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Saturday, January 16, 2010

Q4 GDP: Beware the Blip

by Calculated Risk on 1/16/2010 02:24:00 PM

In a research note released last night, Goldman Sachs raised their estimate of Q4 GDP from 4.0% to 5.8%. They cautioned that the "headline will be an eye-popper", but that this growth is mostly due to inventory changes: "More than two-thirds of our estimated increase comes from a sudden stabilization in inventories". They also noted "anything between 4½% and 7% is possible given the volatility of the inventory data".

The rest of the note cautions on 2010, and Goldman still sees sluggish growth of just under 2.0% with the unemployment rate peaking in early 2011.

This is what we've been discussing - GDP boosted by inventory changes in the 2nd half of 2009, followed by sluggish growth in 2010.

San Francisco Fed President described the impact of inventory changes back in September: The Outlook for Recovery in the U.S. Economy

I expect the biggest source of expansion in the second half of this year to come from a diminished pace of inventory liquidation by manufacturers, wholesalers, and retailers. Such a pattern is typical of business cycles. Inventory investment often is the catalyst for economic recoveries. True, the boost is usually fairly short-lived, but it can be quite important in getting things going. ...
But what if this doesn't "get things going"?

When was the last time we saw 5%+ GDP growth, due mostly to inventory changes, and increasing unemployment? It was in Q1 1981.

The 1980 recession ended in Q3 1980, and inventory changes boosted Q4 GDP by 3.8%, and Q1 1981 GDP by an amazing 6.4%! However underlying demand remained weak (as defined by GDP ex-inventory changes, and PCE) as shown in the following table:

  1980-IV 1981-I 1981-II 2009-III 2009-IV1
GDP ex-Inventory Changes3.8%2.2%0.8%1.5%2.0%est
Change in Unemployment Rate-0.3%0.2%0.1%0.3%0.2%

Look at the blue period, and notice the boost in GDP from inventory changes in the Q4 1980, and Q1 1981. But PCE was only 1.5% in Q1 1980, and fell to 0.0% in Q2 1980. Since there was no pickup in underlying demand, the economy slid back into recession in July 1981.

Now the causes of the current recession are very different from the early '80s, but once again we are seeing a transitory boost from inventory changes and underlying demand remains weak. With the huge overhang of existing home inventory and record rental vacancies, and the ongoing repair of household balance sheets, I expect underlying demand to remain weak in 2010.

The blip in the 2nd half from inventory changes was expected, and I expect Q4 to be the best quarter for GDP for some time.

1 Q4 2009 is estimated. GDP is from Goldman Sachs, and ex-inventory and PCE is from my own estimate.