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January 4, 2011

2010 In Review: GDP

GDP is an interesting beast. Economists use GDP growth to determine whether or not we are in a recession. GDP declines for more than two consecutive quarters is defined as being in a recession. While this past (or present) recession is classified as the worst since the Great Depression, it only lasted four quarters, which may be (in duration) one of the shortest in U.S. history.

Now, before we give the government or the Federal Reserve credit for shortening the length of the recession, we need to understand the dynamics of GDP and how they have changed in the modern era. In the 4th quarter of 2009, GDP jumped at more than 5% (annualized). This was because businesses were busy replenishing inventory. How is this?

In a recession, sales fall below expectations, and as a result, retailers tend to curb back orders from manufacturers. This lowers production and allows for the early effects of the recession to deepen. After this initial "shock," businesses begin holding less inventory in order to manage decreased sales without losing money (or having to change prices). When inventory levels get low, and there are signs of life in the economy, businesses will have a burst of new orders.

This increase in orders temporarily boosts production, productivity, and GDP. This trend started in the second half of the 20th century and has contributed to the cause of our recessions being shorter in duration. While this may serve a short-term benefit, the sugar high fades, causing GDP growth to slow in the two to three quarters that follow.

An economic catalyst is needed in order for growth to be maintained past this point. Low interest rates were the key to the last growth cycle, but as we learned, it also created the massive bubble and current recession. Now, policyholders are relying on the same low rates to steer us back into sustainable economic growth.

Third quarter GDP (2.6%) was somewhat disappointing because economists expected another inventory boom like we had last year. However, it appears that "sugar rushes" are over for some time and that GDP will be modest for the foreseeable future. For our predictions on 2011 GDP (and we may go out further than that), check out our economic forecast article this Friday.

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