Reading the Data

Economic data releases that were delayed due to the partial government shutdown, including fourth quarter Gross Domestic Product, have been rolling in. These reports may seem a bit dated, and the figures are subject to revision, but the hope is that, combined with fresher figures for January and February, they may help to gauge the strength of the economy over the next few quarters.

Real GDP rose at a 2.6% annual rate in the “initial” estimate for 4Q18. In terms of the available component data, this report falls somewhere between the usual “advance” and “2nd” estimates. Consumer spending rose a bit more than anticipated, although monthly figures showed an unusual drop in December. Much of the December weakness was in motor vehicles and energy (lower prices and lower consumption). Income rose sharply in December, reflecting farm subsidies and increased dividends. The Bureau of Economic Analysis also released income figures for January, which showed a reversal in farm income and dividends. Wage and salary growth was moderately strong in December, although somewhat slower in January – and should continue to provide support for consumer spending growth over the near term.

Inventories and foreign trade are relatively small portions of GDP, but they account for more than their fair share of volatility in GDP growth. Inventories rose at a faster pace in 3Q18, adding 2.3 percentage points to GDP growth. Contrary to expectations, the pace of inventory growth remained elevated in 4Q18, adding 0.1 percentage point (recall the change in inventories contributes to the level of GDP growth and the change in the change in inventories contributes to GDP growth – in other words, faster inventory accumulation adds to GDP growth, slower inventory accumulation subtracts). Net exports (a wider trade deficit) subtracted 2.0 percentage points from GDP growth in 3Q18, and the trade balance widened a little more in 4Q18, subtracting 0.2 percentage point from GDP growth. Private Domestic Final Purchases (PDFP) is GDP less net exports and the change in inventories. PDFP, a measure of underlying domestic demand, rose at a 3.1% annual rate in 4Q18 (also up 3.1% y/y).

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The level of GDP now exceeds the Congressional Budget Office’s estimate of potential GDP (the rate consistent with a steady unemployment rate and stable inflation). Estimates of potential GDP are imprecise, but taken at face value, the recent data suggest that the economy has moved beyond full employment. Last year, a number of Fed officials thought it might be appropriate to move the federal funds rate above a neutral level to lead GDP back to its potential. Needless to say, the moderate inflation trend and the uncertainties surrounding the estimate of potential GDP suggest that the Fed can be patient in deciding the next move.