GDP release – U.S. Economic Snapshot

Q2 GDP and June PCE

Posted on July 27, 2024July 27, 2024 by peter.c.rupert

By Paul Gomme and Peter Rupert

On July 25 the BEA announced that the advance estimate of real GDP increased 2.8% in Q2 on an annualized basis. The gains were fairly widespread, except for residential and non-residential structures, that fell 1.4% and 3.3%, respectively. Personal consumption expenditures, PCE, increased 2.3% and was the largest contributor to overall growth, at 1.57 percentage points.

PCE price index

On July 26, the BEA announced that the personal consumption expenditures, PCE, price index increased 0.95% on an annualized basis. Our preferred trend measure came in at 1.9%.

The Fed’s preferred measure, the PCE ex food and energy came in at 2.2% on an annualized basis while our trend measure came in at 2.6% and has continued to fall for the last 5 months.

As we have mentioned many times before, we believe our trend measure better captures the path of inflation and, more importantly, implications for Fed policy. For example, the annualized monthly change was higher in June, 2.2%, than in May, 1.5%. It seems pretty obvious that the Fed will not change its current stance on policy given this one month blip.

Policy Discussion

No doubt, there will be a lot of chatter about whether the FOMC should lower the Fed funds rate at its July 30-31 meeting, or wait until September. Or something else. To wade through all this, it helps to have a framework to organize thoughts about the incoming data. Arguably, the so-called Taylor rule has the broadest acceptance in the economics-policy profession. Briefly, the Taylor rule says that the Federal funds rate should be set as: (a) the natural real interest rate plus (b) the target inflation rate (2%) with (c) an upward adjustment when actual inflation exceeds target and (d) a downward adjustment reflecting slack on the real side of the economy. Typically, this slack is measured by either the output gap, or the unemployment rate gap. It’s easiest to understand why one of these gaps is included in the Taylor rule by thinking about what happens when there’s a negative gap. In the case of the unemployment rate, the idea is the demand for labor is high. Consequently, either firms will have to offer higher wages, or workers have more bargaining power and can command higher wages. Either way, these nominal wage channels put upward pressure on prices through some sort of “cost push” channel. This could be as simple as firms pricing using a constant markup over their (marginal) costs. In the case of a negative output gap, the story is that demand is outstripping supply, and firms find it easier to raise their prices. Returning to the Taylor rule, the idea is that these gaps reflect future inflationary pressures, and that the FOMC should respond now to head off future inflation.

There’s a lot of wiggle room in the Taylor rule. First, one needs an estimate of the natural real interest rate. The Atlanta Fed’s Taylor rule calculator provides eight (8!) choices for the real interest rate, currently ranging from 0.7% to 2.5%. That said, a given measure of the real interest rate does not change much over time.

Second, how to think about the deviation of inflation from target? As mentioned above, we like our trend measure which has moved down in 2024. The Taylor rule would, then, prescribe a lower Fed funds rate. But that prescription depends on the FOMC having religiously followed the Taylor rule over the past few years — which it almost certainly hasn’t. Nonetheless, some commentators may suggest that it’s time to start lowing the Fed funds rate since PCE inflation has come down in 2024.

Third, how to measure real-side slack? The output gap is given by potential output less actual output. The problem here is the nebulous concept of “potential” output. The fact that FRED has a potential GDP series is of no comfort. (“Fake data!”) To be absolutely clear, the output gap is a made-up number. Similarly, the unemployment rate gap is the difference between the “natural unemployment rate” and the actual unemployment rate. Some may substitute NAIRU (the non-accelerating inflation rate of unemployment) for natural unemployment rate, but it’s the same basic idea. As with the output gap, there’s the problem of measuring the natural unemployment rate. (“More fake data!”) Between the output gap and the unemployment rate gap, the Atlanta Fed provides 18 (yes, 18!) measures of real-side slack. What’s does the Taylor rule say should be happening with the Fed funds rate based on recent real-side data? Currently, estimates of the output gap are positive: there’s slack in the economy which tends to push down the Taylor rule’s prescription for the Fed funds rate. The strong growth in the second quarter is likely to cut the size of this gap (unless of course, potential output is revised!) which calls for a higher Fed funds rate. On the other hand, the unemployment rate has increased, and so the unemployment rate gap has increased which, through the Taylor rule, would call for a lower Fed funds rate.

