Explaining the GDP Boom

Further insight into yesterday’s big GDP numbers was provided by the release this morning of the September personal income and spending data by the BEA. Both income and spending were sharply lower in September compared to August. The reason? Overwhelmingly, it was because of the end of the one-time tax rebates sent out over the summer. In the graph below, you can see the big bump in both disposable income and consumer spending in July and August, which was almost entirely due to the tax rebates.

What does this mean? Three things.

First: this provides strong evidence that the huge increase in GDP last quarter, which was powered largely by consumer spending, was largely due to the tax cut. Good old fashioned Keynesianism, as AB pointed out. The mortgage refinancing boom helped some, too, but the lion’s share of the credit goes to the tax cuts.

Second: this suggests that last quarter’s GDP figures were an aberration. The fourth quarter will most likely not be nearly as good, since the tax rebates have now been spent and their impact on the economy is pretty much gone. So expect GDP growth to slow.

Third: we can also expect the third quarter GDP growth figure of 7.2% to be revised downward when the updated estimate is released on November 25. The advance figures, which we got yesterday, are mostly based on July and August economic activity. The revisions will take September more into account, and thus will be lower. When all is said and done, we may well find that 3Q GDP growth was around 6%.

One last point about yesterday’s GDP report. Don’t spend too much time looking for a downside to it. Even if it’s only 6%, it’s a genuinely good report. The economy is indeed slowly improving (though there are reasons why I think the economy will slow down again in another 6-12 months). Those are real gains, which we can’t ignore, as much as we want to see W. crash and burn. The important question to ask about the economy’s growth is whether it’s sustainable. As this post indicates, I tend to think that it’s not.

Regardless, I think that AB is right that the Democrats shouldn’t be putting all of their hopes on a poor economy giving them the election next year. The economy won’t be great, but it won’t be terrible, either. With each passing week, it becomes more clear to me that the way to beat Bush is with his disastrous foreign policy, his secrecy, and his lies.