The United States almost certainly just experienced its fastest three months of economic growth on record. That doesn’t mean the economy is strong.
The Commerce Department on Thursday (US time) will release its preliminary estimate of economic growth for the third quarter. Economists surveyed by FactSet expect it to show that gross domestic product — the broadest measure of goods and services produced in the United States — grew about 7 per cent from the second quarter, or 30 per cent on an annualised basis (more about that in a bit).
If those forecasts are even close to correct, it would represent the fastest growth since reliable records began after World War II. Until now, the best quarter was a 3.9 per cent gain (16.7 per cent annualised) in 1950.
This GDP report will be particularly closely watched, arriving as the last major piece of economic data before Election Day next Tuesday.
But it doesn’t make sense to think about Thursday’s report in isolation. The third quarter’s record-setting growth is effectively an echo of the second quarter’s equally unprecedented contraction, when business shutdowns and stay-at-home orders led gross domestic product to fall by 9 per cent. Strong growth was inevitable as the economy began to reopen.
While the economy has revived considerably since earlier this year, it is far short of its level before the pandemic. And progress is slowing.
“Employment has come back to some extent, but the unemployment rate is still high; wage and salary income is still low,” said Ben Herzon, executive director of IHS Markit, a forecasting firm. “Demand is still being depressed by the pandemic.”
In superlative-laden Facebook ads purchased days before the report, President Donald Trump and his supporters have already begun to promote it as evidence of a strong rebound. The truth is more complicated. Here is how economists are thinking about the report and why the numbers could be misleading.
The economy is still in a hole
If GDP fell by 9 per cent in the second quarter, and rose by about 7 per cent in the third quarter, it might sound as if the economy is almost back to where it started.
It isn’t. The big drop in output in the second quarter means that third-quarter growth is being measured against a smaller base. A simple illustration of the same phenomenon: If you have $US100 and lose half, you have $US50. If you then manage to increase your money by half, that will bring your holdings to $US75, not all the way back to $US100.
To really evaluate the recovery, it makes sense to focus less on quarter-to-quarter changes and instead look at how the economy compares to the fourth quarter of last year, before the pandemic began. If economists’ forecasts are correct, GDP will be 3 per cent to 4 per cent lower in the third quarter than at the end of last year. By comparison, GDP shrank 4 per cent over the entire year and a half of the Great Recession a decade ago.
In other words: Even after the record-setting rebound in the third quarter, the economy is still in a hole as large as the worst point of many past recessions.
Most ‘third-quarter growth’ actually happened in the second quarter
Here is where things get really confusing: Third-quarter growth will look historically strong, even though all three months that made up the quarter were relatively weak.
That seeming paradox is the result of how the government reports GDP statistics.
Quarterly GDP figures represent the average amount of economic output over a three-month period. In normal times, output changes only gradually — growing or shrinking only 2 per cent or 3 per cent per year — so the change from the first month of a quarter to the last is small.
Last spring, however, changes that would ordinarily take years played out in a matter of weeks. Monthly estimates from IHS Markit show that GDP fell more than 5 per cent in March and more than 10 per cent in April, before rising roughly 5 per cent in May and 6 per cent in June.
Quarterly averages obscure those big swings, however. GDP fell 1.3 per cent in the first quarter (when two relatively normal months were followed by the big drop in March) and 9 per cent in the second (when output plunged in the first month of the quarter then rose in the next two).
The big rebound in May and June meant that the third quarter effectively had a head start. In fact, even if there had been zero growth in July, August or September, and the economy had stayed exactly the same size as at the end of the second quarter, that would still represent 5.4 per cent quarterly growth — the strongest gain on record.
Of course, the economy did experience some growth during the third quarter. IHS Markit estimates that GDP grew about 1.5 per cent in July and less than 1 per cent in August and September. But those are much weaker gains than the quarterly GDP figures might seem to suggest.
Annualised figures are even more misleading
Gross domestic product in the United States is usually reported at an annual rate, meaning how much output would grow or shrink if that rate of change were sustained for a full year. That convention makes it easier to compare data collected over different time periods. But during periods of rapid change, annual rates can be confusing.
In the second quarter, for example, GDP fell at an annual rate of 31.4 per cent. That makes it sound as if the economy shrank by nearly one-third, when in fact it shrank by a bit less than a tenth.
To avoid confusion, in the coverage of Thursday’s report, The Times plans to emphasise simple, non-annual percentage changes from both the second quarter and the fourth quarter of last year, before the pandemic began. (We gave a more detailed explanation of this decision before the second-quarter report in July.)
Benchmarks make a big difference
When the pandemic first hit in the spring, many economists and policymakers hoped that by shutting down nonessential businesses and encouraging people to stay home, the United States could quickly bring the virus under control, then reopen with minimal lasting economic damage. That would allow for a “V-shaped” recession and recovery — a steep drop, followed by an equally steep rebound.
Relative to that expectation, the US response has been a failure. The economy bounced back in May and June, but only partway. Most forecasters don’t expect GDP to return to its pre-pandemic level until late next year at the earliest.
Compared with forecasts from April and May, however, the economic rebound has beaten expectations. The nonpartisan Congressional Budget Office, for example, released a forecast in late April showing a steeper second-quarter decline and a weaker third-quarter rebound than ended up happening. The office also expected the unemployment rate to stay above 10 per cent through the end of this year; instead, the rate fell below that benchmark in August and fell further to 7.9 per cent in September.
The New York Times