Thursday, August 28, 2008

Recession Spoiler: Real GDP Grew At 3.3% in Q2

Real GDP exceed consensus expectations and grew at an annual rate of 3.3% in the second quarter 2008 (see chart above), a significant upward revision from the 1.9% advance estimate one month ago. According to First Trust Advisors, "The largest drag on real GDP continues to be home building, which subtracted 0.6 points from the growth rate. Excluding housing, real GDP grew at a 4.0% rate in Q2."

The 3.3% growth in real, second-quarter GDP was also above the 2.72% average since 1998 (see chart above).


At 8/28/2008 11:06 AM, Blogger OBloodyHell said...

It's all gummint lies, I tell you!! All gummint lies!!!


TV Announcer: Today, more on the current RECESSION...
Inigo Montoya: You keep using that word... I do not think it means what you think it means.


At 8/28/2008 12:28 PM, Blogger bobble said...

you neglected to mention it, but you should consider that fact that BEA used 1.2% as the GDP price deflator to compute inflation-adjusted GDP.

do you believe that inflation is 1.2%?

At 8/28/2008 1:23 PM, Anonymous ej said...


You have to understand what the price deflator is though. Its not a measure of inflation like CPI or the PCE deflator in the personal income data. Im not sure how it works exactly, but tts based on a chained product group that changes based on import/export subsistition and how the distribution of goods moves based on price changes. The nominal output used this same set to determain value, you have to use a similarly calcualted inflation guage. If you used CPI for exmaple with nominal GDP, we would have shown to have virtually no actual growth over the past fifty years, even in the late nineties when we obviously were growing.

At 8/28/2008 1:51 PM, Anonymous Fred said...

Bob McTeer has more analysis of the GDP numbers on his blog at

At 8/28/2008 2:36 PM, Anonymous Anonymous said...

Don't Turn Off the Recession Siren Yet

At 8/28/2008 2:43 PM, Anonymous Anonymous said...

Gap Between GDP Deflator and CPI widest since 1980

At 8/28/2008 3:01 PM, Blogger bobble said...

EJ:"Its not a measure of inflation like CPI or the PCE deflator in the personal income data."

thanks for pointing that out, EJ. i still look at the GDP figure sceptically. but here is the best explanation i have been able to findof why it's so low: imports aren't included in GDP

At 8/28/2008 3:23 PM, Anonymous bob wright said...

ej (or anyone):

What does it mean when you speak about a "chained" series?

What does chained mean?

At 8/28/2008 3:56 PM, Blogger the buggy professor said...

Thanks again, Mark, for being consistently more upbeat about our economy's performance than almost anyone else . . . including your data-driven commentaries that combat the excessive doomster stuff in the media and in public opinion.


1) The question raised by bobble and replied to by ej duplicates in many ways the earlier debate here at Carpe Diem on the relative merits of the CPI and CPI-core in measuring inflation rates . . . along with the even more technical issue of the BEA (Bureau of Economic Analysis) taking the BLS (Bureau of Labor) CPI indices and converting them into the PCE or Personal Consumption Expenditure index.

And note. Just as the CPI-core index --- which removes highly volatile prices in food and energy --- doesn't match what the average household faces when paying weekly and monthly bill for what it consumers, so the PCE deflator doesn't necessarily reflect the prices that households actually pay in consuming goods and services, but rather the costs to suppliers of producing those goods and services.

2) Average people, when confronted with these complex different indexes of inflation, can easily grow exasperated because they don't understand why government statistical measures of prices --- or trends in GDP for that matter --- don't match up with their own widely shared perceptions of price rises.

But there is a good rationale for producing different indexes --- not least, in the case of core-CPI as a guide to the Federal Reserve policymakers when they consider whether to reduce the money supply and hence raise interest rates, because there will be a fairly quick negative trade-off in increased unemployment if the Fed policymakers over-estimate the mid-term trend-rate in inflation and raise interest rates either unnecessarily or too high.

If, for instance, the Fed had looked at the overall CPI trends between early April and mid-July, it would likely have become excessively worried, raised interest rates at its monthly meeting in July, and possibly plunge the US economy into a recession . . . maybe a serious one at that.

Fortunately, by looking at core-CPI, the Fed didn't worry much about rising prices and didn't raise interest rates. A justified move, no? Because in the next month oil prices fell sharply back to where they roughly were in early April.

3) What follows?

Well, there is no conspiracy here by government to hoodwink the public, or by the Fed (not part of the government) to analyze inflationary-pressures and movements in prices up and down. Which is not to say that households are wrong if they continue to focus on the still high prices of energy and food and even let such concerns influence their vote for the presidential candidates.

