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Economy in Brief

If Second Quarter Real GDP Growth "Disappointed", It Wasn't for Lack of Demand
by Paul L. Kasriel  August 2, 2021

The advance guestimate of Q2:2021 real Gross Domestic Product (GDP) annualized growth made by the Bureau of Economic Analysis (BEA) "disappointed" at 6.5% vs. a consensus guesstimate of about 8-1/2%. Advance is italicized to emphasize that the BEA does not have complete data on some important components of GDP such as inventories and net exports. In addition, the data the BEA does have are preliminary and, therefore, are subject to revision. Disappointed is in parentheses because I do not know how one can be disappointed by median forecasts whose accuracy is never evaluated in the media. An inaccurate forecaster might be disappointed by his/her/their failing. But how can I be disappointed that an actual outcome fell short of some median of inaccurate forecasts? Now that I have gotten that off my chest, I will argue that real GDP growth in the second quarter was constrained by lack of supply, not lack of demand.

Remember, GDP measures the amount of goods and services produced in an economy. Some of the goods and services are produced to satisfy domestic demand – household consumer spending, private investment expenditures, including residential and inventories, and government expenditures on goods and services. In addition, some of the domestic production is used to satisfy foreign demand, i.e., exports. So, total demand for newly-produced US goods and services would be the sum of consumer spending, private investment expenditures, government expenditures on goods and services plus exports. Another way of expressing this is that total demand for newly-produced US goods and services is GDP plus imports. The proof of this is left as an exercise for Econ 101 students.

So, let's look at how the nominal total demand, domestic and foreign, for US produced goods and services has performed in relation to the real supply of them in the five quarters from Q1:2020, the quarter before covid caused shutdowns of US businesses, and Q2:2021, the latest quarter for which we have data. This is shown in Chart 1. The blue bars represent the five-quarter percent change in the nominal total demand for US-produced goods and services (nominal GDP plus imports). The red bars represent the five-quarter percent change in US real production of goods and services (real GDP). Ignore the data shown for Q1:2021 and concentrate on the blue and red bars shown for Q2:2021. In the five quarters since Q1:2020, nominal total demand for US-produced goods and services has increased by 6.8% (not annualized) whilst the total real supply of US-produced goods and services has increased by only 2.1%.

Chart 1

And why has growth in the nominal demand for US-produced goods and services, at least the domestic demand, been so strong in the five quarters ended Q2:2021? Because in the past five quarters the Fed and the US commercial banking system have created credit out of thin air by 20.8% (not annualized) in credit (see Chart 2). If they create it, we will spend it on something – goods, services and assets.

Chart 2

And why hasn't US production of goods and services kept up with the nominal demand for them? In part, because of a shortage of labor supply in Q2:2021 vs. Q1:2020. Chart 3 shows the index of weekly hours (number of workers times the number of hours worked) for US private industries. The Q2:2021 index was three percentage points lower than that of Q1:2020.

Chart 3

There has been about a 7-1/4% increase in nominal domestic demand for goods and services (Gross Domestic Purchases)in the five quarters ended Q2:2021. With US production constrained, this increased nominal domestic demand is being partially accommodated by higher growth in real imports. In the five quarters ended Q2:2021, real imports have increased by 8.25% (see Chart 4).

Chart 4

When growth in demand exceeds growth in supply, prices rise. That is why the chain price index for Gross Domestic Purchases has risen at an annualized rate of 4.8% in the two quarters ended Q2:2021, the fastest two-quarter growth rate since the 5.1% registered in the two quarters ended Q3:1982. Yet, with the exception of the presidents of the St. Louis Fed and the Dallas Fed, James Bullard (an IU PhD, go Big Red) and Robert Kaplan, respectively, FOMC members want to keep the monetary policy pedal to the metal until all the perceived gender/racial inequities in the labor market have been eradicated. (I am all in favor of eliminating labor-market inequities, but I believe that macroeconomic monetary policy is too blunt an instrument to accomplish this without generating higher sustained inflation. More focused microeconomic policies would be more effective in alleviating these inequities without generating higher inflation.) The theme of this year's Jackson Hole annual Fed barbecue (August 26-28) is "Macroeconomic Policy in an Uneven Economy". Boy, would I love to attend, but evidently, my invitation got lost in the mail.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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