Like a Recession?

by: Menzie Chinn August 29, 2008    

Menzie Chinn

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The preliminary GDP release yesterday provided a number of surprises. The first surprise was not that GDP was higher than the advance release (given the June trade figures reported earlier this month), but rather that at 3.3% it exceeded the 2.8% [SAAR] of the consensus [0]. The second surprise is that the reduction in imports comprises an even larger proportion of the overall growth.

Let's turn first to the surprise. The change in the contribution due to net exports was anticipated, given the release of the monthly trade figures for June, which were unavailable at the time of the advance release. However, one big change was in the contribution of inventories. Apparently, they decreased by a smaller amount (-1.44 ppts vs. originally estimated -1.92 ppts). While this increases GDP in 08Q2, this might suggest a bigger reduction in output in the current quarter, as pro.ducers seek to match inventory stocks to anticipated output.

But let's return to trade. Figure 1 illustrates real GDP growth in ppts SAAR (blue bars), and the contributions from Net Exports (red line) and Imports (green line).

y1.gif

Figure 1: GDP growth q/q at annual rates (blue bars), contribution from net exports (red line), and contribution from imports of goods and services (green line). Source: BEA GDP advance release of 28 August 2008.

Interestingly, the change in trade sectors accounts for almost all of growth (in the advance, it accounted for more than all GDP growth). And while the proportions coming from export growth and import shrinkage are about the same, here I think absolute percentage point contributions are important. Reductions in real imports now are calculated to contribute 1.45 ppts, as opposed to the earlier estimate of 1.26 ppts.

Of course, some of this reduction is due to the weaker dollar, as journalistic accounts have stressed. But unlike exports, imports are -- according to macroeconomic estimates -- highly insensitive with respect to exchange rates, and much more elastic with respect to income [1]. So I suspect that real income is either actually stagnants or falling, or perceived to fall in the near future (I'm not so Keynesian as to think only current income matters). Figure 2 depicts the log real dollar exchange rate (calculated against a broad basket of currencies (blue), lagged two years, and both net exports to GDP and net exports ex oil to GDP ratios (red, teal, respectively).

y2.gif

Figure 2: Log real dollar exchange rate (Fed broad index) (blue, left axis), net exports to GDP ratio (red, right axis), net exports ex-oil to GDP ratio (teal, right axis). Source: BEA GDP release of 28 August 2008, Federal Reserve Board, and author's calculations.

The steep dropoff in the non-oil trade balance to GDP ratio suggests to me a big income (and perhaps wealth) effect, but I admit to not having conducted a formal decomposition into income and price effects.

Now we come to the issue that absorbed so much interest at the time of the advance GDP release. The divergence between real GDP and real Gross Domestic Purchases remains. Indeed it has expanded, from 2.4 ppts to 3.1 ppts. In Figure 3, I plot real GDP and Gross Domestic Purchases growth, and in Figure 4, the respective growth rates of the deflators.

y3.gif

Figure 3: GDP growth q/q annual rates (calculated using log differences) (blue line) and Gross Domestic Purchases growth (red line). Source: BEA GDP release of 28 August 2008, and author's calculations.



y4.gif

Figure 4: GDP deflator growth q/q annual rates (calculated using log differences) (blue line) and Gross Domestic Purchases deflator growth (red line). Source: BEA GDP release of 28 August 2008, and author's calculations.

Recalling the following definitions:

GDP = C + I + G + EX - IM

Gross domestic purchases = C + I + G

It's clear that the amount that we're expending on (from consumers, businesses, and government) is barely growing; given q/q annualized growth of 0.3 ppts (log terms), it's essentially zero. So the factories may be humming, but that's because exports are up, thereby illustrating how much continued growth in GDP depends upon the trends in the rest of the world.

Figure 4 illustrates why -- as noted earlier -- the GDP deflator does not jibe with what we as consumers see. It's because the prices for what we produce have diverged in a significant way from the prices for what we consume.

To me, this last outcome is not a surprise [3] (pdf). When a country consumes much more than it produces, then at some point, it has to repay some of the debt incurred. Repaying involves producing more than consuming. We're not even at that point yet -- we're merely moving toward producing more than we're consuming. How much longer the process will continue, and how far (i.e., will we actually run a trade surplus in the foreseeable future?) depends on a lot of things, including the desirability of American assets, and hence how much foreigners want to lend to us. So, as I say, two surprises, and -- for me -- one non-surprise.

What are the prospects abroad? For Europe, I'll just refer to Jim's post. It remains to be seen what happens in East Asia. But while GDP is not yet shrinking (at least not according to the current data), there's still a good chance in the future, as the slowdown spreads across borders.

A lot more coverage at Economists View.

Update: Earlier remarks of a similar nature in WSJ RealTime Economics

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This article has 10 comments:

