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Economic Growth Rates Will Be Distorted The Rest Of The Year Due To How They Are Calculated

When the Bureau of Economic Analysis or BEA releases its first estimate for the economy’s second quarter growth rate it is going to look very ugly. There are various estimates but they tend to cluster around a 40% decline for the U.S. economy.

Multiplying by 4 will distort the reading

However, the number that is published on July 30 will be distorted due to the way the BEA calculates it. What the BEA does is use the quarter-to-quarter change in the economy and essentially multiplies it by four to get an annualized number. That means if the economy grows 1% from one quarter to the next it reports an annualized rate of 4%.

The BEA is assuming that the one-quarter change will continue for the next three quarters. With a large economy and fairly consistent growth rates this calculation gives a fairly accurate description of the growth rate.

However, with the economy being decimated by the coronavirus and being in lockdown for a few months, the multiplication effect will distort the results for the rest of the year. This can be seen in the table below from the Congressional Budget Office or CBO.

It has the June quarter’s GDP falling 11.2% from the March quarter or 37.7% on an annualized basis. Note, I have emailed the CBO asking why the June quarter’s annualized number is less than four times the quarter-to-quarter forecast but have not heard back.

It then has the economy increasing 5% from the June to September quarters, which results in a 21.5% annualized growth rate. For the December quarter the pace falls to 2.5% quarter-to-quarter resulting in a 10.4% annual rate.

The worst quarter ever followed by the best ever

As the chart below from the Federal Reserve of St. Louis shows the 37.7% decline in the June quarter will be almost four times the worst ever reported. It will then rebound to the best ever at 21.5% and still show very strong growth in the December quarter.

A better way to judge the economy is to look at year over year rates. This helps to lessen the impact of multiplying one quarter’s change by four. It isn’t perfect given the huge gyrations that are currently occurring, but it is a better way to understanding what is happening.

The Federal Reserve Bank of New York twice a week publishes its “Weekly Economic Index” that attempts to provide a real-time read on the economy versus having to wait for the official GDP report. It is “an index of ten daily and weekly indicators of real economic activity, scaled to align with the four-quarter GDP growth rate” per the website.

As the two charts below show the economy took a drastic downturn in March and has been slowly recovering. Instead of showing a 40%ish decline for the June quarter, it is currently estimating a 7.64% fall on a full year basis for the June quarter.

It could take a decade to recover from Covid-19’s impact

One last way to look at the economy is to take a longer-term view. The Peter G. Peterson Foundation has combined the Congressional Budget Office’s economic forecasts to extrapolate how long it will take for the economy to get back to the economic output that was forecast before the virus hit. It is projecting that it could take 10 years for the economy to fully recover.
Source: Forbes

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