If you follow any news site, you’ve seen some splashy headlines recently. “US GDP surged a record 33%” and “US economic activity rose at a record 33.1%” are among the few I spotted. Yes, the Bureau of Economic Analysis (BEA) released their quarterly Gross Domestic Product (GDP) numbers for Q3 2020 and boy oh boy are things looking good. We’re up 33.1% from the last quarter. This is much better news than the previous quarter where the U.S. economy shrank 31.4% in the thick of COVID shutdown during Q2 2020 (both of these numbers are records).
The GDP is the grade report for the economy. A good score instills confidence in investors and everyday people like you and me that our economy is not only doing fine, but also becoming bigger and better. A bad score has the opposite effect, and tends to get people worried.
A 33% increase sounds like it beats out a 31% decrease and it got me thinking — are we back on top? Did we conquer the virus economically? (we’re up 2% right?). These numbers are accurate, but they can be misleading and are often taken out of context. Let’s dig a little deeper into the numbers and understand exactly how the economy has held up these past few months.
What is GDP?
Let’s start with the basics. At its simplest, GDP is the total market value of all finished goods and services produced within a country’s borders within a specific time period. The US Government will report on this value each quarter, and compare it to previous quarters. GDP is considered one of the most important financial indicators because it measures a nation’s total economic output and this in turn reflects its financial health. A growing GDP indicates a healthy economy, while a shrinking one indicates something is wrong. Economists will use GDP figures to determine if a country is in recession, what interest rates should be imposed at the national level and many, many other applications.
How is GDP Calculated and Reported?
The way the US Government reports GDP change from quarter to quarter is “annualized”. In other words they do not report the absolute change between 2 quarters, but rather the change between 2 quarters as if that change continued for a period of one year. It’s a forecast rather than an absolute measurement.
Reading that sentence doesn’t make a lot of sense at first, but this method of reporting is more intuitive than you actually think. We’ve all done it before. Think about when you start saving some money from your paycheck. We plan on saving $200 a month, which we then annualize (or forecast) to $2,400 per year. The BEA actually have a direct response on why they do this in their FAQ. Their rationale is that showing an annualized number makes it easier to compare each data point. The GDP value is provided at each quarter, so annualizing it will make it an apples to apples comparison no matter which quarter you select. This becomes even more useful when comparing data points across different time scales. A data point for the month of December 2013 annualized is the same as comparing a data point for Q1 2014 annualized.
Okay, so let’s look at some actual numbers.
The only COVID-free time period in this data set is Q4 2019. So let’s consider that the gold standard. Our Real GDP for that quarter clocked in at $19,254 billion, an all time high. End of Q1 2020 marked the beginning of lockdowns and quarantine, but it wasn’t until Q2 2020 where we felt the full effect of these mandates. Our beloved economy shrank to a low of $17,302 billion. Compared to Q1 2020 that’s a -31.4% reduction annually. Now, with a new wind in our backs we have managed to claw our way up to $18,584 billion, which marks an annual percent change of 33.1%. But that’s annualized, and another way of looking at the changes in our GDP is quarterly. This is the absolute change between quarters. Looking at those numbers, they’re a lot smaller. -9.0% instead of -31.4%, and 7.4% instead of 33.1%. For comparing the here and now, this is a more honest and muted view of seeing exactly how the economy is progressing.
If you’re interested in seeing how the BEA calculates the quarterly and annual % changes check out their detailed explanation here.
Things making sense so far? Okay, good — because here’s another curve ball. GDP is not always the same number. It depends if it’s reported as Real GDP or Nominal GDP.
What is the Difference Between Real GDP and Nominal GDP?
Real GDP is the market value of goods and services produced in an economy adjusted for inflation. Currently it’s adjusted with 2012 as the base number. This allows economists to fairly compare previous GDP numbers to determine if the GDP growth is true growth and not just a result of inflation. Real GDP is the most commonly reported and used of the two.
Nominal GDP is the actual, unadjusted market value of goods and services produced in an economy. Just for fun, here is the same table as above but with nominal GDP as the input.
You can see the swings are a little more in the percentage changes, which makes sense as the GDP numbers are higher when unadjusted for inflation.
So Are We Out of the Coronavirus Woods Yet?
If we consider the GDP from Q4 2019 the gold standard, we were sitting at a solid $19,254.0 billion. Currently we’re sitting at $18,584.0 billion. That’s $670 billion shy (but not a true $670 billion — the quarterly GDP figures are once again annualized). From these numbers alone it’s clear we’re not back to the level we were in 2019. And GDP is just one wavelength within the full economic recovery spectrum. There are many other factors to be considered like unemployment rates, stock market indices, housing market indices and more.
The main takeaway from this post is that a 33% increase does not always beat out a 31% decrease. The numbers are always more nuanced than that.
