Usually when GDP growth unexpectedly drops below zero, economists and markets start screaming “recession!!” With today’s print of GDP (gross domestic product) showing a headline 0.1% contraction, I’d encourage you not to worry too much and think instead about shifting those letters to DGP and remember “Don’t Gotta Panic.”
Today’s initial estimate for fourth-quarter 2012 GDP wasn’t stellar, but it sure was a lot better than the headline 0.1% contraction suggested. Why don’t we have to panic? Well, the big detractors from GDP growth were inventories (1.27 percentage-point drag), defense (1.28 percentage points), and exports (a quarter-point subtraction). Counteracting that, though, private domestic demand held up nicely. Real domestic final sales (doesn’t include inventory accumulation) rose 1.1%; and real private sector sales rose a strong 3.3% (MarketWatch takes a good look at this). Private consumption spending was up 2.2%, non-residential fixed investment increased 8.4%, equipment and software rose 12.4% (the best increase all year), and real residential investment increased by 15.3%.
Consumption was up likely because inflation pressures were subdued and take-home pay rose strongly. Headline PCE (a measure of goods and services consumption by individuals) rose 1.2% and core PCE (the Fed’s preferred measure of core inflation) increased a meager 0.9%. Meanwhile, real personal disposable income spiked up a whopping 6.8%! Compare that to a 1.5% rise for 2012 as whole. Rising take-home pay was supported a rising savings rate, which moved from 3.6% in Q3 to 4.7% in Q4.
Also, remember that this was the first print of fourth-quarter GDP and that advanced estimates are prone to revision. That said, there are some ideas we can take away from this initial estimate. First off, when you look at that drop in defense spending, remember that defense spending can have unexpectedly large and hard-to-predict effects on GDP growth. Defense spending can also be prone to seasonality (Brad Plumer over at Wonkblog has a good explanation on the fourth-quarter shrinkage). Spending rose 13% in Q3 then plummeted to a 22% for Q4 – the fiscal year for the feds ends in September, so there’s a lot of use-it-or-lose it spending in the third quarter. While we’re not likely to see a Q1 2013 repeat of the double-digit quarterly decrease in defense spending, consider that the big drop may presage continued declines, what with major operations winding down in both Iraq and Afghanistan. The sequester, too, could dampen defense spending if it goes through (check out our chief global economist Bob Baur’s thoughts on the sequester).
Second, consider that businesses and private-sector consumers were not as worried about the fiscal cliff as economists thought they would be. During Q4, it was more likely falling gas prices and the wealth effects from an improved housing market that made consumers more apt to spend. These effects may also at least partially offset negative effects from the payroll-tax cut this quarter. And finally, the drag from inventory in Q4 may actually mean a reversal in subsequent quarters, where inventory accumulation will add to GDP.
Looking longer-term, the economy ended 2012 by growing around 2.2% – which is pretty consistent with GDP growth for this recovery. While this latest report wasn’t fabulous and the headline was less than pleasing, private-sector components were certainly supportive of a continued economic expansion. So, all in all, while this was a negative print for Q4 GDP, we’d argue that it’s one of the most positive negative prints we’ve seen.