Why Was 3rd Quarter GDP Revised Up to 2.5%?

By Daniel Indiviglio

Americans have another reason to be thankful this week: third quarter GDP was a little stronger than they first thought. The U.S. economy grew at an annualized rate of 2.5% last quarter, according to the Bureau of Economic Analysis. That is brisker than the 2.0% rate first estimated in October. Although economists might like to see even more aggressive growth, 2.5% certainly looks a lot better than consumers sentiment suggested. What caused the revision?

First, here's how the history now looks, taking the new third quarter growth estimate into account:

GDP 2010-Q3 rev2.png

There are many components of GDP, so it should come as no surprise that there are several reasons for the new estimate. First, consumers spent more money than was previously thought -- about $5.7 billion more. That was almost entirely due to more spending on goods, as spending on services was virtually unchanged. Most of the revision was due to more spending on motor vehicles and gasoline than the first estimate indicated.

But personal spending only accounted for around one-third of the $16.7 billion upward revision. So other factors also came into play here. Business spending was not really one of them, however. Although a few components like construction and equipment spending were a little better than the first estimate indicated, weaker-than-thought inventory growth erased their gain.

Net exports also contributed to the higher GDP revision. In particular, the U.S. exported $5.9 billion more goods than initially thought. While that's good news, the increase did not nearly turn net exports positive, as imports were not revised much They remained $506.7 billion higher than exports on an annualized basis.

Finally, state and local governments didn't cut spending as the first GDP estimate suggested. In fact, their spending rose slightly, by $2.9 billion. October's calculation incorrectly stated a $900 million decline. Federal spending, however, was largely unchanged by the revision.

Overall, a 2.5% growth rate is neither terrible nor wonderful. For better job growth, a number above 3% would be more comforting. One of the major reasons for the weak growth, despite the revision, remains the housing market. It contracted in the third quarter. Without its steep decline, GDP would have been 0.75% higher, with 3.25% growth. For the labor market to recover, it will have to do so in spite of the real estate market.

Of course, it's important to bear in mind that this analysis is all based on just the second estimate. We'll have to wait a little longer to know the final estimate, which will be revealed in December.

This article available online at:

http://www.theatlantic.com/business/archive/2010/11/why-was-3rd-quarter-gdp-revised-up-to-25/66941/