GDP update

Last week I wrote how the upbeat revised GDP number seemed fishy.  At the least, it was an inconsistent data point in an otherwise dour economy.  Today, Barron's had another explanation of why this number was suprisingly optimistic and may also be the reason why the official GDP numbers have been stronger than many of us economy watchers would have thought.

The GDP number we hear about- the one we care about- is actually called the "real GDP" number (no kidding) which is different from "nominal GDP".  In economics, "nominal" refers to the actual number as calculated, which does not compare apples-to-apples with last year's GDP number because of inflation.  This is where "real" GDP comes into play by removing the effect of inflation.  If I sell you the same number of widgets next year, but the price rises 5%, nominal activity grew 5%, but real activity didn't grow (0%), i.e. I did the same amount of productive work.  Thus, we are interested in real GDP.

The real GDP calculation uses a statistical method called the GDP deflator as opposed to the Consumer Price Index or CPI most people are familar with.  Barron's looked deeper than I did and found that the deflator or measure of inflation they used was just 1.3% in Q2 compared with 8% for the CPI.  Now before you scream "conspiracy!", calculations of inflation are always subject to estimation, statistical abnormalties, highly variable inputs and poor methodology without anyone conspiring to report bad numbers.  What is important to recognize is that whatever statistical method is generating very low GDP deflator numbers, is also artificially propping up reported real GDP.  For example, if nominal GDP is 4.6% and inflation is just 1.3%, then real GDP is a healthy 3.3%.  However, if actual inflation is closer to the 4.6% midpoint between the deflator and CPI, then GDP growth is zero or even negative!  All those economic measurements showing contraction of economic activity are not lying- indeed the economy is weak and nowhere near 3% growth.