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March 29th, 2012


Markets mostly yawned Thursday morning as the Bureau of Economic Analysis released the final reading on real GDP growth in Q4’11. At 3.0%, output was unchanged from the annual rate reported in the preliminary estimate and merely matched the Reuters News consensus estimate. But before brushing the as-expected release aside, some dealers took notice of the much faster rise in real gross domestic income (GDI) last quarter. For a given quarter, the estimates of GDP and GDI may differ for a variety of reasons, including the incorporation of largely independent source data. Over longer time spans, however, the BEA’s GDP and GDI estimates tend to follow similar patterns of change. Furthermore, experience has demonstrated that when the two measures deviate, GDI emerges as the superior measure of underlying economic momentum.


Real GDI, which measures the output of the economy as the costs incurred and the incomes earned in the production of GDP, increased 4.4% in Q4, a 177-pp improvement over the Q3 rate. Real GDP grew by 3.0% in the latest quarter, only a 114-pp increase over the prior quarter’s rate. And while annual growth in real GDP slowed from 3.0% in 2010 to 1.7% in 2011, real GDI growth only slowed from 3.6% in 2010 to 2.1% in 2011. In fact, 2011 was the second year in a row that GDI’s growth rate surpassed the growth rate in GDP.

In a Spring 2010 Federal Reserve paper aimed at determining which measure (GDI or GDP) better represents the actual business cycle fluctuations in output growth, staff economists contended, “A wide variety of results suggest the answer is GDI. Results on revisions to the estimates, and correlations with numerous other cyclically sensitive variables, are particularly favorable to GDI.” The most recent GDI data available for use in the study showed “the 2007–09 downturn to have been considerably worse than is reflected in GDP.” It should follow, however, that the data from 2010-11 show the expansion to be considerably better than is reflected in GDP.

Morgan Stanley Research attributes the boost in real income rise to more favorable terms of trade, the ratio of export prices to import prices. The dealer warned, “The first impact of declining terms of trade is that, all else equal, gross domestic income growth will be lower.” BNP Paribas Global Markets similarly remarked that GDI boosts tend to come “more by improvements in the terms of trade, such as when energy prices fall as they did in the second half of 2011.” As energy prices have reversed course to head higher in Q1’12, however, the terms of trade should have declined in the current quarter and GDI growth should have slowed.

Noting how the 2.4% quarterly average for real GDI exceeded the 1.6% pace for GDP, economists at UBS Securities felt, “GDI suggests that GDP may be understated” and said, “Perhaps this is another explanation for unemployment falling a bit faster than suggested by GDP growth—the GDP data may be missing some output. This would help explain the seeming deviation from the Okun’s Law-consistent unemployment rate that Fed Chairman Bernanke spoke about earlier this week.”

Hinting at the conclusions made in the Fed’s research paper, First Trust Advisors observed, “When there is a discrepancy, the government tends to later revise GDP toward GDI.” The firm believes, “[Real GDP] growth in 2011 was probably better than 1.6%. It would also help explain why the unemployment rate has been dropping faster than one would expect given modest GDP growth. Meanwhile, nominal GDP was up at a 3.8% rate in Q4 and up 3.8% in the past year, which means that a zero percent federal funds rate is too loose and quantitative easing is not needed.”


While MKM Partners called the first estimate of GDI “solid”, it urged restraint when interpreting recent improvements as an “all-clear” for the central bank to remove policy accommodation. MKM offered, “The recent strength in GDI is consistent with the stronger private payroll figures and the decline in jobless claims seen in recent months. Thus, underlying economic momentum appears to have picked up some. Unfortunately, there is a long way back to the pre-bubble, pre-crisis path. We believe it makes sense for Bernanke to be cautious in his economic assessment and to beat back calls for tighter money from the hard-money structuralists. We need a sustained, multi-year period of above-trend growth to get back to normal levels of output and employment.”

The GDI report, today’s included, gets far less attention in the markets than its cousin, GDP. But as the Fed has concluded empirically that “GDI better reflects the business cycle fluctuations in true output growth”, dealers are at last more likely to start following the paper’s clear recommendation from two years ago that, “Economists and statisticians interested in business cycle fluctuations in U.S. output should pay attention to the income-side estimates and consider using some sort of weighted average of the income- and expenditure-side estimates in their analyses.”


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