25 Nov 2011

Inside Baseball on GDP and Inventories

Economics 9 Comments

A while ago I dug into the mysterious world of GDP accounting and wrote an article (one of my personal favorites) showing the absurdities into which “inventory adjustments” could lead. On a related note, I sent the following email to some guys I work with about the recent revision to the 3rd quarter GDP figures:

The reason we care about inventories at all, is that they calculate GDP by counting spending. So to keep it simple, let’s say consumers and businesses spend $1 trillion buying vehicles. Right there, that goes into GDP and raises it by $1 trillion.

But now they have to adjust it. What if $100 billion of those vehicles were made in foreign countries? Well we don’t want to count that as part of US GDP. So we subtract $100 billion from the original figure. That’s what it means when the BEA says “imports subtract from GDP.”

What about inventories? Well, if the private inventories of vehicles in US car dealerships went down by $300 billion during the period, then we don’t want to include them in this period’s GDP figure, since they were obviously produced in a previous period. So if inventories drop during a period, then we subtract the change out of the original GDP figure too.

Now the really tricky thing. Strictly speaking, the BEA isn’t reporting the level of GDP, but rather the headlines all talk about the percentage rate of *growth* in GDP. And then they break that down and say which components contributed to the growth.

This leads to some weird things. For example, in the advance estimate press release
http://bea.gov/newsreleases/national/gdp/2011/gdp3q11_adv.htm
it says this about inventories:

The change in real private inventories subtracted 1.08 percentage points from the third-quarter
change in real GDP after subtracting 0.28 percentage point from the second-quarter change.  Private
businesses increased inventories $5.4 billion in the third quarter, following increases of $39.1 billion in
the second quarter and $49.1 billion in the first.

So if you read that carefully, it is saying that even though the BEA (at the time) thought private inventories had *increased* $5.4 billion in the third quarter, that number was still making them knock off 1.08 percentage points from the growth rate they reported. In other words, they would have otherwise reported a growth rate of 3.58 percent, but then because inventories only grew $5.4 billion, they instead originally only reported a GDP growth of 3.58 – 1.08 = 2.5 percent.

The answer to this weird thing is that even though (they originally thought) inventories grew in the third quarter, they didn’t grow as much as they had in the second quarter (when they grew by $39.1 billion). So the slowdown in the rate of growth of private inventories, was dragging down the number they could report for total GDP growth.

Anyway, it’s a subtle little point, but I know most people don’t quite get that. They just paraphrase the BEA press release about inventories and I’m quite sure most have no idea how it really works.

9 Responses to “Inside Baseball on GDP and Inventories”

  1. Major_Freedom says:

    Since it’s cut off:

    “The change in real private inventories subtracted 1.08 percentage points from the third-quarter
    change in real GDP after subtracting 0.28 percentage point from the second-quarter change. Private
    businesses increased inventories $5.4 billion in the third quarter, following increases of $39.1 billion in
    the second quarter and $49.1 billion in the first.”

  2. AP Lerner says:

    You actually nail a pretty good point on this post Mr. Murphy when you say ‘They just paraphrase the BEA press release about inventories and I’m quite sure most have no idea how it really works’.

    Except, there is nothing weird, exotic, absurd or phony about GDP accounting. The data and methodologies are extremely transparent and informative if you take the time to read and analyze the data correctly. Just because most ‘economists’, arm chair economists, and the press are too lazy to actually look at the data does not make the data or the calculation absurd…its the analyst that’s absurd. And lazy. But then again, 99.9% of the economists, arm chair economists, and the press don’t even have a basic understanding of the monetary system, so why should we expect them to take the time to look beyond headlines, especially if the headline benefits there ideology.

    • Bob Roddis says:

      I guess you told him, AP. Smart people who lack an ideology all know that the government can fearlessly promise $100 trillion in unfunded adult diaper changing services plus free hip and knee replacements because it is the monopoly issuer of fiat currency.

    • Major_Freedom says:

      Except, there is nothing weird, exotic, absurd or phony about GDP accounting.

      This is yet more evidence AP Lerner is an economically illiterate pawn.

    • Bob Roddis says:

      AP, in a few years when I’m in that old folks home, I expect outstanding individualized service like this:

      http://tinyurl.com/7m2bjmt

      Price or supply should be no barrier to a plush environment because the government is the monopoly issuer of fiat money.

      • Joseph Fetz says:

        You want to be rubbed down by cute redheads wielding furry mittens? Sounds a little kinky.
        😉

        • MamMoTh says:

          He will be doing the rubbing to afford his diapers

          • Joseph Fetz says:

            Well, these days old people do have to work… even after retirement. It has something to do with the ‘monetary system’, at least that’s what I’m hearin’.
            😛

            • Joseph Fetz says:

              I can see this just by looking at my food and rent.