Markets and Economy

Time to Dump GDP?

GDP growth has been weak for years, but by most measures, the economy is strong and the recovery is nearly complete. Is GDP still a credible measure of economic health?
Jim Glassman, Head Economist, Commercial Banking
July 6, 2016

Throughout the recovery, GDP estimates have been a consistent source of disappointment. Yet despite periodic downshifts in growth, the economy itself has steadily improved. By most concrete measures—including employment, the stock market, real estate values, consumer spending, the federal deficit and household balance sheets—the economy has gradually gained ground. So perhaps the error lies in GDP.

Secular Stagnation, or Something Else?

At first glance, slow GDP growth seems to confirm fears of secular stagnation. Some pessimistic economists believe we have entered a new era of falling productivity, low interest rates and growing structural unemployment.

However, the past year has dispelled the myth of workers rendered permanently “unemployable” by technology: As new jobs open up, millions of workforce dropouts are returning to work. And there are good reasons to believe that today’s low long-term interest rates are the result of massive distortion from central banks, not a dismal outlook among bond investors.

The perception of falling worker productivity is also highly dubious. While poor productivity growth is implied by weak GDP—if the labor force is steadily growing while production is flat, then the average worker must be less productive—this begs an important question: Whose productivity is suffering? Surely not workers in the "gig economy" who are putting idle resources to productive use. And not the manufacturing workers operating cutting-edge automated equipment, or the white-collar workers who draw on increasingly sophisticated software and telecom tools to enhance their output.

Rising incomes further compound the mystery of poor worker productivity. Gross domestic income (GDI) has consistently outpaced the growth of GDP—GDI has expanded at 2.44 percent annually throughout the recovery, while GDP growth has been stuck at 2.1 percent. According to official estimates, American workers have now earned $363 billion more than they have produced since 2009. This strongly suggests that the measurement of GDP is incomplete, and that worker productivity is growing faster than GDP implies.

What’s GDP Missing?

It's possible that GDP’s true growth rate is not so slow. The measurement’s blind spots are well known:

Imputations may be another source of undercounting. A full 16 percent of the economy is composed of unpriced transactions whose value must be “imputed” for GDP estimates. For example, when a bank offers free checking, the service is unpriced but still has value. The bank processes checks and maintains accounts in return for the investment income from their account holders’ money. To impute the value of this service for GDP, the Bureau of Economic Analysis (BEA) compares the interest rate offered on the checking account (typically zero) against the yield on similarly safe long-term investments, like government bonds. 

This is a perfectly logical way of valuing the service—return on investment is exactly what's being traded between the account holder and the bank. However, today’s low bond yields are likely the result of quantitative easing abroad. The imputed value of free checking is being depressed by central banks in Europe and Japan.

Imputation is also used to determine the value of homeownership, which gives long-term interest rates an outsized influence over GDP figures. The total impact of declining imputation values may account for half a percentage point of missing GDP growth.

Whom to Believe?

Measuring GDP is inherently difficult, and the BEA constantly refines its methodology to better reflect developments in the real economy. But when GDP trends disagree with clear signals from other measures of economic health—when companies are continuing to add workers, investors are optimistic about future earnings and consumers are opening their pocketbooks—it's perfectly reasonable to assume GDP is missing some sources of economic strength.


View our economic commentary disclaimer.

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