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Tuesday, August 5, 2008

BEA's GDP Deflator... cut the BLS!

Yesterday we detailed that Q2 Real GDP appeared to be artificially high due to a GDP Deflator which implied an understated 1.1% annualized inflation rate (Real GDP = Nominal GDP / GDP Deflator). Below is a chart that shows where all of that inflation is hiding.

For the quarter, the Bureau of Labor Statistics "BLS" reported nondurable goods inflation a full 3% higher than the Bureau of Economic Analysis "BEA". With this lower inflation rate, the BEA reported a 4% annualized real growth rate for nondurable goods in the second quarter, which contributed an outsized 1.84% of the 1.9% Real GDP for the quarter.

Swapping the BLS nondurable goods inflation rate in for the BEA GDP Deflator, we knock off a full 1.2% from that 1.84%, bringing GDP in the second quarter to 0.60% all else equal.

Teresa directs us to an interesting post by James Hamilton arguing that the GDP Deflator may in fact be accurate.

I think James' example is simple and his logic is easy to understand, but it isn't necessarily applicable to the real world (or specifically to the U.S.). James' story involves an Island which grows one good (a coconut, which it doesn't "produce") and imports oil.

The U.S. does not have many "natural goods" like coconuts. Thus, we use that super-expensive imported oil as an input for our final goods. Thus, inflation has crept up as this expensive source of energy has flowed through the supply chain (YoY: energy up 70%+, PPI up 10%, CPI up 5%, Core CPI up 2.5-3%).

A better example would have been coconuts and a fertilizer that is essential to grow coconuts. In this case had fertilizer doubled in price, I have feeling that $515.10 worth of coconuts would not have gotten you the 510 initially assumed by the Island's BEA in the first round of its Real GDP calculation, but rather only 470 as the higher price of fertilizer increased the price of the final good, hurting demand. Thus, rather than an increase in GDP from 500 to 510 coconuts, there was a recession to 470 (same nominal GDP in both cases).

At the end of the day, we need to look at the numbers and ask ourselves if they make sense and 1.1% does not. Should the GDP Deflator be as high as that implied by the CPI? Probably not, but somewhere in between would cause another revision to GDP, which was my point all along...