TLDR: Inflation is coming down; the Taylor rule dictates a lower Fed funds rate. The output gap has narrowed; raise the Fed funds rate. The unemployment gap increased; lower the Fed funds rate.

So, here is the rub, even with the most widely used model at hand, it offers little guidance as to what to do next. Indeed, there is way too much wiggle room to come to a coherent and consistent policy recommendation.

October PCE inflation and GDP revision

Posted on December 2, 2023 by Paul Gomme

On November 30, the Bureau of Economic Analysis (BEA) released PCE (Personal Consumption Expenditure) data for October 2023. The BEA notes a small monthly change in the PCE deflator (0.6% at an annual rate, down from 4.5% in September), and that the 12-month PCE inflation rate came in at 3.0% (down from 3.4% in September). These numbers largely mirror the earlier CPI (Consumer Price Index) release: the annualized monthly change fell from 4.8% to 0.5%; the 12-month rate from 3.7% to 3.2%. We prefer to look at the 3-month annualized inflation rate which also fell, from 3.7% to 3.2%; CPI inflation fell from 4.9% to 4.4%.

The cognoscenti know that the Fed’s preferred inflation measure is so-called core PCE inflation (taking out the food and energy components). By this measure, the monthly inflation rate fell from 3.8% to 2.0%, a larger decline than recorded by core CPI (3.9% to 2.8%). The 12-month inflation rate fell by 0.2 percentage points, to 3.5%; core CPI inflation fell by 0.1 percentage point to 3.0%. While our preferred 3-month annualized inflation rate fell, it was essentially unchanged at 2.4%. In contrast, the 3-month annualized change in core CPI rose in October, from 3.1% to 3.4%

In summary, the PCE inflation numbers for October confirm what was seen in the CPI inflation reported about two weeks earlier: inflation is down. How much depends on which series you focus upon. Keeping in mind that CPI inflation tends to run about 0.5 percentage points higher than PCE inflation, the data for October suggest that the US economy is approaching the Fed’s 2.0% inflation target.

Gross Domestic Product (Second Estimate)

On November 29 the BEA announced that real GDP for Q3 was revised up from 4.9% to 5.2%. While revisions to nonresidential fixed investment and state and local government spending were the leading causes of the increase, consumer spending was revised down.

Policy outlook

Given the continued decline in the inflation numbers and the continued strength in the output numbers, it appears the economy has digested the record increases in the Fed Funds rate without roiling the real side of the economy. There seems little doubt at this point that Fed policy is achieving its inflation reduction goal and may have reached the peak of the Fed Funds rate during this cycle. That is, nothing in the data points to the need for further increases in the rate and the market is suggesting some rate declines in 2024.

4th Quarter GDP….Downward Revision….Keeps Us Guessing

Posted on March 1, 2015 by Peter Rupert

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report
The BEA’s second estimate of 4th quarter GDP trimmed the growth rate to 2.2% from 2.6%. The downward revision will certainly give those more “patient” policy makers additional ammo to sit back and let the dust settle further before making any moves.

Since the recovery began, real GDP has continued a long, slow climb out of the depths. As is evident in the graph below, the growth has been weaker than the typical recovery. Said differently, almost 30 quarters since the previous peak real GDP is less then 10% higher now; however, in the past real GDP was 20-30% higher after 30 quarters from the previous peak.

Meanwhile, a version of the Taylor Rule with unemployment targeted at 6% and inflation at 2% calls out for an increase…and has been for more than 4 years.

However, average hourly earnings growth has been anemic, stuck around 2% since 2010, meaning any changes in real earnings came from changes in inflation. The latest drop in inflation has meant an increase in real hourly earnings of about 2%. As can be seen in the graph below real hourly earnings growth since 2010 spent lots of time in negative territory, rarely hit even 1% and has averaged about zero.

Moreover, five year out inflation expectations are also low.

With no inflation pressures now or later, many on the FOMC likely feel little reason to begin liftoff. Indeed, from Chair Yellen’s remarks to Congress,

In sum, since the July 2014 Monetary Policy Report, there has been important progress toward the FOMC’s objective of maximum employment. However, despite this improvement, too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.

While many were thinking that liftoff might begin in the middle of this year, but these words from her testimony imply later rather than sooner,

The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings. If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis.

But recent data have confirmed that falling oil and commodity prices may be masking movements in prices. Core inflation – excluding food and energy – jumped at the last reading and markets reacted. The FOMC seems to be leery of acting too soon on liftoff but the bigger worry is that the costs of acting too late might be higher.