  •  
    Aug 29 04:10 AM
    On a state level: 23 states are currently in a recession. 18 are "at risk" and 9 are actually expanding.
    Reply | Link to Comment
  •  
    Aug 29 07:37 AM
    In the end ,the overall economic activity will determine the direction of the markets.To say that the imports are not affected by FX rates but rather income is misinterpretation of facts.The higher import prices do have an impact on the real disposable income (they reduce it).The problem is the J-curve which implies that a shift in the export/import trend(trade) may take up to12 months as a result of the currency shifts.
    Meaning that as the prices of imports rise the demand for imports will shift but it will take up to 12 months to be noticed.
    In the end ,what matters is that the U.S economy is doing better than the mass hysteria would suggest.Monetary and fiscal measures were implemented that will enhance the economic recovery,but we need to allow for the lag.In fact it is the Europe that may be heading for the statistical recession as the U.S is recovering from the unnerving deceleration. Asia and Emerging market zone in general will be heading for a major recession as the growth in that area is being neutralized by the record per capita debt and existing record leverage.
    The socio /political impact of the Russia's recent "military actions" will enhance geometrically the flows into the dollar assets contributing to the major stock market rally and the rebound in the housing market.
    I just wish that the economists,rating agencies ,the FED and the others had expressed degree of caution (based on the risks that have existed then) two years or a year ago-I did as early as June of 2005 and reiterated the perspective on September 18 of 2007.
    Now that the problems/issues have been identified and are being addressed ,I am confident that the markets/economy are in the process of major consolidation and are on the way for the unprecedented rebound.
    It had taken years to derail the U.S economy ,but we are only short period away from a mega recovery.
    The market volatility will continue ,driven by the record short open interest in the equities.
    Let's not minimize the good news and it was.The negative market /economic opinions should be evaluated within the context of the record shorts(equities).
    Reply | Link to Comment
  •  
    Aug 29 08:52 AM
    The title of Menzie's article says it all, "so why does it feels like a recession?". Current available evidence suggest that there is a high probability [no not a certainty] that the world economy with the US at the core rolling into a much needed recession to correct the imbalances and excesses. Empires wax and wane, the UK was once ascendant, then the US, then Japan, then China. So must the world economy wax and wane [ie go through cycles] although the long term trend is up. It may not be a bad idea to be in cash till real opportunities come by; this may take some time even a few years. In between there will be plenty of opportunities for savvy traders.
    Reply | Link to Comment
  •  
    Aug 29 09:03 AM
    It would seem to me that at about $120 a brl for oil, if we can increase US oil production to 2 to 3 million barrels a day we would significantly increase domestic production and reduce import consumption in terms of the GDP calculation.
    Reply | Link to Comment
  •  
    Aug 29 10:33 AM
    With the way the Bush administration tried to manipulate economic statistics to try and show the 2001 recession started on Clinton's watch, I would view these numbers with a great deal of skepticism. From what was it, flat 4th quarter last year, .5% in the 1st quarter to 3.3 in the 2nd? Something smells fishy especially with a lot of our trading partners also slowing down. Wouldn't put it past them.
    Reply | Link to Comment
  •  
    Aug 29 10:35 AM
    "So must the world economy wax and wane [ie go through cycles] although the long term trend is up. "

    Yeah, right. Ludvig Von Mises identified the cause of the business cycle as fractional reserve central banking while Keynes blamed in on "animal spirits". Take your pick.
    Reply | Link to Comment
  •  
    Aug 29 10:37 AM
    One conclusion I draw is that if the recent bounce up in the dollar continues, the one area of strength vis a vis GDP (exports) will weaken. One cause for a strengthening dollar could be a recession in Europe and a slowdown (if not recession) in Asia. Thus we could be entering a self-reinforcing spiral into recession.

    On the good side, this scenario could decrease upward pressure on energy prices. Oil below $100 for a significant period of time? Yes, it could happen. A correlated question is: Will oil below $100 provide an excuse to avoid facing our long-term energy problem?
    Reply | Link to Comment
  •  
    Aug 29 11:07 AM
    You nailed it Paul. I do agree with your premise particularly on exports and overall analysis Gabe, just feel it will take longer for a recovery then you believe. This is because of the mountain of debt the consumer will need to restructure, service or default. Job creation also takes time to boost wages which speaks into your export analysis. Energy jobs will be created next year as well but this will take 12-24 months to begin having a real impact on stabalizing the economy. Housing will remain a negative counter-balance through much of 2009.

    Washington policy (or lack thereof) come this March will determine the recovery time of our economy. Geopolitics is a wild card. North Korea or Iran testing nukes would create some further market instability and let's pray we see no terror spectacular between December-March.

    I still say the next Bull will be 2013 and in between it will be years of light recession-heavy recession and possible depression based on Washington's response.
    Reply | Link to Comment
  •  
    Aug 29 11:25 AM
    "On the good side, this scenario could decrease upward pressure on energy prices. Oil below $100 for a significant period of time? Yes, it could happen. A correlated question is: Will oil below $100 provide an excuse to avoid facing our long-term energy problem?"

    This is a really good question. I only have an opinion and that is based on proposals by both Democrats and Republicans. Either or shall both launch an energy independence program even if oil is at $90 in March of 2009. I believe both parties recognize that energy is now a national security as well as economic issue. Each camp varies on approach with Dems heavily leaning toward natural gas, more hybrid vehicles, some hydrogen improved MPG standards, some nuclear and 'clean' coal/biodeisel (LOL on that one, all coal was considered DIRTY to House Dems one year ago).

    The idea of taxing the oil companies to give $1,000 rebate to Americans is a foolish one and I really hope this doesn't occur. I believe it is just an election strategy by Obama or lip service in other words. But the rest of the $150 B energy investment plan seems to have some merit.

    I do favor the Republican plan which in many ways are similar to the Democrat plan and includes drilling offshore, ANWR, Bakken, nuclear, coal/biodesel, hydrogen/battery research.

    Both plans will increase skilled jobs and begin to offset petroleum prices in the mid-term.
    Reply | Link to Comment
  •  
    Aug 29 10:19 PM
    On a technical point, I suggest Gabe Borenstein check the econometric literature regarding the existence of a J-curve for the US. I think you will find the empirical evidence is surprisingly weak. In addition, you mis-quote my analysis -- I did not say that exchange rates have no affect on imports; merely that the elasticity is smaller than the corresponding one for exports.
    Reply | Link to Comment
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