The hard fact remains: no one measure can possibly capture all the complexities in price movements --- some goods and services rising rapidly, some hardly at all, and some falling; not to mention the possibilities of subtitution for cheaper goods and services or the need to take into account quality changes and visits to discount stores like Walmart instead of shopping at Safeway or Macy's or Best Buy.

And all these complications are further tangled by some highly technical issues --- not least the use of Laspeyres vs. Paasche price indexes.

4) Enter the GDP price-deflator.

The CPI is a Laspeyres index. It seeks to capture the costs of a bundle of goods --- weighted according to household budgets --- that an average consumer can buy at current prices and quantities. The PCE index is a Paasche index and is chain-linked in its measures of costs for producing goods and services. It reflects the costs of the same bundle (quantity) of goods and services (or but using a base-year set of prices, not current ones. For slightly technical algebraic reasons, the Lespeyres index systematically overstates price rises or inflationary tendencies, and the Paasche systematically understates it.

Seems technical and hard to understand, no?

Welcome to the club of statistical economics. Economists aare often confused themselves, including the statisticians who deal with these matters when it comes to explaining them to the public (or other economists).


Still, grasp this point. Laspeyres indexing overstates inflation because, to put it bluntly, it assumes that the same quantities of goods and services in the basket will be consumed in the current period as was the case in the base-period, even though we know that as prices rise of some of those goods and services, consumers will purchase less of the more expensive ones and "substitute" away to other goods and services.

Thus if steak rises in prices noticeably in the current period, people will buy less of it and instead purchase cheaper hamburger or chicken. (It was this reasoning that, among other things, led the Boskin Commission to urge the BLS to consider the impact of at least some substitution effects in calculating the CPI --- as well as consider the impact of quality improvements and cheaper prices overall at discount stores like Costco, Home Improvement, Target, and Walmart. By adopting the Boskin recommendations made in 1995, the CPI still systematically overstates inflationary tendencies, but less so they it did before 1995.

5) Enter the GDP price-deflator. It is as different from the CPI as CPI-core is, only it measures something different. It is used to translate "nominal" changes in GDP --- over a quarter or a year, say --- into "real" GDP.

Nominal increases in GDP reflect both an increase in the production of goods and services consumed in the US. To remove the price changes, the GDP deflator --- developed and used by the BEA (Bureau of Economic Analysis in the Commerce Department) ---In doing so, the deflator takes inflation out and measures “real” increases in GDP, and it seems all the more useful because after 1995, thanks to the Boskin Commission again, the BEA continually changes the base-year for prices not ever several years, but rather continuously over time.

Consider an example. The average prices in 2006 and 2007 are actually used now to measure real growth from the end of 2006 to the end of 2007, and so on, creating the image of a “chain” that allows someone to compare the output of goods and services between 2006 and 2007 or between any two dates you want.
In short, the GDP deflator –- which reduced nominal GDP output by 1.1% in the second quarter --- is a Paasche index, and it will do the opposite of the Laspeyres: it will systematically understate the impact of higher prices on consumers.

6) What are the components of real GDP, arrived at by the deflator?

Y = C + I + G + NE

Where C = total household consumption (which includes the price-adjusted goods and services produced in the US and imported)

I = total investment by private businesses (likewise, including the prices of domestically produced as well as imported components of capital goods and inventories)

G = total government consumption of goods and services (including domestically produced and imported goods and services) bought by federal, state, and local governments.

NX = US exports – US imports

Notice that though the total costs of imports is subtracted from real GDP, the actual consumption of imported goods and services is accounted for by private C, business I, and government G. An

7) Remember what was said at the end of 5) above: “In short, the GDP deflator –- which reduced nominal GDP output by 1.1% in the second quarter --- is a Paasche index, and it will do the opposite of the Laspeyres: it will systematically understate the impact of higher prices on consumers.”

Some economists are unhappy with the gap here, even though there is no alternative other than a resort to a non-chained linked measure of a Laspeyres sort, and even though as we’ve seen the CPI is not what the Fed follows, but rather CPI-core. And consumers, of course, are concerned about the CPI, and again some economists (not many, it seems) fret along with some of the public that substitution and quality effects are misleading as well.


There is no end to such debates. These different measures --- CPI, CPI-core, PCE (a chain-weighted measure), and the GDP price-deflator --- are not similar, and the GDP deflator in particular (like the CPI-core) is not what the average household regards as inflation.

