Real GDP Up; Real Final Sales Down/Was the Economy Stronger or Weaker in the First Quarter?

Casual consumers of economic data, i.e. normal people, probably understand instinctively that the details behind the headline numbers matter. However, they can at least rest assured that such a large increase in the real GDP estimate as we had from the 4th quarter to the 1st quarter—from plus 0.4% to plus 2.5%–at least gets the direction right. Or, can they?

Several significant swings in the components of GDP are worthy of note, but I always look first at inventories. And, sure enough, an inventory swing dominates the latest GDP estimates. Inventory changes subtracted 1.52 percentage points from the real GDP estimate in the 4th quarter while adding 1.03 percentage points to the 1st quarter, for a net swing of 2.55 percentage points. Excluding inventory changes, real final sales increased 1.5% in the first quarter compared with an increase of 1.9% in the 4th quarter. In other words, excluding inventory changes, real GDP actually declined from the 4th quarter to the 1st—the opposite direction from the headline number.

I don’t mean to suggest that real final sales is always a better measure of economic activity than real GDP because they exclude inventories. Inventory changes are notoriously hard to interpret. If businesses build inventories deliberately because sales have been good and are forecast to continue improving, then more inventory ‘investment’ should be counted along with other components of GDP. However, if inventories accumulate on the shelves because sales have fallen relative to expectations, then they will be a negative influence on future GDP and probably should be discounted. My point is that it is always useful to see what volatile inventories are contributing to GDP changes and make an educated guess as to whether their arithmetic contribution is misleading.

Comments (10)

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  1. Desai says:

    I feel like it might be a mix of both scenarios you painted in the blog post. That said, I hope atleast the high numbers boost confidence.

  2. Ron says:

    Great post pointing out the importance of inventory effects on GDP estimates. Not being knowledgeable on measures of GDP, I would venture to think that lots of externalities have hidden effects that aren’t included in these measures.

  3. Andrew says:

    I would think that unmeasured inventory effects on real GDP could present misleading numbers, but as you mention, these could be either positive or negatively misleading.

  4. Gabriel Odom says:

    I say that this is a good thing. Whenever firms clear out considerable inventory, they have to produce more. Additionally, numbers this strong in Q1 may spur Consumer Confidence up significantly in Q2. Combine this with the seasonal component of Q2 summer spending, and I believe this will set the stage for sustained real growth in Q2 – but I’ve been wrong before.

  5. E. Carr says:

    I’m under the impression the inventory build-up was due to the agriculture industry which was building inventory after last year’s droughts. I think the 1st quarter’s GDP growth should be taken with a grain of salt. Like other above me, I hope the “normal person” doesn’t understand the implications of inventory build-up and instead feel more confident in making that big purchase they have been putting off.

  6. Harley says:

    You make a curious point E. Carr — is the point to foster consumer confidence, whether or not it’s justified?

  7. Jack says:

    Typically when firms clear out significant inventory it’s to generate numbers for a positive financial report — not that they have to produce more.

  8. Tomasz Gorski says:

    A short yet so informative post Bob! This can be of real help of to those like me, who are not quite clear about the inventory effects on GDP.

  9. H. James Prince says:

    E. Carr, that is the exact opposite of what we want to happen. We want people to make those big purchases. We want people to believe that the economy is getting better.

  10. Greg Magnus says:

    Interesting post, but like you said in the last paragraph, we cannot establish sales/consumption of goods as better judgment of GDP growth, because it doesn’t have all of the variable that calculate national wealth as a whole.