U.S. economy grew 2.5 percent in Q3

Gross Domestic Product (GDP), the measure of the nation's output of goods and services, grew by 2.5 percent in the third quarter of the year, according to recently revised figures from the U.S. Bureau of Economic Analysis. The latest revision (released November 23) was improved over the 2.0 percent rise reported in the earlier initial estimate. Analysts looking for good news emphasized that a "double dip downturn" in GDP is nowhere in sight. However, even the most optimistic observers don't regard a 2.5 percent GDP increase as a signal that the economy is shifting into a higher gear.

Gross Domestic Product (GDP), the measure of the nation's output of goods and services, grew by 2.5 percent in the third quarter of the year, according to recently revised figures from the U.S. Bureau of Economic Analysis. The latest revision (released November 23) was improved over the 2.0 percent rise reported in the earlier initial estimate.

Growth rates represent inflation-adjusted changes from the prior quarter, expressed at an annualized rate. Analysts looking for good news emphasized that a "double dip downturn" in GDP is nowhere in sight. They pointed to the third quarter increase as the fifth consecutive quarterly gain in GDP since the recession ended in the middle of last year.

However, even the most optimistic observers don't regard a 2.5 percent GDP increase as a signal that the economy is shifting into a higher gear. The average growth rate of GDP during the most recent expansion periods has been a full percentage point greater, at 3.6 percent.

Growth rates

Although the pace of GDP growth in Q3 was better than in the previous quarter, it was the increase in consumer spending that caught the eye of most economy watchers. Spending by households on goods and services was up by 2.8 percent, the best gain since a 4.1 percent increase was posted by consumers in Q4 of 2006.

Last quarter, consumer spending was up by only 2.2 percent. Business spending on equipment and software grew at 16.8 percent in Q3, the fourth consecutive quarter of double-digit increases. While exports were up by 6.3 percent, imports surged by 16.8 percent, resulting in a net negative influence on GDP, since spending on imports sends dollars to foreign economies.

The growth drivers

Growth rates for individual components of GDP only reveal part of the story behind increases in overall output. When large components such as household consumer spending rise or fall, the effect on GDP is more potent than when smaller components change, even if the rate of change is quite sharp.

For example, spending on residential housing was down by a whopping 27.5 percent in Q3. But, today, residential housing accounts for about the same proportion of GDP as consumer spending on recreation services (both are just over $300 billion in value, in 2005 dollars, or less than 3 percent of GDP).

The overall effect on GDP of the decrease in residential spending was to reduce GDP by .75 percent, still significant but only about one-third as important as the influence of stronger imports. The major positive and negative influences of components on GDP percentage growth for the third quarter are shown in the accompanying table. The positive items in the table sum to a growth rate approaching 6 percent, led by consumer spending.

Additions to inventories contributed approximately one-half of the overall gain in GDP, a pattern that has continued for each of the five quarters in the expansion to date. And as in previous quarters, the single largest negative force was imports, subtracting 2.52 percentage points off of GDP growth. The net effect of exports minus imports was to reduce GDP by1.76 percentage points.

Dueling forecasts

Federal Reserve minutes of meetings early in November reveal that expectation about economic growth for the rest of this year and 2011 were scaled back, providing some background to new Fed efforts to boost the economy with up to $600 billion of bond purchases. According to the minutes, the Fed anticipates GDP growth of up to 2.5 percent in 2010, down from a previous range of 3.0 to 3.5 percent.

Further, the outlook for 2011 was cut back to between 3.0 and 3.6 percent from more optimistic original estimates of from 3.5 percent to 4.2 percent. The latest W. P. Carey Round Number Forecast for GDP incorporates the expected influence of the expansionary Fed policy for 2011. GDP growth is now estimated at 3.0 percent for 2011.

While 3.0 percent is pessimistic compared to the current Fed outlook, private economists contributing to Blue Chip Economic Indicators are even gloomier. The November Blue Chip consensus calls for only 2.5 percent growth next year, slower than the 2.7 percent consensus held for 2010 growth.

Meanwhile, four Blue Chip contributors are projecting GDP will grow by less than 2.0 percent. Of these, two (Goldman Sachs and the Conference Board) are former winners of the Lawrence Klein Award for Forecast Accuracy, presented annually by the W. P. Carey School. Just three of the 50 forecast panel members foresee growth of 3.0 percent or greater in 2011.

And of these, it turns out that two (Ford Motor Company and Comerica Bank) are former winners of the W. P. Carey School's Klein Award. What this likely means is that the economy might grow by a little in 2011 or it might grow by just a bit more than a little, but it won't grow by much, and probably not by enough to make a dent in unemployment, or provide the boost to business confidence that is needed to get back to more robust growth rates.