The GDP conspiracy
19 May, 2015
Now the Wall Street Journal says; "Commerce Department to Offer New Ways to Measure the Economy." What's this all about?
I think this could be a conspiracy theory, Larry. Many investors will be well aware that the shocking first quarter economic numbers in the U.S. were distorted by bad weather. Now there is a storm brewing in terms of how GDP is measured and conspiracy theorists would say that the White House is taking too much of an interest in it.
What's going to happen is that in late June the US Commerce Department will add more figures to its gross domestic product calculations and it will include stuff about gross domestic income — which is an alternative approach to measuring activity in the economy. The Federal Reserve Bank of San Francisco has already highlighted that it's useful to have that. Philadelphia's Federal Reserve Bank has said that they already calculate something called 'GDP Plus', and they say that that paints a better picture of the economy.
The White House's own Council of Economic Advisers is in favour of yet another measure, which is the "final sales to private domestic purchasers" and according to White House figures, if you use that kind-of number you're to get an economy that is running at a 1.1% pace in the first quarter, as opposed to 0.2% in the traditional measure — so it's not surprising that they prefer a new calculation.
What's the problem with GDP measures?
Well, I think this is a good opportunity to explain to listeners why they shouldn't take too much notice of GDP numbers when they come out. They're probably a big highlight of the economic calendar. But, they always come out with a long lag and they are subject to revisions as new information becomes available.
You might think these are sort-of minor problems but one could argue that they have brought about the fall of governments. If you look back in history, in 1976 the UK GDP figures were grim and the worsening debt to GDP ratio was causing turmoil in the markets.
The then Chancellor of the Exchequer, famously had to cancel a trip to Hong Kong and literally turn back on his way to Heathrow when figures came out. The UK government was forced to request a loan from the International Monetary Fund, and to do that they were required to cut spending and other painful economic reforms.
Two years later after this self-imposed misery the government lost a no confidence vote and the general election went to Mrs Margaret Thatcher. However, subsequent revisions showed that the economy was not in such a dire strait as the initial 1976 numbers made out, but by then Margaret Thatcher was obviously firmly in control — and the rest is history.
So, given the pivotal role it's had in the past, it's no surprise that the arcane world of GDP measurement is so interesting to politicians these days!
Should we take any notice of them?
Well, I think it's good when you need a measurement that is focused on products rather than services. It tries to measure all of the activity in the economy, but the P in GDP stands for Product and these are the easiest things to count — how many kilos of milk powder an economy produced for example.
When it comes to services, a long time ago GDP did not included services at all — they were thought to be a drag on the economy's real purpose. But these days services are included; something like a haircut would constitute a part of GDP.
But where it gets problematic is when public services are provided by the government, because some of the government's transactions are just transfer payments and some are real services and some are a mixture of both.
Traditionally, the best use of GDP was when a country wanted to assess they could afford to wage war on its neighbor. If you produced enough tons of steel and bushels of wheat, you might feel comfortably placed to sustain a military conflict.
But the main use of GDP these days is of course to assess whether the central bank should be putting on the brakes or pushing the accelerator, and that's why everyone in politics (including those in the White House) can get pretty involved when there is a change to the method!