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The unexpected slight decline in fourth quarter gross domestic product, or GDP, did not produce a media meltdown, stock market plunge, or a flurry of calls from my panicky friends and relatives. This makes me think that maybe, just maybe, people are beginning to grasp some basic economic concepts. Put briefly, here’s why it happened and what it signifies.
We have several different ways to measure output. The most common method is to simply add up the gross expenditures in an economy in a three-month period and then adjust for things we bought that were not made in our country or were made prior to the quarter. We break these expenditures into three big categories: consumption, investment, and government spending on goods and services. What the recent fourth-quarter data tell us is that consumption and investment increased at more or less the same rate they have been going up the last year or two, but that government spending fell quite a bit in the fourth quarter, slightly more than consumption and investment went up. Government spending may decline again in the first quarter of 2013, especially if the rescissions are not canceled — or are canceled late in the quarter — but no credible forecaster sees consumption or investment falling as well, so this slight fiscal drag may persist a bit longer.
Another positive economic sign is that government tax revenue has increased smartly the last few months. Tax revenue is closely tied to economic growth and it can often be the canary in the coal mine in terms of anticipating an economic downturn. The increased revenue therefore suggests a true recession is probably not on the horizon.
Short run perturbations in GDP mean little. The only danger associated with a negative number is that the pundits and citizenry might perceive this as a harbinger of another recession, which the government duly seizes on as a reason (or excuse) to increase government spending. The fact that the markets took the GDP drop in stride, combined with the relatively healthy job growth of the past few months, suggests that the economy will keep to its recent trend of steady but unspectacular gains.
What should be of bigger concern are the various indications that long-run growth trends have fallen, which manifest themselves in lower productivity growth and shrinking private investment. These suggest that returning to our pre-recession levels of economic growth may be difficult or even impossible, which in turn would mean that solving the impending long-term budget crisis — or getting some of the millions of discouraged workers back into the labor market — is going to be more difficult than we anticipate.