The final read of second quarter GDP was just released, showing an annualized rate of growth of 3.9%. This follows a revised Q1 post of 0.6%. All in, the US economy in the first half appears to have expanded at something like a 2.25% rate of growth. But the GDP report that we read online or in the newspapers will actually tell us very little about how we're doing personally or why for so many people this might still feel like a recession.
The official measure of GDP is compiled quarterly by the Bureau of Economic Research of the Commerce Department of the US government. It's intended to measure the production of all goods and services in the economy. The measure is then adjusted for inflation, compared to the prior quarter, and annualized. The result is what is referred to as the "real" rate of growth in the economy during the quarter, or simply GDP.
But the Commerce Department has no way of actually tracking inflation adjusted sales. If your bill at the grocery store is $200, the grocer doesn't report those sales to the government adjusted for inflation. Rather, sales data for your grocer and throughout the economy are reported on a nominal (or real dollar) basis as they occur.
So how does Commerce get to the "real" inflation adjusted rate of GDP that we all read? Very simply, they start with total sales from all sectors, consumer, business, government, investment and adjust for the net value of exports (i.e., exports-imports). This total, or nominal GDP, is then reduced by Commerce's estimate of inflation. Different than the CPI that most of us are familiar with, Commerce uses a GDP price inflator, as its preferred measure of inflation. If inflation (or the GDP deflator) in a quarter were zero, for instance, then nominal and real GDP would be the exact same number. But it seldom is. So inflation is subtracted from the current dollar number to arrive at reported GDP.
Now, this being the case, we must also bear in mind that it's in the government's interest to report as high a quarterly GDP as possible. After all, politicians can point to (real) GDP as a measure of growth and the vitality of the economy. Negative GDP changes indicate recessions. Severe GDP declines, depressions. This is not to say that Commerce is cheating or cooking the books, but here's the point. GDP growth as we are all accustomed to seeing it, is a calculated number. It depends heavily on what GDP delator is subtracted from nominal GDP in order to produce the real GDP that we all read about. Again, not to suggest foul play, but by understating inflation, the government could (were they so inclined) artificially overstate the headline rate of growth in the economy.
More to the point of this article, though, is understanding that whatever rate of inflation the government calculates, the number is only meaningful to us to the extent that the rate of inflation of the things that each of us actually buys, precisely reflects the "basket" of items used to comprise the GDP deflator. Now here's where this gets interesting.
Let's take 2015 Q1 numbers as a point of reference. For Q1, the rate of GDP (after revisions) was revised to show an increase of 0.6%. In the Commerce report, they indicate that the growth of nominal production of goods and services, was 0.8%, indicating that the GDP price deflator (or the government's official measure of inflation) for the first quarter was 0.2%, or close to zero. None of you felt any inflation in the first quarter, did you?
And that's the point. The GDP deflator reflects changes in prices for a government calculated, theoretical basket of goods and services. Because it is a collection of items, however, each individual item will have its own rate of price inflation. Some prices may be rising, some falling but when you roll it all together and assign weightings, Commerce can compute an average price change, or GDP deflator.
Here's why this is so important. Let's say that in Q1, when the GDP deflator was 0.2%, food costs rose by 3% and rents rose by 5%. But these gains were offset by falling prices in electronics, computers and washing machines. The result was 0.2% overall, or virtually no change in inflation for the quarter. But let's also assume that you, personally, didn't buy a new washing machine or computer, but you did buy groceries and pay rent. Then for you, personally, the rate of inflation was (on an annualized basis) something closer to 4%. When this rate is subtracted from nominal GDP of 0.8%, then GDP to you felt like -3.2% - a deep recession.
This illustration points to the problem with the GDP statistic. As with much economic data, it is often reported on the basis of broad aggregates in the economy, in this case a broad measure of assumed inflation. By using aggregates to arrive at economic data for the economy as a whole, we may be losing sight of what the average consumer may actually be experiencing.