Finally, from the end of the testimony,

As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its objectives of maximum employment and price stability.

Good to know, thanks.

4th Quarter GDP and Compensation

Posted on January 31, 2015 by Peter Rupert

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report
The BEA’s advance estimate of GDP for the 4th quarter shows a 2.6% increase in real GDP, sharply lower than the 4- 5.0% rises for the 2nd and 3rd quarter. This was below prior estimates and was largely taken by the markets as negative overall. Personal consumption expenditures led the positive side of things, growing at 4.3%, making it the largest contributor to growth. Exports and private nonresidential fixed investment also contributed to the growth. Working against that growth was an increase in imports, growing 8.9%, contributing -1.39 percentage points to the growth. Government spending also saw a large decline.

Although the growth was below the prior quarters, the economy increased at a rate of 2.5% over the prior year. This continues to be respectable recovery although not as fast as many prior rebounds. The open question is whether the moderation of the rebound reflects the drag created by the stagnant European and Japanese Economies and the slowing of the BRICS. The strengthening of the dollar will begin to take a toll on exports over the coming quarters so it remains to be seen if the recovery can pick up any momentum.

Labor Markets

Also out today is the Employment Cost Index from the BLS. The ECI for all civilian workers increased 0.6% in the 4th quarter. Wages and salaries (70% of compensation) rose 0.5% while benefits (30% of compensation) increased 0.6%. Plaguing some policy makers is the weak response of compensation of employees; however, some are less concerned. From the FOMC minutes of the December meeting:

Although a few participants suggested that the recent uptick in the employment cost index or average hourly earnings could be a tentative sign of an upturn in wage growth, most participants saw no clear evidence of a broad-based acceleration in wages. A couple of participants, however, pointing to the weak statistical relationship between wage inflation and labor market conditions, suggested that the pace of wage inflation was providing relatively little information about the degree of labor underutilization.

Further, they see the recent decline in energy prices as helpful in supporting consumption growth. From Wednesday’s FOMC statement (emphasis added):

Information received since the Federal Open Market Committee met in December suggests that economic activity has been expanding at a solid pace. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power.

Q3 GDP Final Estimate: Christmas Came in The Third Quarter

Posted on December 26, 2014 by Peter Rupert

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced in the 3rd estimate that real GDP increased at a s.a.a.r. of 5.0% for 2014 Q3. This was the strongest quarterly growth rate in over a decade. It seems clear that the U.S. recovery is continuing apace and, if the economy is not held back by weak growth in Europe and the BRICS, we should continue to improve. A favorable sign is that personal consumption expenditures (PCE) contributed about half of the total, split pretty evenly between goods and services. Durable goods expenditures continued to be strong, increasing 9.2% after a 14.1% increase in the 2nd quarter.

How confident should we be that this expansion has legs?

Five percent growth is a healthy number and a good excuse for an extra glass of holiday cheer. It still makes sense, however, to view this recovery in the context of other business cycles. When we do, it is apparent that this economy is still climbing out of what was a very deep hole and very tepid recovery to date. The pictures below show the path of GDP, Consumption and Investment, in this recovery contrasted with the paths of other post-war business cycles. This makes it clear that, while things are looking better, we might want to keep the good champagne corked for a while longer. The fact that this recovery is set against the background of a world economy that is very feeble is a cause for tempering the optimism.

Another positive sign for the holiday is the report from the BLS today that, once again, initial claims for unemployment has declined. The 4-week moving average has been trending down and now is as low as at any time over the last several decades.

The Context

The picture below reprises a theme from our previous post. The U.S. recovery looks great when contrasted with Japan and Europe. The question is can we continue to sustain this progress when they are struggling? Economic linkages wax and wane as the terms of trade change between nations. Falling commodity prices have strengthened the U.S. dollar. Some trading partners have pushed down the value of their currencies. These contribute to keeping inflation low and this in turn helps domestic consumption. Most signs point to the recovery continuing to be robust but there are many moving parts to this picture and we will have to continue to watch them all.

Q3 GDP Gets a Lift and Invites a Global Perspective on the U.S. Economy.

Posted on November 26, 2014 by Peter Rupert

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced the second estimate for real GDP this morning, boosting Q3 growth to 3.9% from 3.5% announced in the advance estimate. The increase came largely from boosts in business investment and consumption. The equipment component of business fixed investment increased 10.7%. Residential structures showed only a 2.7% rise while the Case-Shiller and FHFA home price indices were essentially flat.

