## Take That, Osama

April 26th, 2002 - 10:44 am

This site claimed almost two months ago that US economic growth for 2002 would beat the Treasury Department’s expectations.

Now it seems the economy might out-do even my Rosey Scenario, and by no small measure, either. The AP reports Q1 growth at a damn near 6% annual rate.

Still laughing at my suggestion to buy a cheap index fund? Eventually, the markets — and corporate bottom lines — will notice.

It’s probably better to look not at the quarterly GDP growth number–5.8% for the first quarter–but at the final sales growth number–2.6%. GDP growth swings erratically and violently about final sales growth as inventories are unexpectedly built up and liquidated, but in the end come back to final sales.

The tremendously strong first quarter growth number was driven to a remarkably large extent by shifts in inventories.

In the fourth quarter of 2001 U.S. businesses shrunk their inventories by $30 billion. In the first quarter of 2001 U.S. businesses shrunk their inventories by $9 billion. This reduction in the rate at which inventories declined all by itself induced a +3.1 percentage point swing in the rate of real GDP growth between the fourth quarter of 2001 and the first quarter of 2002.

Why? The national income accountants think of it this way: $21 billion more was spent on inventory investment in the first quarter of 2002 than in the fourth quarter of 2001. But this is just one quarter’s change in inventories. If the reduced pace of inventory reduction was maintained for a year, over that year it would add up to an extra $84 billion of investment in inventories. So the swing in inventories is a swing of $84 billion in the inventory contribution to the level of GDP measured at an annual rate.

But this swing in the level of GDP measured at an annual rate is just one quarter’s swing. If we were to have a similar swing over the next three quarters as well, it would boost the level of GDP by $336 billion–or 3.1%. Thus the swing in inventories boosts the rate of growth of GDP from the fourth quarter of 2001 to the first quarter of 2002 by 3.1%.

So the swing in inventories means that a -0.2% of a year’s GDP reduction in inventories that was there in the fourth quarter of 2001 was not there in the first quarter of 2002. That meant that first-quarter GDP was 0.8% higher than fourth-quarter GDP. And this 0.8 percentage point jump in the level of real GDP in one quarter translates into a 3.1 percentage point contribution to the annual GDP growth rate: a *big* swing to come out of a $21 billion shift in spending patterns.

It’s not that there’s anything *wrong* with the GDP number–the national income accountants are doing their job in a consistent fashion. But there is something wrong with projecting an inventory-heavy number into the future: we can’t expect inventory investment to grow by $21 billion every quarter…