Tuesday, August 23, 2011

GDP Uncertainty



This post is really about data representation, not economics.

Several commentators have noted the sharp drops in the Bureau of Economic Analysis estimates of the rate of change in the U. S. GDP in and around Q4 2008.  For example, the Economist observed:
The BEA’s first estimate of output in the fourth quarter of 2008, published in January of 2009, showed a contraction of 3.8%, later revised to a 6.8% drop. The new numbers change the figure yet again, to a shocking 8.9% fall in GDP. For 2009 as a whole, the American economy shrank by 3.5% rather than the previously reported 2.6%.

Such tardy and substantial changes to the basic picture of the downturn have left many perplexed. The fault lies in the grindingly slow process of government data collection. The BEA pieces together its GDP estimates from a range of monthly economic surveys. Those data, themselves subject to annual revisions, are fed into calculations of national output. Delays plague each step of the process. The 2009 Annual Survey of Manufactures, for instance, was published at last in the fourth quarter of 2010. Its impact on GDP was not revealed until this July, however, because the BEA reports annual revisions just once a year.
In its advance (earliest) release, the BEA did caution its audience regarding what "advanced" means when talking about a release.
The Bureau emphasized that the fourth-quarter “advance” estimates are based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4).  The fourth-quarter “preliminary” estimates, based on more comprehensive data, will be released on February 27, 2009.
By the way, that "box on page 4" is interesting.  It reports that
Information on the assumptions used for unavailable source data is provided in a technical note
that is posted with the news release on BEA's Web site. Within a few days after the release, a detailed "Key Source Data and Assumptions" file is posted on the Web site. In the middle of each month, an analysis of the current quarterly estimates of GDP and related series is made available on the Web site; click on Survey of Current Business, "GDP and the Economy."


That's a lot to digest to attempt to understand the caveats (assuming you understand the methodology, which happened to change in 2009).  Note that the assumption details are posted "within a few days" of the release itself.

Models outside the BEA appear to have headed toward what was apparently a more accurate estimate.  At least some are bound to.  One analyst consensus estimated the GDP rate at -5.4 percent.  When markets closed on January 30, 2008, the Financial Times had this to say :

The S&P 500 closed down 2.3 per cent at 825.88, the Dow Jones Industrial Average 1.8 per cent lower at 8,000.86 and the Nasdaq Composite index off 2.1 per cent at 1,476.42.

The market had opened higher after US Department of Commerce figures showed that fourth quarter gross domestic product contracted at a 3.8 per cent annual rate, which, although bleak, was not as bad as feared.
But leading indices slipped into negative territory after the open as analysts pointed out that the headline figure – helped by the number of unwanted unsold goods – belied more worrying underlying trends.
The BEA's subsequent 2008:Q4 "preliminary" (second) release on February 27, 2009 reported a -6.2 percent annualized (and seasonally adjusted) rate of change from the prior period.  That was down from -3.8 percent in the advanced release 28 days prior.  The preliminary number was almost twice the advanced (earlier) number.  The BEA commented:

The preliminary estimate of the fourth-quarter change in real GDP is 2.4 percentage points, or $74.4 billion, lower than the advance estimate issued last month.  The downward revision to the percent change in real GDP was widespread; the largest contributors were downward revisions to private inventory investment, to exports, and to personal consumption expenditures for nondurable goods.
Note the relationship to the Financial Times comments a month earlier.  The S&P 500 was off 2.4% that day, and the yield curve steepened, with the 2-year note down 6 basis points and the 10-year note up 4 basis points.

The BEA's GDP estimation obviously isn't easy or immediate,   In certain circumstances, estimating quarterly GDP is especially hard, and subsequent BEA estimates of 2008:Q4 GDP did not really stabilize (presumably partly due to changes in methodology).  Here's the timeline for BEA updates to the 2008:Q4 GDP rate of change:

BEA 2008:Q4 GDP change releases


That's a long time to wait for market- and policy-moving data.  (Perhaps you can argue that much of the change was due to methodological changes, but where does that gets you?)  Was 2008:Q4 a fluke?  Here's the story for the BEA GDP estimates for the four quarters of 2008:

BEA 2008 quarterly GDP change releases 


2008 was not a good year for BEA GDP estimates.  Models often depart from reality at inconvenient times.  The BEA discusses some of these challenges here.  Changes in methodology complicate things.

For forecasts, error bars and other indicators of confidence, variance, distribution, etc., are of course common.  Here's a particularly relevant example from the Federal Reserve, which has its own staff for tracking this stuff:

Source: Federal Open Market Committee
This graph comes directly from the minutes of the Federal Open Market Committee on January 27-28, 2009, and the authors depict the "central tendency" for each forecast period.  Even though 2008 was history, it's obvious now that those recent historical numbers were not themselves history but instead forecasts of the past.  Presenting them as single numbers can encourage a confidence that is not always justified.  2008 GDP estimates deserved "central tendency" bars too.

Cheap shot: What were the error bars on S&P's Lehman counter-party credit risk rating that was reaffirmed in July 2008?

We try to be circumspect when we encounter point estimates.  In our projects, we often go to a fair amount of trouble to carry around information about distributions, confidence, or caveats.  Rarely convenient but often powerful.  We'll have more to report on this topic.


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