Tuesday, February 28, 2006

U.S. Growth Revised Up-Particularly Nominal Growth

As most analysts had expected , U.S. GDP growth for the fourth quarter were upwardly revised, from 1.1% to 1.6% in volume terms. The upward revision was from 0.7% to 1.3% in terms of trade adjusted real terms and from 4.2% to 5.0% in nominal terms.

The upward revisions were the most significant both in real and even more so nominal terms in the areas which surprised the most on the downside in the first estimate, namely business investments and government purchases. Business investments gowth were upwardly revised in real terms from 2.8% to 5.4% and from 6.6% to 9.5% in nominal terms while government purchases were upwardly revised from -2.4% to -0.7% in real terms and from 2.1% to 4.9% in nominal terms. Also contributing to the upward revision were higher inventory build-up and slightly higher private consumption. Residential investments were however downwardly revised, while the trade deficit were upwardly revised.

The big positive for the U.S. economy in this report apart from the upward revision of the overall number is particularly the upward revision in business investments, as well as a upward revision of the savings rate from -0.4% to -0.2% on account of a upward revision of personal income for the third and fourth quarters.

There are however a few negatives as well, namely the higher trade deficit, the higher inflation and the higher burden of government. And particularly the latter issues are reported in a misleading way by most news outlets. This report for example would have you believe that inflation was in fact revised down and that government spending decreased. Both claims are false because of the misleading focus on the "core" rate of consumer price inflation. While the core rate of consumer prices were downwardly revised from 2.2% to 2.1%, the price index for domestic purchases (the most relevant measure of inflation) was upwardly revised from 3.4% to 3.6%. And because the prices of government purchases is increasing so rapidly , 5.6%, government spending rose in fact 4.9%, rather than the alleged decrease that news story cites on account of the volume measure. This is only a shade lower than the 5.0% nominal GDP growth. Indeed if you take the high rate of inflation for government purchases into account, government purchases have increased faster than the private economy during the last year, 7.1% , compared to the 6.4% nominal GDP increase.

As for the first quarter number, we should particularly expect much higher consumer spending growth on account of the extraordinarily strong January number and probably also higher growth of business investments and government purchases. This will probably be partially counteracted by a continued increase in the trade deficit which likely increased to at least $70 billion in January, as well as probably no positive contribution from inventories (which contributed with 1.62%:points to fourth quarter growth). All told however, total growth will certainly rise significantly from 1.6%, maybe up to 4%. Some analysts expect an even bigger increase, up to 5% growth, but I think they probably underestimate just how much the trade deficit will likely rise.


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