What Happened to GDP in the First Quarter?

Economists' GDP estimate was revised down dramatically to 0.4% from 1.9% due to two main factors

600 inventory shelves REUTERS Jason Reed.jpg

Although the big news today was supposed to be the second quarter's growth rate, it was overshadowed by the giant revision to first quarter GDP. The second quarter's growth was pretty weak at 1.3%, but the first quarter's growth was revised down from 1.9% to a measly 0.4%. This is a pretty drastic change, particularly during a quarter when the economy appeared to be gaining some steam. What happened?

If you dig into the numbers you find two main culprits responsible for the revision: business investment and net exports. Let's see what happened here.

Business Investment

In June, the first quarter's growth in business investment was estimated to be $52.4 billion, annualized. Instead, economists now say it was just $16.4 billion. Investment in equipment and software was little changed, however. Home sales were also estimated pretty accurately.

The main reason why business investment was worse than we thought was due to inventories. Instead of growing at the annualized rate of $39.5 billion, they grew at the rate of just $10.8 billion. This indicates that firms weren't ramping up their inventories as rapidly as thought.

Due to this correction, instead of adding 1.5% to GDP, business investment added just 0.5%. So now we know where 1% of the growth went.

Net Exports

The rest of the revision is mostly accounted for in the worse result of net exports. But really, it can be mostly isolated to imports. They were higher than we thought, which means that net exports were lower.

In particular, imports grew by an annualized $16.3 billion more than initially estimated. As a result, instead of adding about 0.14% to growth, net exports brought GDP down by 0.34%. Th revision to net exports cut growth by about another 0.5%.

The implications of this revision are mostly macro in nature. A 0.4% growth rate is bad by pretty much any standard. Now we policymakers are faced with the question of what to do about an economy that barely grew in the first part of 2011, and at an annualized rate of just 0.8% over the year's entire first half.

What about the specific components responsible for the revision? That businesses weren't as interesting in growing their inventories might be particularly troubling, as it shows a more pessimistic outlook than first anticipated. The increase in imports isn't as much of a concern from a recovery perspective, though it does show a greater demand on the part of Americans for goods from abroad than we thought. Obviously, if they instead purchased more domestically produced goods, then GDP growth would have been stronger.

Image Credit: REUTERS/Jason Reed