If you want, you can find some of the technical debate argued at Econbrowser, click here:


Good luck if you think you can find enough information here, there, and everywhere that will end the debates, whether the technical ones or the more common-sense differences between the value of the CPI-core followed by the Federal Reserve and the CPI that captures more effectively the impact of higher prices (in the short-run) on household consumers paying daily, weekly, and monthly bills.


Michael Gordon, AKA, the buggy professor

At 8/28/2008 5:02 PM, Anonymous bob wright said...

but what does "chain weighted" or "chain linked" mean?

At 8/28/2008 7:27 PM, Anonymous BARKLEY said...

right on!
no recession this time around
I remember recessions....
20% interest rates...
9/11 attack....
this time just did not smell like a recession

At 8/28/2008 8:25 PM, Anonymous Anonymous said...

Banana republico

At 8/28/2008 9:20 PM, Blogger the buggy professor said...

Bob wright said...
'but what does "chain weighted" or "chain linked" mean?'

The answer: in any price index, there's a base year for the prices of goods and services, always set to 100.

In the past, before the Boskin Commission recommendations about measuring inflation (1995) the base-year prices were revised only every several years. That was known as a fixed-weight deflator: the base year for prices would be set at 100, and the further the number of years that went by before revising the base year, the more likely the upward bias in the CPI would accentuate --- remember, it is a Laspeyres index, with such a bias built into it. By contrast, the GDP deflator --- which deals with all the price movements in the economy (not just a fixed basket of goods for consumers)--- had a downward bias (a Paasche index).

A chain-linked index simply updates the base-year (100) every year.


Here is a good summary by another writer. It has the added virtue of comparing the CPI and GDP deflator and how chain-linking helps to offset the built-in biases of them (source:

"The CPI, which is the most well-known price index; (i)has an upward bias since it is a Laspeyres index, and (ii)only covers private consumption expenditures.

"Hence, in judging the developments of prices, it is indispensable to use the GDP deflator together, as it covers the overall economy.

"Nevertheless, the following three factors should be taken into consideration when using the GDP deflator:

(i) since the base year is old, the downward bias of the Paasche index may possibly be large;

(ii) the large short-term fluctuations make it difficult to gauge the underlying trend of price movements;

and (iii) the effect of “quality adjustment” on its decline rather than changes in nominal prices is larger compared to the CPI.

Under these circumstances, a degree of caution is warranted when using the GDP deflator as an indicator for the underlying trend of price movements, and also as a proxy for thee expected rate of deflation.

The problem of an increase in bias of the GDP deflator or any other indices caused by the passage of time from the base year can be improved to a certain degree by adopting the “chain index,” in which the base year is constantly renewed. I

n the previous example of PCs and food, if the base year is revised annually or, in othe rwords, the price index level of each good is reset to 100 every year, the [upward: added b y Gordon] bias of the Laspeyres index, for instance, will no longer exist. This is because the impact of PC prices will not diminish over the years.

Taking these advantages into account, the United States has switched its GDP deflator to a chain-type index from the 1992-year base. Furthermore, the chain index of the CPI is released on a monthly basis"


Note that the EU and Japan have also moved to a chain-linked GDP deflator as well as providing for a chain-linked CPI as an alternative measure to the fixed-weight CPI.

Hope that clarifies things. The topic gets quickly technical, and involves quantity, quality, substitution, and price estimates that --- beyond a certain point --- really require mathematical presentation as well as theoretical justifications. And it's easy, alas, to get lost in the abtractions.


Michael Gordon, AKA, the buggy professor

At 8/29/2008 4:18 AM, Anonymous Anonymous said...

Mish completely dismantles this nonsense

It's a wonder people can call themselves economists and read these numbers as optimistically as they have been. Larry Kudlow is a raving lunatic on this stuff

At 8/29/2008 5:05 AM, Anonymous Anonymous said...

In other news chocorat has been increased from 200g to 100g.

At 8/29/2008 9:04 AM, Blogger David said...

"if steak rises in prices noticeably in the current period, people will buy less of it and instead purchase cheaper hamburger or chicken"...IIRC, the level of substitution used in the Laspeyres CPI calculation is more constrained than this: that is, it will look at substitution among cuts of steak, but not between steak and chicken. Can anyone shed any light on this?

At 8/29/2008 9:34 AM, Blogger the buggy professor said...

1) Despite the gleeful pouncing by some posters in this thread who find the reported GDP growth, adjusted for real growth by the use of the GDO deflator, absurd --- and, in their minds, probably a fraud --- the big disconnect between the GDP deflator's 1.2% and the reported CPI of over 5%, that same disconnect existed in the late 1980s.

