A few notes on the GDP revisions

The new GDP figures include some pretty significant revisions of the past data.  Most people have focused on the fact that the new figures show a significantly bigger drop in 2009 GDP than originally estimated.  Even the original 2009 NGDP figures showed the biggest drop since 1938, but these have been revised further downward.

It appears to me that most of the revision is based on changes in the third quarter of 2008.  Before discussing those revisions, I’d like to talk about why that quarter is so important.  The standard view of this recession is that the housing slump of 2007 triggered a moderate banking crisis and a very mild recession at the beginning of 2008.  Then after Lehman failed, the banking crisis got much worse, and therefore the recession became much worse.

My view has always been different.  I agree with the standard interpretation of the original, and relatively mild, recession of early 2008.  But I argued that the recession worsened dramatically before Lehman failed, and that this led to a decline in NGDP growth expectations that severely reduced asset prices and made the banking crisis much worse.

One problem with my view is that it seemed like the severe fall in GDP (real and nominal) began in the 4th quarter of 2008, which was after Lehman had failed in mid-September.  Initial reports showed only a 0.3% fall in 2008:Q3 RGDP.  As a result, all I could do was rather pathetically argue that July was a strong month, and point to the fact that industrial production (which is measured monthly) suddenly began falling sharply in August 2008.  And that this showed the economic weakness had spread out of housing even before Lehman failed.

The newly revised GDP accounts paint a very different picture of the recession.  Instead of two quarters of steeply falling RGDP (2008:Q4, and 2009:Q1) there are now three really bad quarters.  The third quarter of 2008 is now estimated to have seen a 4.0% plunge in RGDP.  Nominal growth slowed abruptly from the roughly 5% norm of preceding years, to only 0.4%.  And even that is probably overstated, as the nominal GDP numbers rely on rent imputation values for housing that almost comically overstate inflation during a housing crash (as I’ve discussed in previous posts.)

So now we know that the severe recession of 2008-09 began in the third quarter.  Since Lehman didn’t fail until the quarter was almost over, there is simply no way it could explain why the recession got much worse during those summer months.  What can explain the worsening recession?  How about a Fed that refused to cut rates for nearly 6 months after April 2008, despite a steadily falling Wicksellian equilibrium interest rate.  A Fed focusing on headline inflation numbers driven up by imported oil prices, not the expenditures on American-made goods and services.

BTW, how can the initial GDP numbers be so far off in an economy that is swimming with data and high tech computers?  Four weeks after the quarter ended the RGDP growth was forecast at negative 0.3%, and only now, two years later, we find out it was minus 4.0%?  That’s a pretty major error at a particularly important moment in the business cycle.  Too bad our policy makers were blindfolded as they were making crucial policy decisions.  Time to target the forecast?

One thing that makes me think I am on the right track is that every time I learn something new, it seems to support my view of events.  In many cases this was data that was already out there, but that I had not bothered to look up.  This includes the big drop in TIPS spreads, which began well before Lehman failed.  The huge rise in real interest rates in late 2008.  The huge rise in the dollar in late 2008, the fact that the housing crash spread from the sub-prime markets to the heartland  (and commercial RE) at precisely the moment when the recession spread from housing to industrial production in August 2008.  All of this I discovered in mid-2009, after I had already begun blogging.  But now we have information that neither I nor anyone else had access to until few days ago.  And again, it is strongly supportive of my GDP —-> post-Lehman crisis view of causality, and strongly in conflict with the conventional Lehman crisis —-> falling GDP interpretation.

I eagerly await further data revisions.

PS.  It’s worth looking at the NGDP numbers in the link above.  (Bottom line)  During the 4 quarters from mid-2008 to mid-2009, NGDP actually fell 3%; a bit more than 8% below the 5.2% long run trend, not less as I had assumed.  And during the so-called “recovery” of the past 4 quarters it has fallen another 1% below the 5% trend.  Where’s the effect of that $787 billion in fiscal stimulus?

And for those who believe wage and price flexibility solves all problems, consider that with 4% NGDP growth, we’d need 3.7% deflation to get the 7.7% RGDP growth we saw during the first 6 quarters of the 1983-84 recovery.  That recovery had 11% NGDP growth. When was the last time you saw an economy growing at 8% in a period of 4% deflation?  Never?  There’s a reason for that, wages and prices aren’t nearly flexible enough to overcome that sort of nominal sluggishness.