Comment on GDP data

The Bureau of Economic Analysis released its estimates for economic growth in the second quarter of 2005 today. Growth of gross domestic product (GDP) slowed from an annualized rate of 3.8 percent in the first quarter to 3.4 percent in the second quarter.

The big news, though, comes from the BEA's revised growth estimates for previous years. It turns out that the economy grew slower than previously expected. In 10 out of twelve quarters from the end of 2001 to early 2005, the economy grew slower than previously reported. For instance, in the first quarter of 2002, the economy grew at 2.7 percent instead of the previously estimated 3.4 percent, a difference of 0.7 percentage points (figure 1). On average, the economy grew 0.3 percentage points slower than previously reported from 2001 to 2004. This may not seem like much, but after three and a half years, this amounts to almost $100 billion (in 2000 dollars) in GDP.

Differences Between Revised and Previous Estimates of Economic Growth

Notes: All figures are annualized percent. Author's calculations based on data from the Bureau of Economic Analysis, National Income and Product Accounts, Washington, D.c=: BEA.

In addition to weaker than expected growth in previous years, economic growth slowed again in the second quarter. Much of the slowdown in economic growth in the second quarter had to do with businesses drawing down inventories, e.g. automobile companies selling last year's models with rebates.

At the same time, consumption growth continued to slow, too. Household consumption grew by 3.3 percent in the second quarter after increasing by 3.5 percent in the first quarter. Importantly, the growth in consumption came at the expense of households saving at the lowest rate in history. The personal savings rate fell to a historically low 0.2 percent in the second quarter of 2005.

The flip side to the low saving rate is that inflation adjusted wages and salaries grew at their slowest rate in more than a year. Real wages and salaries grew by 1.6 percent in the second quarter, down from 3.8 percent in the first quarter.

The import figures are in line with this slowdown in consumption. In particular, imports fell for the first time in more than two years. Imports declined by 0.2 percent in the second quarter of 2005, due in part to people buying fewer goods overseas.

The biggest contributing factor to the decline in imports, though, was a sharp drop in petroleum imports. Petroleum and related products declined by 30.1 percent in the second quarter.

Following lower imports and higher exports, the trade deficit fell from an all time high of 5.7 percent of GDP in the first quarter to 5.5 percent in the second quarter. Recent growth, though, in the U.S. dollar and higher oil prices may ultimately contribute to a rising trade deficit again.

Also, business investment expanded at a rate of 9.0 percent in the second quarter of 2005, after growing only 5.7 percent in the prior quarter. This growth was especially pronounced in equipment and software, which expanded by 11.0 percent in the second quarter of 2005.

It seems clear that the economy needs stronger economic growth, especially in light of the fact that the economy grew slower than previously thought. To see stronger growth, businesses need ongoing incentives to invest more in domestic capacity, i.e. continued consumption growth. With households virtually not saving anything and real wage and salary growth slowing, today's figures are grounds for concern as it is unclear how households will continue to finance higher consumption levels over time.