While not quite top-line, a few other numbers from Friday’s release are especially important. The headline growth rate of 4.1 percent is an annualized quarterly growth rate, which makes it quite noisy. Other measures are more useful to pull out the trend, or the underlying, sustainable growth rate.
— Year/year: Between Q2 last year and this year, real GDP was up 2.8 percent, slightly up from 2.6 percent last quarter (the figure below shows that the annual rate is a smoother version of the quarterly rates). Since 2017, the average year/year growth rate has been about 2.5 percent, which is a reasonable estimate of the underlying trend. As you can see at the end of the figure, GDP has accelerated a bit in recent quarters, but it’s about where it was in 2014-2015, so don’t let anybody tell you that Friday’s results are unprecedented.
— Temporary factors, including the trade war, pushed up growth last quarter, which boosted exports and government spending. Final sales to private, domestic purchasers takes out those components but leaves us with an even stronger growth rate of 4.3 percent, suggesting quite strong private sector demand. Here again, however, it’s more revealing to look at year/year changes, and the figure below shows a trend growth rate in this measure of about 3 percent around a fairly steady trend.
Why the jump to 4.1 percent? Growth in the spring was powered by consumer spending, which contributed 2.7 points to the 4.1 top-line number. Business investment was so-so in the quarter, so not much to see from the alleged tax-cut effects boosting business investment, though it’s still early for that. Housing investment was a negative, and given softness in that sector, I’m putting housing on my watchlist going forward. Net exports added a point to growth, a big contribution that is largely a function of the trade war, as described below.
Sounds like good news. Is it? That’s a trickier question than you might think. At one level, of course it’s good news. It signals that the economic expansion is still solidly on track, even amid a lot of worrisome noise around trade. Moreover, the faster pace of growth in the quarter does not appear to pose overheating risks: A key price gauge rose about 2 percent, and workers’ wage gains are, if anything, behind the growth curve.
In fact, there’s a lot of evidence that GDP growth is not reaching middle- and low-income workers, at least not as much as we’d expect given the tight labor market. Moreover, GDP is not the be-all and end-all that we often make it out to be, especially on days when the number is released. It doesn’t account for either environmental degradation or the distribution of growth, nor does it measure well-being, which, in richer countries, is only weakly correlated with GDP.
That said, the absence of GDP growth, as in recessions, is unequivocally negative. Thus, the key insight about GDP growth is to recognize not just its importance but its limitations.
What impact does the trade war have on Friday’s results? Exports are a plus to GDP, and in an effort to sell their products abroad before the tariffs took effect, farmers jammed a lot of produce, e.g., soybeans, into the global supply chain last quarter. Such time-shift factors — export more now, less later — should not be conflated with the underlying trend.
Ultimately, most of us who scrutinize such things believe the trade war is likely to slow growth a bit, in part through a higher trade deficit (in fact, numerous factors are pushing up the dollar, which makes our exports less competitive). While its impact on overall GDP growth may be small — we’re much less exposed to foreign trade than other advanced economies — its impact on specific industries, like agriculture exporters, are already being felt. Moreover, the extent of escalation is unknown at this point, so this, too, is worth watching.
Is the strong number due to the tax cuts? Not just the tax cuts, but billions in deficit-financed spending, are juicing GDP growth. It’s very unusual in the history of American fiscal policy to apply this much stimulus at this stage of the recovery, as the private-sector economy is already closing in on full capacity. However, we have no evidence at this point that the fiscal boost is leading to overheating, as in much faster price growth, that the Fed would feel compelled to offset with faster rate hikes.
The other key point about the tax cuts and other deficit spending is that they are scheduled to fade by around 2020, meaning that unless Congress decides to put even more spending or tax cuts on the credit card, this source of stimulus will provide less support for growth in a few years. That doesn’t imply recession, by the way, but it does signal a potential downshift.
Is this relatively high growth rate sustainable? No. It’s an upside outlier that will come down in future quarters. I especially wouldn’t count on net exports to provide the boost they did last quarter, and I just noted that the fiscal impulse is likely to fade as well. That said, remember that our GDP is almost 70 percent consumer spending, so as long as the tight labor market keeps generating solid job gains, even if real wages don’t grow that much, we’ll still get strong consumer spending fueling GDP growth, just closer to the 2.5 percent underlying trend than to Friday’s 4 percent number.
I can see where economists and politicians might get excited about this news. But what should normal people think about it? If you’re someone whose family depends on your paycheck vs. your stock portfolio, you should be happy to see the Goldilocks aspects of Friday’s report — faster growth without overheating prices — but you’ve every right to hold your applause until overall growth starts to lift your living standards. Especially in our era of high economic inequality, GDP should definitely not be taken as a signal of broad well-being. For that, we have to look at not just how “the economy” is doing, but how all the people in the economy are doing.