The contribution of investment to GDP growth was less than a third of the contribution in the second quarter while the contribution of Exports, while still positive, was less than a half of what it was. The GDP numbers suggest that the U.S. economy is strong and resilient although there are reasons for concern. Chief among these concerns is that major trading partners of the U.S. are struggling – some of them mightily. In this post we look at the U.S.in relation to other major trading partners and the powerful emerging economies. Our comparisons are somewhat hampered by the reliability and availability of data (see our rant on europeansnapshot) but we show what we can.

The U.S. in Perspective

North America

The first thing to note is that North American Economy as a whole is recovering well. The U.S., Canada and Mexico are all expanding in the seven years since the financial crisis of 2007-2009 brought many of the worlds economies to their knees. The picture below shows the trajectory of the North American economies since the financial crisis. This is important because Canada is the top U.S. trading partner and Mexico ranks third behind China. If these economies were faltering that would hold back the U.S. but they are not.

Europe and Japan

Outside of North America the other most important trade relationship is with Europe. Taken as a whole the EU accounts for 17% of world GDP, slightly more than the U.S. Europe – U.S. trade accounts for 40% of world trade in services and 30% of world trade in goods. Japan accounts for about 5% of world GDP and is the fourth largest trading partner. The picture below shows that Europe and Japan are both stagnant. The European debt crisis is in the past but the crisis revealed many weaknesses in the design and execution of European integration that has resulted in what we called Europe’s Lost Decade on our companion blog. Japan has experienced two quarters of recession as Mr. Abe’s “three arrows” policy has seemingly backfired. Although the U.S. looks strong by comparison to these major trading partners their weakness constitutes a major headwind for the U.S. economy. If they are not well it is harder for us to do well.

GDP slowing in BRICS

Much of the momentum in the world economy for the past decade has been contributed by the fast growing emerging market economies referred to as the BRICS – Brazil, Russia, India, China and South Africa. Data limitations are a major limitation in looking at these economies but the pictures below give a sense of the recent pattern. Brazil has slipped into recession as has Russia. Partial data suggests that Chinese growth is slowing. The BRICS excluding China seem to be slowing somewhat, growing more at the pace of the U.S. than at their historical pace.

The Engine of World Growth?
However disappointing we may find the pace of this recovery, The U.S. and North American economies look decidedly stronger than those of our other major trading partners. Without more widespread recovery U.S. growth will be held back. But Japan and Europe suffer from structural problems – unfavorable demographics and inefficient labor markets that are not easily fixed. It may be that we should be giving thanks for our blessings.

Q3 GDP: Continued (Sporadic) Recovery

Posted on November 3, 2014 by Peter Rupert

by Zach Bethune, Thomas Cooley and Peter Rupert

GDP Report

The BEA announced in the advance estimate that real GDP increased at a s.a.a.r. of 3.5% for 2014 Q3. The estimate is down over a percentage point from the 4.6% growth rate in the second quarter, although it is still in line with the average pace of growth during the current recovery of 2.16%.

The growth in GDP was led by an increase of 1.8% in personal consumption expenditures which also cooled off from its 2.5% rate in the second quarter. Other components contributing to the increase were exports (7.8%), nonresidential fixed investment (5.5%), and both federal (10.0%) and state and local (1.3%) government spending. The increase in federal defense spending (16.0%) was the largest since 2009 Q2. Defense spending and inventories have a habit of reversing in subsequent quarters so it is not necessarily a robust improvement in the outlook.

Real personal income increased at an annual rate of 3.2%, up slightly from its second quarter growth rate of 2.9%.

A day before the BEA release, the FOMC released this statement on October 29. The FOMC ended Q3, but kept the possibility that if things deteriorated they could drag it out again. The statement was guarded when talking about recent conditions (highlighted text is ours):

…economic activity is expanding at a moderate pace. Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.

The most significant early signal of improvements in the labor market came from the employment cost index ( abroad measure that includes benefits) which, after months of staying flat, showed a sharp spike up in recent months. Average hourly earnings are also moving higher in recent months. Fed watchers will be watching this closely in the coming months to see if it portends increasing price pressure elsewhere in the economy. Nevertheless, the most likely outcome for the near future is that inflation will continue to be below target and interest rates will continue at their current level.