Why Today’s GDP Report Isn’t As Bad As It Looks

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Lucas Jackson / Reuters / REUTERS

Tug boats maneuver cargo ships, one of which is onto their docks in Bayonne, N.J., on Aug. 24, 2011.

The American public (or at least those of us who keep up on the latest macroeconomic data) awoke to some startling news this morning: According to initial estimates from the Commerce Department the American economy actually shrank in the fourth quarter of 2012. Yes, you read that right — not the sluggish growth we’ve been used to since the end of the 2008-2009 recession, but an honest-to-goodness contraction of 0.1%. Predictably, political pundits on the right had a field day – can you blame them? — using the data as evidence of the failure of the “Obama economy.” On Wall Street however, the markets have more or less been shrugging off the news, with the Dow down a slight 0.07% in morning trading. So what’s the deal?

In short, if you take a deeper look into the report, it’s not as bad as the headline number suggests. The biggest factors driving the contraction were a big drop in defense spending, which as The Washington Post explains is most likely related to the Defense Department preparing for the large cuts to its budget which were supposed to go into effect January 1, but have been postponed for a couple months as part of the fiscal cliff deal. (This should also provide an object lesson in the effects of government spending cuts on near-term GDP growth.) The other main factor dragging down the headline number was a decline in business inventories, which is likely just a reaction to firms working off inventory buildups from the previous two quarters.

Other numbers, meanwhile, including consumer spending, non-residential fixed investment (a fancy term that describes non-residential buildings or business equipment), and residential fixed investment (home building) were strong. This suggests that businesses and consumers are still feeling relatively good about the economy, and they are slowly increasing their spending in a way that is indicative of a slow-but-steady recovery.

In addition, estimates on GDP growth from the Commerce Department are just that — estimates, and they can often be pretty far off, especially if other indicators in the economy don’t validate their claims. As economist and Brookings Institute Senior Fellow Justin Wolfers described in a note to the press:

Overall, there’s nothing in today’s GDP report to change my view: The US economy was doing OK — maybe even pretty well — but definitely not great in the final quarter of 2012.  While this morning’s negative growth number is an attention grabber, realize it’s for last quarter, it’s an early guess, and it’s contradicted by most other data which point to an economy that is still growing, although perhaps not fast enough.

Wolfers ended with a sarcastic trivia question: “When is the last time that the first big hint of bad economic news came from an advance GDP report?  Answer: Never.” In other words, GDP reports are great for figuring out what went wrong with an economy looking backwards, but they aren’t good at predicting recessions. If we were in a recession, we’d know it, and not because of a report from the government.

That is not to say that all is hunky dory with the economy. Growth remains far too slow to pull us out of the deep hole in employment, or pull us back in line with the full productive capacity of our economy. Even without the drag on growth that government spending cuts have been putting on the economy, we’re still nowhere near the sustained run of 4% or so GDP growth that the American economy needs to quickly escape from its doldrums.

In other words, if you’re so inclined to blame a political figure or party for our lame economy, go right ahead. We still have a lame economy. But at least it’s not one that’s headed for recession in the near term.