2) What do the late 1980s and the recent sustained growth of the US economy have in common?

Tersely put, export-led growth --- a big boom in US exports. They doubled between 1985 and into 1990. Their current rate of growth has been even faster.

3) When exports start rising fast, they can keep an economy growing even when domestic consumption (private and government) and investment fall off --- though in fact business investment in capital goods has been robust. That's because US factories are humming loudly, exporting abroad.


4) For similar reasons, when export-led growth is driving an economy even if domestic consumption is falling at a slower rate, US national savings increase. An increase in national savings equals a reduction in national consumption.

We need to get used to this trend --- US production diverted abroad. Whatever happens to US export growth in the near future --- depending in part on growth abroad in Asia and the EU, in part on the dollar's exchange rate (trade-weighted) --- we will probably have to, as a nation, continue to reduce our overall total debt to foreign holders of US financial assets by continuing to narrow our trade deficit, and especially on the export side.

(Imports, note, seem to not respond so quickly, or easily, and for a variety of reasons --- not least, because foreign businesses can always try reducing their profit margins here until they encounter sustained losses.)

5) In short, there is no conspiracy, no manipulation of the figures by the BEA, which is in charge of gathering, analyzing, and adjusting the data about GDP. If the GDP deflator doesn't capture what average household consumers find is going on, that's because it deals with all sorts of consumption and investment.

The same gap, remember, exists between the CPI-core and the CPI . . . the latter capturing volatile energy and food prices, and the former excluding them as a guide to Federal Reserve policymaking about interest rates.

6) There are, as my earlier comments here and elsewhere indicate, some legitimate controversies that exist between economists and statisticians about the technical accuracy of various indexes --- CPI, CPI-chain-linked, PCE-chain-linked, and the GDP deflator. That's because all price indexes have to estimate quantities of goods and services produced and sold (here or abroad), and price changes.


The outcome?

Well, no one index can do both perfectly, and all the more so for a huge economy like ours with 150 million or so workers, millions of businesses, internal purchases by multinational corporations, imports and exports, investments here and abroad, and so on . . . not to mention the huge role of government purchases and subsidies.

Then, too, believe it or not, the funds available to the BEA have been cut by the Bush-Jr administrations, and so countering this trend might allow for more research by the BEA's expert staff into these highly technical matters.


7) For those with some grounding in economic theory, you might find this link to Econbrowser --- with its diagrams --- a useful source of intelligent discussion:

At 8/29/2008 2:52 PM, Blogger OBloodyHell said...

> That's because US factories are humming loudly, exporting abroad.

No, professor, that can't possibly be true!!

We've all been told about it!

We've shipped all our factory jobs overseas!!



At 8/29/2008 2:53 PM, Blogger the buggy professor said...

One final comment or two, and my own limited knowledge of the technical complications involving the GDP deflator --- by itself and what it does, or compared with the CPI --- will be exhausted.

Still, a brief summary account may help to clarify any remaining problems about their differences. And I'm drawing on the summary set out by Gregory Mankiw of Harvard, who was George W. Bush's chairman of the Council of Economic Advisers --- yes, a Republican neo-Keynesian, and somebody who worried in that post about changes in real and nominal GDP. (Macroeconomics, 6th ed., 2007), pp. 31-35.

1) The GDP deflator seeks to measure the prices of all goods and services produced in the US. By contrast, the CPI measures the prices of only goods and services that consumers buy (or most of them: a man buying the services of a hooker won't find in the CPI whether he paid too much or not on his drunken trip to Las Vegas).

If, then, business firms or the government bought goods that went up in price during 2007, any price increases won't be reflected in the CPI, but will in the GDP deflator.

2) Remember, the GDP deflator measures the prices of goods (and services of course) produced nationally.

It purposefully excludes the prices of imported goods, such as imported Hondas or imported oil . . . though, of course, the prices of Hondas or gas sold in the US also reflect the prices of Hondas built in the US --- just as the price of gas sold in your local gas station reflects the price of oil produced here. (Anyway, the global oil market is an integrated one, and price rises of oil/barrel sold to Shell in Kuwait are the same as those sold to Shell in Texas.)

The CPI, by contrast, will capture the price changes in imported goods bought by consumers.

3) And finally, as by now should be clear, the CPI uses fixed weights attached to the basket of consumer goods it tracks, using a base-year in the past for comparison --- that year set to 100. By contrast, the GDP deflator is chain-linked, with the weights adjusted yearly.

And the GDP deflator allows the basket of goods to change yearly.

