This statement is indeed accurate if one focuses on real GDP. I present the log of real GDP in Chained 2000$, normalized to 0 at the NBER-defined trough in 2001Q4. I also present for reference log GDP in the previous two expansions, normalized to 0 in the previous troughs in 1991Q1 and 1982Q4. (For those interested in output gaps, the mean WSJ forecast predicts output will be 2.7% below CBO's estimate of potential output by end-2008, in log terms.)

The graph clearly indicates that GDP is now substantially below (4%, in log terms) where it was at this time in the previous expansion. It is 12% below the corresponding level in the 1982-00 expansion.

I also plot the implied level of GDP assuming the mean forecast from the WSJ survey for GDP is realized. In that case, by 2009Q2, output will be 7% below the corresponding level in the previous expansion.

While the mean forecast is of interest, so too is the dispersion in forecasts. In the figure below, I plot the mean forecast, and the highest and lowest forecasts (using as the reference for highest and lowest the 2008 Q4/Q4 growth rate), from James F. Smith of Western Carolina University and Parsec Financial Management (2.82%), and Paul Ashworth of Capital Economics (0.24%), respectively.

The mean forecast projects a bump up in growth in 2009Q1. The high forecast by James Smith projects rapid growth all the way through the forecast period. Of course, Smith in the November 2007 survey provided the highest forecast of the surveyed economists for every quarter from 2007Q4-2008Q4, as well as the highest for 2008 Q4/Q4. (In March 2008, Smith also had the highest forecast for 2008Q1 growth, at 2.6%, and tied for highest Q4/Q4 growth, at 3.5%.) The lowest Q4/Q4 forecast comes from Paul Ashworth; he forecasts a 0.24% growth rate for 2008.

In Figure 3, I present a histogram of the 2008 Q4/Q4 growth rates, as implied by the q/q growth rates reported by the respondents to the survey. Smith is the single observation in the top bin. Ashworth is one of four respondents in the bottom bin. Highlighting the skewed nature of the distribution, Smith is more than 2 standard deviations from mean, while Ashworth is about 1.4 standard deviations below mean.

If we take the most optimistic forecaster's view, then by 2009Q2, GDP will be only 4.8% below the corresponding point in the previous expansion. Taking the pessimistic view, it will be 8.3% below.

These forecasts were conducted in the first week of July. Hence, they predate the surprise jump in CPI inflation. Higher than anticipated inflation could have a variety of offsetting impacts. First, it could signal greater demand pressures, so GDP forecasts would be revised upward. On the other hand, taking into account the Fed’s reaction function, one might think that monetary policy would therefore be tighter than otherwise, and hence output -- at least several quarters out -- would be lower than previously projected.

Today, additional information was released, for industrial production. Here the picture is mixed. Both industrial production and manufacturing production (recall industrial production includes output from utilities which can be influenced by weather factors, even when seasonally adjusted) rose slightly (I think "edged up" is the phrase).

Note that by the metric of the Nation’s factories, utilities and mines, the economy is not growing, over a 3 month moving period.

Finally, both Macroeconomic Advisers and e-Forecasting released estimates of monthly GDP today (May for MA, and June for e-Forecasting). These series are presented in Figure 4. At this point we have a substantial disjuncture between the implications arising from the two organizations' assessments. E-Forecasting’s figures indicate that in 2008Q2 GDP has declined 0.6% q/q on an annualized basis, while MA is predicting a 2.9% q/q growth rate, taking into account the April and May estimates and a forecasted 0.6% growth (annualized) in June.

Without knowing more about the track records of each of the estimates of GDP, I'm reluctant to say which one better tracks the state of the economy (or, less ambitiously, track the state of the advance GDP release…) . Any informed commentary or references from readers welcome.

What is true is that over the 1992-current period, an estimated error correction model assuming cointegrating between the two series (with long run unitary elasticity) indicates that the MA series reverts more strongly to conditional mean than does the e-Forecasting series. In a statistical sense, then, one might think the last observations of the e-Forecasting series are more likely to be closer to the underlying trend represented by both series (recalling that both series are calibrated to match the quarterly actual GDP series reported by BEA). In an informal sense, I think of this statistical result as meaning that the MA series bounces around more than the e-Forecasting series. This is not a conclusion with economic content, though, as it doesn't say which series better represents the economy's state. It might be the case that economic output does jump around a lot, month to month.

Technorati Tags: potential GDP, recession, output+gap, industrial+production, forecasts.

A surprising report from the Commerce Department today, which indicated that seasonally adjusted nominal sales for retail trade and food services were 1% higher in May compared with April. The new estimates of March and April sales (in red in the figure below) were also revised substantially up from the previous (blue) estimates that had been reported last month.

Source: ALFRED

Although a 1% monthly gain would translate into a 12% annual rate if maintained, the newly revised April numbers are still barely above the values last November in nominal terms. Calculated Risk notes that the year-on-year comparisons, when adjusted using an anticipated PCE deflator, remain negative even with the strong new estimates.

Source: Calculated Risk

The latest numbers nevertheless lend support for Peter Hooper's prediction that the fiscal rebate stimulus could give a sharp kick to spending. Greg Ip reports:

With today's retail sales report, forecasters at Morgan Stanley have scrapped their longstanding call for the economy to shrink in the current quarter. The firm, whose continuously updated estimates of quarterly real GDP are closely watched, now sees it expanding at an annual rate of 0.5% in the current quarter, a shift from the previous call of minus 0.2%. This was primarily due to the stronger than expected retail sales report which led the firm to revise up its estimate of personal consumption growth to 1.6% from 0.2%. The firm said it also expects first quarter GDP growth to be revised up to 1.2% from 0.9%.

