Why GDP Seemingly Rise During A Recession

On Monday, the NBER officially announced that the current U.S. recession started in December 2007. I personally think that it started even earlier, in October 2007 as the coincident indicator index of the Conference Board -which contains the same indicators as the NBER's recession indicators- peaked in October 2007. The main reason for this discrepancy is the fact that the NBER oddly uses the GDP deflator to deflate business sales instead of the PPI. As the PPI has increased a lot more than the GDP deflator (which was greatly depressed by the terms of trade effect, even as nominal sales rose because of higher import prices, creating a distortion), this causes the NBER to greatly exaggerate the level of real business sales.

Anyway, it is perhaps of lesser importance whether October or December 2007 was the month of the peak. There can be little dooubt that America has been in a recession for about a year now and that this recession has become a lot more severe in recent months. Yet, it is worth noting that the recession so far hasn't met the media definition of a recession, namely two consecutive quarters of contraction. There has been two quarters of contraction, Q4 2007 and Q3 2008, but the two quarters in between seemingly had positive growth. This is something which Michael Mandel of Business Week finds puzzling.

Yet long time readers of this blog should be able to recall that I have already solved this mystery: namely growth was a terms of trade illusion caused by the perverse GDP deflator methodology and that moreover the production numbers likely overstated nominal growth given the fact that growth in national income was much slower.