Thursday, May 21, 2015

GDP Seasonal Adjustment: There's No Smoking Gun

Summary: First quarter GDP growth was stronger than originally estimated. When adjusted for seasonality, the economy grew 1.8%, which is consistent with the average growth rate over the past three years. It is also consistent with a wide variety of economic data (employment, wages, housing, consumption) released in the past several months. And, finally, it is consistent with the message being sent by the treasury market.

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This week, the Bureau of Economic Analysis (BEA) announced that it would be revising the seasonal adjustment methodology it uses in estimating quarterly GDP.  For anyone following US macro data, this announcement was of no surprise (read further here and here).

For at least 15 years, the BEA's methodology has consistently underestimated first quarter GDP. If BEA's methodology worked perfectly, first quarter seasonally adjusted real GDP growth should not be consistently higher or lower than growth in any other quarter.

That the methodology needed revising was obvious. First quarter GDP was 1% lower than the remainder of the year from 2000-10 and 2.3% lower from 2010-14 (data from the SF Fed; full post here).

Cynics have been predictably fast to label the BEA's actions as form fitting the data. As usual, they miss the point.

Seasonally adjusting data simply removes fluctuations in the data that repeat each year (like weather and holiday patterns) so that the underlying trend in the economy can be clearly seen. In the same way, removing volatile energy and food prices allow for a better view of the trend in inflation.

When the seasonal adjustment to first quarter of 2015 GDP is improved, growth will be revised from 0.2% to 1.8%. That is comparable to recent growth: annual GDP growth the past 3 years has averaged 2.3%.

The upward revision in first quarter GDP growth should not surprise anyone who has been following the US economy. In recent months, there has been a wide variety of positive developments, for example:
  • Through April, the average monthly gain in employment during the past year was the highest in more than 15 years
  • Employee compensation through the first quarter of 2015 grew at the highest rate in 6 1/2 years.
  • Personal consumption (70% of the economy) in the first quarter of 2015 grew at the highest rate in 5 years.  
  • Housing starts and building permits in April reached at a new 8 year high.  

The persistent improvement in these metrics made BEA's initial GDP figures for the first quarter seem surprisingly weak. The change in their methodology will hopefully make this less likely to occur in the future.

That economic growth continues to trend positive is also the message being sent by the treasury market. The spread in yields has been widening over the past four months. 

Sadly for the cynics and economic doomsayers, the BEA's decision to improve their methodology does not reveal a smoking gun or a conspiracy theory. The economy continues to grow, a fact which remains true no matter how the data is parsed. 

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