Remember here: A price index that tracks a fixed basket of goods is a Laspeyres index. A price index that tracks a changing basket of goods and weights is a Paasche index. A Laspeyres index will systematically overstate price inflation, because it won't capture the change in quantities purchased by consumers as their prices rise through substitution to cheaper goods. And a Paasche will systematically understate it, and for the opposite reason: it will capture the substitution shift from higher priced to cheaper like-goods --- say, from steak to hamburger --- but in the process it will reduce consumers' welfare that such substitution might entail.


4) An example (taken from Gregory Mankiw's Macroeconomics, 6th ed): Suppose the national orange crop is destroyed by a huge frost in 2009. Since there are still some oranges on super-market shelves, their price will sky-rocket.

The GDP deflator 2009 will not reflect that soaring price of oranges. Why? Because oranges won't show up as part of nominal GDP. By contrast, the CPI will capture the big price-rise of oranges and hence show probably a noticeable rise in the CPI index.

5) Finally, the Boskin Commission --- looking at the CPI --- urged the BLS in 1995 to adjust the CPI index so that it would take into account the measurement error that follows from ignoring substitution, quality, and discount-store effects.

The committee thought there was an upward bias of between 0.8% to 1.6% yearly, and said 1.1% was their collective best judgment.

So if the CPI --- remember, it includes the volatile prices of energy goods and food (which the CPI-core excludes --- still overstates inflation for consumer-households, it does so these days by less than 1.0% or so.

That, anyway, is Mankiw's judgment, even though (as he and others note) there are still controversies about the CPI, the core-CPI, the PCE, CPI-chain linked, and the GDP deflator. As is the case, please note, in virtually every area of macroeconomics and for that matter in much of micro-economics regarding the extent of market failures, their severity, and the role or not of government in correcting them.


Michael Gordon, AKA, the buggy professor

At 8/29/2008 2:59 PM, Blogger OBloodyHell said...

> we will probably have to, as a nation, continue to reduce our overall total debt to foreign holders of US financial assets by continuing to narrow our trade deficit, and especially on the export side.

This argument ignores the degree of invisible export the nation has through commercial and non-commercial piracy. I put it to you that the total aggregate "real" value (i.e., what we could reasonably get for it at the prices people would be willing to and able to pay) is vastly underestimated.

I think that pirated US IP is sufficient to make a serious dent in the deficit, and probably in the national debt.

Nope, no proof. I just have a feel for how much of it is actually occurring, and, if there was an international system which treated copyright rationally -- as a reward for creators not tied to control of their creations (literally impossible in a digital age with the internet in existence) -- then the balance of trade associated with the US would be extremely different.

At 8/29/2008 2:59 PM, Blogger bob wright said...

buggy professor,

I appreciate your reasoned and fact based posts - as opposed to the name calling and hyperbole too often seen on this and other blogs from those who hide behind anonymity.

At 8/29/2008 3:59 PM, Anonymous QT said...


Well said. Some of these concepts are very difficult to get your head around.

All too often these discussions can get a bit heated. If anything, we should appreciate that there are others who are interested in exploring ideas.

If we just wanted agreement, life would be unspeakably dull.

At 8/29/2008 7:27 PM, Blogger the buggy professor said...

1) Just chanced on a remarkably clear and informative effort --- put out by the Federal Reserve of Atlanta's economists --- to explain which measures of prices the Federal Reserve tracks in its decisions to change interest rates.

Click here:

There are even new measures the Fed uses that I never heard of. And you can't but come away without appreciating how complex it is to find the right measures that would guide the Fed's decision-making.

2) The gist of the analysis is this: the Federal Reserve doesn't just look at CPI-core, but a variety of core measures.

3) Note that the president of that regional Federal Reserve branch is concerned about inflationary tendencies now afoot:

“No matter how you measure it, the aggregate inflation we are experiencing in the United States at the moment is uncomfortably high…

“Measures of core inflation in the United States suggest that overall price pressures have been on the rise, perhaps because higher commodities costs have begun to affect prices paid by consumers and businesses across a broader range of other goods and services…"


Wouldn't it be a marvel if all economists expressed themselves as clearly as Professor Mark Perry does, as well as these Federal Reserve economists. (If you think I'm exaggerating, pick up any late issue of the American Economic Review: even if you have a decent grounding in statistical work --- and are willing to give leeway to the rife use of jargon --- you should also bring to your reading a bottle or two of strong stuff if you hope to hack and hew your way through the dense undergrowth of verbiage and what seems at times 4th dimension mathematics.


Michael Gordon, AKA, the buggy professor


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