Closing the Books on 2018

Yesterday, after a delay due to the government shutdown, the Bureau of Economic Analysis (BEA) released its first look at gross domestic product (GDP) in the final quarter of 2018. The release will be the occasion for lots of commentary on whether the Trump Administration has hit its economic growth targets, whether the tax cuts “worked,” and a variety of other political takes on the numbers.

Sometimes, however, it is useful to step back and assess the big picture. The table (below) is intended to help this effort. It shows top-line GDP growth, growth in various components of GDP, and a few measures of price inflation.

Technical aside: In each case, the entry for a year shows the growth rate in the 4th quarter measured from the 4th quarter the previous year. This is the cleanest comparison because it automatically adjusts for purely seasonal impacts like the Christmas shopping season, August vacations, and so forth.

What do we learn? First, the economy grew at an appreciably more rapid rate – 3.1 percent – than in recent years, and is up considerably from the most recent low in 2016. If one looks at the quarter-by-quarter data, GDP growth has accelerated every quarter since the 2nd quarter of 2016.

Second, where does that growth come from? It is built on a very solid household sector; personal consumption expenditures (PCE) growth has been in the 2.7 to 3.0 percent range from 2015 to the present. With an extremely low unemployment rate and rising wages, household income is growing solidly, and there is no reason to expect PCE growth to tail off. It is the biggest reason why we should not fear a 2019 downturn.

While PCE provides a strong foundation, the acceleration in growth is due to the recent rise in business spending and government spending. Non-residential fixed investment has grown at 6.3 and 7.0 percent the past two years and is well above its 2015-16 pace. The components – equipment, structures, and intellectual-property products (e.g., software) – are all showing strength. Residential investment reflects the weak 2018 housing market. The strength in investment was a concern after a weak 3rd quarter in 2018, but the big picture provides a clear image of acceleration. The additional government spending may taper off, but there is no particular reason to expect a downshift in investment.

In short, there is sustained and accelerating growth and low unemployment – both good news.

The flip side of the equation is inflation performance. There has been constant chatter about the Fed failing to meet its 2 percent inflation target. Looking at the growth of the price index for PCE, both the overall and “core” (excluding food and energy) versions, it looks like the Fed is nearly on target at 1.9 percent inflation. It is certainly moving in the right direction and up notably over the past several years.

As it turns out, the BEA has to impute the price of some goods and services. For example, if you own your home, the BEA imputes the monthly amount you would have to pay to rent it to yourself. Since these estimations are prone to error, the final two rows show the PCE calculated using only market transactions (and, thus, prices). These measures come in a bit lower at 1.7 percent, but are also moving in the right direction.

It is easy to lose perspective in the midst of daily fluctuations in financial markets, weekly measures of unemployment insurance claims, and an avalanche of noisy monthly data. Stepping back and looking at the recent record on a year-by-year basis washes out a lot of the noise and shows an economy that is accelerating, benefitting from stronger investment spending, and moving toward the Fed’s inflation target.