GDP confusion and inflation

Hmmm... the headline number for the advance GDP report for Q1 seemed rather low, lower than seems to make sense for what was really going on in Q1. Of course, we can always fall back on the fact that this is only the "advance" report, that even the BEA admits that the report is "based on source data that are incomplete or subject to further revision by the source agency", and that upward revisions are very typical for this report, but still... that number was awfully low. But I think I did find the reason, and it relates to confusion about inflation.

The headline number for annualized real GDP growth in Q1 was 1.3%. We get "real" GDP by taking "nominal" GDP and subtracting inflation, or what the BEA calls the "implicit price deflator." It turns out that the implicit price deflator was a whopping 4.0%, which is much higher than any estimate of inflation for Q1 that I have heard about. The annualized "nominal" GDP growth rate in Q1 was a quite healthy 5.3%. Subtract 4.0% from 5.3% and you get that anemic 1.3%.

So, where did this 4.0% come from? I don't know exactly, for sure, but it appears to be headline CPI inflation for the December, January, and February period. Headline CPI inflation was 0.4% in December, 0.2% in January, and 0.4% in February, which sums to 1.0% for three months or multiplying by 4 to annualize it produces 4.0%, which happens to be the number that BEA is using for their implicit price deflator. So, yeah, inflation was an annualized 4.0% for that period. Maybe they actually used some different data series for the January to March period, but they're close enough. Most of that inflation shows up in higher energy prices which come from higher prices for imported oil, and those imports are a subtraction from GDP, so it is almost as if we were double-subtracting from "actual" GDP griowth.

Specifically, the BEA report gives a price index of 118.073 for Q1 and 116.930 for Q4, the annualized difference being 3.91%, which is close to 4.0, kind of.

One reason that GDP was weaker than the economy "feels" is that there was a decline in exports, which we don't directly "see" in our daily lives (unless you are in the export business) and there was an increase in imports, which gets masked by apparent domestic "activity", plus the fact that part of the rise in imports was simply rising energy oil prices. But even with all of that, nominal GDP growth was nonetheless quite reasonable for the quarter.

If we substitute a more reasonable value for inflation, say 2.4%, which is the core inflation for that same December to February period, we get a pseudo-real annualized GDP growth rate of 2.9%, which is about what the economy felt like.

So, what do you think... was inflation really 4.0% in Q1?

-- Jack Krupansky