The federal government released its much-anticipated preliminary estimate of third quarter real GDP this week. The report arrives at a pivotal time in America: on the eve of a hotly contested presidential election where both candidates are aggressively prosecuting their cases for (re)election, in the midst of a tremendous and widespread third spike in coronavirus cases, and after the expiration of essential fiscal policy relief efforts that helped buoy the economy throughout the late spring and summer. What did the report reveal and how should the data be interpreted?
No Surprise: Third Quarter Rebound
As The Concord Coalition anticipated back in June (“Beware the Dead Cat Bounce”), the U.S. economy predictably rebounded in the third quarter after a devastating second quarter crash. The Congressional Budget Office and many economists anticipated this result based on the reopening of many businesses after the April lockdown and the income support provided by the $2.4 trillion in fiscal relief efforts enacted in late spring. After adjusting for seasonal factors, the Bureau of Economic Analysis reported that the domestic economy grew 7.4 percent from the previous quarter – a sharp reversal from the 9 percent decline in Q2.
If the 7.4 percent growth rate observed in the third quarter persisted for an entire year, the economy would be 33.1 percent larger after four quarters – the annualized growth rate reported by many news outlets.
The large summer jump reflected a resurgence in consumer spending, which traditionally accounts for two-thirds of real GDP. Shoppers spent heavily on cars, clothing, and footwear as they returned to retail stores. The bar and restaurant industry also posted gains as many entered the first phase of reopening under new restrictions. Housing-related spending also increased, as low interest rates fueled new home purchases and associated spending on household goods and furniture.
Some sectors underperformed, however. Government spending fell following the expiration of the CARES Act relief funds, subtracting from real GDP. International trade in goods and services also dragged as the U.S. economy imported more than it exported.
Putting the Data in Context: Not Yet Back to Normal
By any measure, third quarter real GDP growth was record-shattering. It was the fastest growth rate since the government began to track quarterly GDP data in 1947. But it was also preceded by a larger, record-setting decline, and the economy still hasn’t fully bounced back. Overall, economic activity is still $670 billion, or 3.5 percent below where it was at the end of 2019.
Moreover, storm clouds lie ahead. GDP data is backward-looking – it reveals what happened in the past – and part way through the third quarter, key emergency relief and income support programs expired. In fact, below the headline GDP number, the BEA report reveals that personal income fell $541 billion in the third quarter, following a $1.45 trillion increase in the second quarter. Why? CARES Act pandemic unemployment benefits ended and Americans exhausted their CARES Act rebate checks.
Looking forward, economists worry that the economy is slowing again now that those extra safety net programs have gone away. Plus, COVID-19 infections are spiking again and worries about renewed lockdown restrictions could deepen the pandemic-induced recession. Moreover, millions of people remain unemployed. As of September, the US labor market had recovered only half of the jobs lost to the pandemic and over 22 million Americans are receiving some form of unemployment assistance.
Conclusion: Without Additional Efforts to Fight the Virus, Q3 Gains will Fade
It is reassuring to see evidence that the massive pandemic relief bills enacted by Congress and the President earlier this year on a bipartisan basis have been effective. Clearly, however, the U.S. economy is not out of danger and economists across the political spectrum agree that another tranche of emergency spending – a CARES Act v2.0 – is necessary to prevent further, and perhaps lasting, damage.
It is equally clear that the fate of the economy is closely tied to how quickly and effectively the nation is able to control the newly alarming spread of COVID-19.
Moreover, unless and until Americans adjust their behavior to get this virus under control, we could be trapped in an expensive and unproductive loop of trillion-dollar rescue packages to help prop up the domestic economy as the virus spreads unabated. If we want to maintain economic momentum and mitigate the budgetary toll, we need to make fighting the virus our top priority.
SIDEBAR: The Case for and Against the Use of Annualized Growth Rates
For non-economists, understanding GDP statistics can be confusing. GDP growth can be reported a number of different ways—from one consecutive quarter to the next, from the same quarter one year ago, or on an annualized basis. The latter is used by many statisticians, but many economists and The Concord Coalition prefer to report GDP growth on a quarter-over-consecutive-quarter basis because it reflects what actually happened rather than what *might* happen in the future.
Federal agencies report real GDP growth on an annualized basis, however, so there must be a rationale, right? Yes, in normal, steady-state times, this methodology makes sense. Consider: if real GDP growth is 0.6% in one quarter, it's useful to think "if we keep this up, we'll grow 2.4% over the year."
But right now, times aren’t normal. The economy is rebounding from a collapse in GDP brought on by an intentional shuttering of the economy, not in response to any normal business cycle phenomenon, so it's pointless to think about this rebound in annualized terms. The New York Times writer, Ben Casselman, summed up the case for and against annualized growth rates in a July 2020 column published in anticipation of the Q2 GDP report earlier this year:
The United States has traditionally reported G.D.P. and some other economic statistics as annual rates. Rather than simply giving the percentage change from one quarter to the next, the government reports how much G.D.P. would grow or shrink if that rate of change were sustained for a full year. (Because growth rates compound on themselves, this calculation is a bit more complicated than simply multiplying by four. The figures are also adjusted for seasonal patterns, so they are more properly described as “seasonally adjusted annual rates.”)
Annual rates make it easier for analysts to compare data collected over different time periods. If you’ve ever estimated how much you’d save over a full year if you kicked your daily latte habit, or worked out how many home runs a favorite player would hit if his current hot streak lasted for a full season, you’ve performed a similar calculation.
But when annual rates are applied to short-term changes, the results can be misleading, as Neil Irwin of The Upshot explained in May. If you received a $500 bonus one month, you wouldn’t think of it as a “$6,000 raise, on an annualized basis,” because you know it’s a one-time windfall, not a long-term change in your income.
Right now, the economy is going through extreme short-term changes. Activity largely halted in much of the country in April, rebounded sharply in May and June, and now looks as if it might be slowing again as surging coronavirus cases force states to slow or reverse reopenings. Those changes are real, and will have a huge effect on family incomes, business profits and state tax revenues. But it doesn’t make much sense to think of them on an annualized basis.