I disagree with James Hamilton

James Hamilton: Strong GDP growth, weak fundamentals, 26 October 2018


Good graphs. Interesting post. Every time Hamilton says something, he shows it on a graph. I like that approach to econ. Hamilton says recent RGDP growth is better than "the 3.1% average for the U.S. economy over the last 70 years, and is well above the 2.2% average rate since the recovery from the Great Recession began".

He says his Recession Indicator Index is "among the lowest levels we ever see", and our economy "remains clearly in the expansion phase".

And he ruminates on the "fundamentals". Government spending pushed growth up more than half a percentage point, he says. But exports are down. Housing construction is down. And "nonresidential fixed investment was also weak."

Okay, I have a question about government spending. If we go back to Keynes, as I understand it he said to get out of the Depression you need a lot of government spending; and then as the economy comes back to normal growth, you can safely cut back on the government spending. Okay: high government spending makes for growth, and low government spending makes for recession. But if you don't go from high to low, if you go from high to the middle ground, you're not undermining growth. You're just sort of transferring the engine of growth back to the private sector. Maybe I have it all wrong?

I don't think so. I think I've just described the whole idea behind "stimulus": you get the economy going, and then you get out of the way.

I can see GDP growth being above the long-term average because of the high level of government spending. But look at the numbers with me. The economy grew at a 3.5% rate; government spending "contributed 0.6 percentage points" to this. So if we subtract government's part, the economy grew at a 2.9% rate. Below three percent. Not worth writing home about.

But we just went from high to low. We should have gone from high to normal. What's normal government growth, maybe half of that 0.6 number? Add 0.2 to the 2.9% rate and we're at 3.1% -- the long-term RGDP growth rate, exactly. If we add 0.3 instead, we're above the long-term average.

So I'm not sure Jim Hamilton's qualms are well founded. I can see being hesitant, but I can't see being worried.


Hamilton's conclusion:

I conclude that the fiscal stimulus continues to help give us a favorable headline number. But I am concerned about weak investment spending and final sales.

Final sales? If we discourage wage hikes as a way to fight inflation, then we can only boost final sales by increasing borrowing and debt. And nobody wants that. So nobody should be surprised if final sales are weak.

Let's set final sales aside, and consider the "weak investment spending":

Residential (red) and Nonresidential (blue) Fixed Investment as Percent of GDP

The red wiggly shows residential fixed investment relative to GDP. It peaked in 2005 -- giving us two years early warning of what was to come -- and has been running low ever since. Weak investment spending? Yes. The economy may have recovered, but things are not back to normal.

Residential investment has seldom been lower. Still, it is not much lower now than it was in the mid-1990s, 1994-98. And those years were good.

The blue wiggly shows nonresidential fixed investment relative to GDP. Nonresidential investment has seldom been higher. Weak investment spending? Nay.

The dashed lines show the most recent values, Q3 2018.

Wiggly blue is Private Nonresidential Fixed Investment (PNFI); Wiggly red is Private Residential Fixed Investment (PRFI); both of them shown as percent of Gross Domestic Product (GDP). I created a "Page short URL" link to the graph at FRED, as usual, but it is garbage, thanks to the recent update of their FRED Graph system.

It's not surprising that residential investment is weak in the wake of a housing crisis. But it's a misreading of the data, I think, to say that nonresidential fixed investment is low.


One more thing. After Hamilton says investment is weak, and before his concluding paragraph, he writes:

Most of the growth came from inventory build-up. GDP measures what is produced. If goods are produced but not purchased, inventories accumulate, so GDP can look strong even though spending is weak. Subtracting off inventories, real final sales were only up at a 1.4% annual rate in the third quarter.

"Most of the growth came from inventory build-up."

Okay, but look at inventory relative to GDP:

Total Business Inventories as a Percent of GDP

Except in the aftermath of the Great Recession, inventories have never been lower. Hamilton says they went up. I say, so what?

Creating inventory puts people to work, right? It increases income, right? Maybe in the next accounting period the stats will show people spending that income. Creating inventory can boost the economy just like government stimulus spending. Maybe it will. Maybe it is.

Or maybe Hamilton is right to worry, and two consecutive quarters of above-average growth is all we can expect.

Hang in there. We'll find out soon enough.