Real GDP Down; Real Final Sales Up: Was the Economy Stronger or Weaker in the First Quarter?

Source: Forbes

Casual consumers of economic data, i.e. normal people, probably understand instinctively that the details behind the headline numbers matter. However, they can at least rest assured that such a large increase in the real GDP estimate as we had from the 4th quarter to the 1st quarter—from plus 0.4% to plus 2.5%–at least gets the direction right. Or, can they?

Several significant swings in the components of GDP are worthy of note, but I always look first at inventories. And, sure enough, an inventory swing dominates the latest GDP estimates. Inventory changes subtracted 1.52 percentage points from the real GDP estimate in the 4th quarter while adding 1.03 percentage points to the 1st quarter, for a net swing of 2.55 percentage points. Excluding inventory changes, real final sales increased 1.5% in the first quarter compared with an increase of 1.9% in the 4th quarter. In other words, excluding inventory changes, real GDP actually declined from the 4th quarter to the 1st—the opposite direction from the headline number.

I don’t mean to suggest that real final sales is always a better measure of economic activity than real GDP because they exclude inventories. Inventory changes are notoriously hard to interpret. If businesses build inventories deliberately because sales have been good and are forecast to continue improving, then more inventory ‘investment’ should be counted along with other components of GDP. However, if inventories accumulate on the shelves because sales have fallen relative to expectations, then they will be a negative influence on future GDP and probably should be discounted. My point is that it is always useful to see what volatile inventories are contributing to GDP changes and make an educated guess as to whether their arithmetic contribution is misleading.