The U.S. Bureau of Economic Analysis (BEA) reported yesterday that in its preliminary estimate the U.S. Gross Domestic Product – GDP – fell at an annualized rate of 34.3% in the second quarter. (The BEA also reported that Real GDP – GDP adjusted for inflation – fell at an annualized rate of 32.9%.) These are unprecedented declines. But what exactly does this mean? Did output, or income, fall by one-third?
The answer is no. Current dollar GDP, which is GDP that is not adjusted for changes in prices, fell by just under 10% in the second quarter. The BEA reports percentage changes in GDP on an annualized basis. That is, what they report as the percentage change in GDP in any quarter is the percentage change in annual GDP that would occur if the current quarterly percentage change were to continue for an entire year.
The actual decline in GDP in the second quarter was from $21.561 trillion to $19.409 trillion. But GDP is what economists call a ‘flow measure,’ a measure that is a dollar amount over a set time period, analogous to a report of your personal income per year. If I ask you your income, you might report it as $50,000 per year. But if I ask you your income this quarter, you would probably report $12,500, assuming your income is steady throughout the year. This is where the BEA differs. When the BEA reports ‘income,’ i.e. GDP, for this quarter, it reports income for this quarter at an annualized value. So, when the BEA reports GDP in Quarter 2 of $19.409 trillion, the actual income produced during quarter 2 was one-fourth that amount.
You can most easily see this by looking at quarterly and annual GDP numbers. In 2019, the BEA reported the numbers in the table below. The quarterly numbers were all a bit over $21 trillion, and the annual number was the average of the four quarterly numbers, so also a number a bit over $21 trillion.
So, let’s get back to 2020 quarter 2. GDP in quarter 1 was $21.561 trillion, which as we just saw indicates an actual three-month flow of income of one-fourth that amount. GDP in quarter 2 was $19.409 trillion, and again the actual three-month income flow was one-fourth that amount. The percentage change between quarter 1 and quarter 2 is -9.98%, regardless of whether we use the BEA’s quarterly numbers or if we divide all of them by 4. The BEA’s report of a 34.3% decline is what would happen if that 9.98% quarterly decline continued for one year. (The calculation is (1-.0998)^4-1 = -.3433 = -34.33%.)
To sum up, the GDP decline was almost 10% in quarter 2 from its value in quarter 1. Quarter 2 is a period during which the U.S. unemployment rate rose from a quarter 1 three-month average of 3.8% to a quarter 2 three-month average of 13.0%, an increase of 9 percentage points. Like the increase in unemployment rates, the decline in GDP is clearly indicative of the traumatic impact on the economy of both the COVID-19 pandemic and the policy response to the pandemic. But please don’t take the headlines quite literally. Although technically correct, these estimates can easily be misunderstood because of the way the GDP numbers are reported. National income fell dramatically in quarter 2, but it fell 10%, not 34%.