New GDP Data, 2013 Growth, the Market Reaction, & the Effects of Government Expenditures

The U.S. Bureau of Economic Analysis (BEA) released their annual comprehensive revision of the national income and product accounts on Wednesday, July 31. Most of the Financial news websites focused primarily on the first estimate of the second quarter of 2013, which was that economic growth was 1.7 percent. The analysis that was presented was that the 1.7 percent was higher than the consensus estimate of 1.5 percent, and thus, was good news. Also, we observed chief economics correspondents saying that they were puzzled by an acceleration of economic growth from quarter 1 to quarter 2, in light of the sequester. These analyses were surprisingly uninformed.

The BEA’s comprehensive revision data release is the largest and most significant economic data release in any given year. The PDF version of the press release that accompanies the updated data was 85 pages. However, even the large quantity of data in those 85 pages was merely the tip of a massive data release. This time the revisions did not just go back five or ten years as is typical, but instead, data like GDP was revised all the way back to 1929! The national income and product accounts dataset contains thousands of economic indicators at monthly, quarterly, and annual frequencies.

From the release we see that economic growth in 2012 was 2.8 percent. The economy, so far in 2013, is only up 1.4 percent from 2012. Unless 2013 second half economic growth is 4.25 percent or higher, which is very unlikely, then the economy will be weaker in 2013 than 2012. This is what financial news websites should have reported. I note also that an estimate of 1.7 percent versus one of 1.5 percent, taken as good news last week, is not statistically significant. Our new forecast for the second half of 2013, yet to be computed, will likely be around 2 percent, which would result in 2013 economic growth of 1.2 percent. It is quite possible that 2013 economic growth will be less than half the pace of 2012!

Interestingly, despite the sequester, both Federal and overall Government sector expenditures rose in the second quarter of this year. The commentary on the sequester was misinformed. If believed the sequester would have an instant effect then Federal government expenditures should have contracted in quarter 2 rather than expanded.

Aside from the data, there is a popular presumption of a positive government expenditure multiplier, where the sequester should negatively impact economic growth. I note that the impact of changes to government expenditures on the economy should be decomposed into 2 pieces, an “identity” effect which would be immediate, and an “economic” effect, which likely occurs with a lag. The identity effect, by definition, will be positive. Thus, the sequester’s identity effect would be to slow economic growth. The economic effect, also referred to as the government expenditure multiplier, is uncertain. Leading empirical research cannot provide a conclusive answer to this question because of nasty measurement issues. To understand the main problem, realize that we cannot do a controlled experiment with the United States economy.

However, modern Macroeconomic theory does provide guidance on this question in a normally functioning economy. Given the government must ultimately pay for greater expenditures with either current or future taxation, and given that virtually all taxation is a disincentive to economic activity, the economic effect of government expenditures is likely negative. Thus, it could be the case that government expenditure expansion might lead to slower economic growth down the road. This is not to say that there should be no government, but that increasing the size of the government not necessarily a win-win policy from the point of view of future economic growth. Finally, a sequester that led to a contraction in government expenditures could lead to an expansion of economic growth down the road, another point missed by the press last Wednesday.

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