Economists David Greenlaw and Ted Wieseman confess to puzzlement at the strength in May and the upwardly revised months of March and April. "We doubt that the tax rebate checks had much impact on this report. Indeed, from an arithmetic standpoint, most of the upward adjustment to our [second quarter] estimates reflected the revisions to March and April-- and, distribution of the checks did not even start until the end of April.... So where is all this spending coming from? We do not have a good answer to this question. The fundamentals still seem quite negative-- income growth is moderating in conjunction with a deteriorating labor market, the wealth effect has swung from a source of support to a significant headwind, and every $1 rise in the price of a gallon of gasoline reduces discretionary spending power by about $120 billion (on an annualized basis).... While the rebate checks should provide some noticeable support for the consumer over the next few months, we doubt the latest readings on retail sales can be sustained for too much longer."

Phil Izzo collects some more pondering, but no definitive explanation, from other economists.

Technorati Tags: macroeconomics, economics, tax stimulus, recession

The easiest thing to do is to pull down the CBO's measure (interpolated to quarterly frequency). This yields the following picture (in logs):

Two observations: (i) recessions do not necessarily coincide with negative output gaps (although they do seem to coincide with the beginning of periods of negative output gaps); and (ii) recoveries do not always coincide with positive output gaps.

This is obvious when one thinks about it, given the NBER BCDC definition of a recession as the following:

A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

That is a recession is the description of the first derivative of output taking on a negative value, while an output gap is a description of output relative to the output level consistent with the "normal" utilization of factors of production (also "full-employment"). For details of how CBO calculates potential GDP, see this document.

Looking at the last ten years provides another insight.

The US economy only barely made it close to full-employment in the expansion of 2001-2007/8/?, and is now declining again. I think I had realized this (especially in the course of various past debates over the surge in tax receipts, which I think has now been resolved -- see [1], [2] for a recollection.)

As I noted in the beginning of this post, I was finding it difficult to discern the most appropriate measure, so I will share the other measures I have investigated as indicators of potential (or "trend") GDP (which can then be used to calculate corresponding measures of the output gap): (1) the Hodrick-Prescott filter; (2) the Band Pass filter; and the quadratic time trend.

The Hodrick-Prescott filter is a ubiquitous two-sided filter used in time series macroeconometrics and elsewhere (I've even seen it used in the analysis of temperature data! [3]). Essentially, the HP filter calculates a trend that minimizes the weighted sum of squared deviations from trend, and squared changes in the the growth rate of the trend. This weighting is controlled by a parameter which is usually set at 1600 for quarterly data. As a public service, I'll note there are serious hazards associated with this filter, especially when trying to correlate various macro series that have been put through the same filter [4].

There is an additional problem (which is often ignored), namely that the HP filter is two-sided, so that running the filter up to the end point of data will tend to result in the trend being too close to the last data point (in our case, the output gap will be pulled to zero).

There are several band pass filters; the one most commonly used in the macroeconometric literature is the Baxter-King version.

Band pass filters are called this because (in the frequency domain) they pass through any cyclical components within a particular frequency band, and elimates the others. In the time domain, this means fluctuations that are shorter or longer than a specific length are ignored. In the business cycle area, then, in order to use this filter, one would have to have a prior on how long a "typical" business cycle is. More on both the HP and BP filters can be found in Tim Cogley's entry for the New Palgrave Dictionary of Economics [5].

The final means of identifying the output gap is to the simplest (at least in implementation) -- take the deviation from an estimated quadratic trend in time. This is not an uncommon procedure, but if you are pretty confident there is a unit root in log GDP, you might feel a little queasy about doing this [6]. But for completeness' sake, I'll show what happens when you do this as well.

Note that in order to circumvent the two-sided filter aspect of the HP filter, I have done a standard fix, which is to use an ARIMA(1,1,1) on log GDP over the 1980-08q1 period to dynamically forecast out 12 quarters, and then apply the HP filter to this "extended" series. I could have done a similar procedure for the BP filter, but opted to use the Christiano and Fitzgerald (2003) one-sided asymmetric version of the band pass filter to estimate the trend series.

First, the good news. Using the band pass filter, one finds that the output gap is still positive, at less than one percentage point of GDP in 2008q1. The HP filter indicates an essentially zero output gap. The quadratic trend indicates something similar to what the CBO indicates -- something close to a 2 percentage point negative output gap in 2008q1, versus 1.5 percentage points for CBO.

I don't want to say that there is one best version. Variations in the sample period, and the parameters used in each filter, will change the results. And of course, data revisions will mean the real-time output gaps will differ from the final revised output gaps we estimate today using either mechanical or judgmental approaches. For a pessimistic view regarding real time use, see Orphanides and van Norden (2004) [pdf].

Nonetheless, the distinction between the rate of change in economic output, and where output levels will gravitate to (and at what pace) is a useful one. And I think it will become of greater usefulness as the slowdown ends, if and when growth resumes. In particular, I'm thinking of whether the pattern of smaller -- but more persistent -- ups and downs continues (the half life of a deviation from potential has risen from 8 quarters in the 1970-90q1 period to 11.6 quarters in the 1990q2-2008q1 period).

Technorati Tags: potential GDP, recession, output+gap, full employment output, trend.

One point to keep in mind, when comparing against previous downturns: for the last few months, the indicators are either preliminary or once/twice revised, while viewing back in time, one will be looking at final, revised, data. For the issue of vintage data and revisions, see these posts (see Creative Destruction, as well as these posts [3], [4], [5]). To access vintage data, see the St. Louis Fed's ALFRED system.

With that caveat in mind, it looks to me like we've passed at least a local maximum, and indicators are trending down.