Matt O’Brien had a good piece on Friday’s GDP numbers noting that we are not seeing the investment boom promised by promoters of the tax cut. However he argued that growth was likely to remain close to 3.0 percent based on the 3.1 percent growth rate reported in final sales to private domestic purchasers. In my GDP write-up I was somewhat less optimistic about near-term growth prospects, pointing to the 1.4 percent growth rate in final sales.

The difference in these two measures is that the final demand measure pulls out inventory changes from GDP. The logic is that changes in the rate of inventory accumulation are erratic and no one thinks that the rate of inventory accumulation will expand infinitely relative to the economy nor the rate at which they are being run down will continually accelerate. For this reason, the final demand measure, which leaves out inventories, seems like a better measure of growth.

The final sales to domestic purchasers measure pulls out government spending and net exports, following a similar logic. Government spending is often erratic, jumping or falling in a given quarter, often due to the timing of purchases, especially with the military. Pulling it out can give a better measure of underlying growth. Net exports are also erratic, but we don’t expect the trade deficit to either continually expand or shrink relative to the overall size of the economy. Therefore pulling out the quarterly changes can give us a better measure of the underlying growth rate.  

While the decision to pull government expenditures out of the GDP figure makes little difference in the most recent quarter (they grew at a 3.3 percent rate, almost the same as the 3.5 percent overall growth rate), the decision on net exports does. The increase in the trade deficit subtracted 1.78 percentage points from growth in the quarter. That is the explanation for the difference between the 3.1 percent growth rate in final sales to domestic purchasers and the 1.4 percent rate of growth of final demand.