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Saturday, January 28, 2006

The Tax Policy Blog: Hurricanes, Government Spending, and GDP

Gerald Prante at the The Tax Policy Blog looks at the difference between GDP and net domestic product growth rates (in levels, NDP=GDP-CFC, where CFC is the consumption of fixed capital, i.e. a measure of depreciation, see the BEA for more). He also notes that much of the spending on hurricane Katrina is reflected in defense spending which rose in the 3rd quarter but fell in the 4th leading to corresponding swings in the GDP figures:

Gerald Prante, The Tax Policy Blog, Hurricanes, Government Spending, and GDP: The Bureau of Economic Analysis today released GDP numbers for the 4th quarter and it showed GDP rising at only 1.1 percent, down significantly from the 4.1 percent growth witnessed in the 3rd quarter of 2005. ... There are two main factors associated with the high volatility of recent GDP growth: (1) Hurricane Katrina and (2) defense spending.

Remember that GDP is Gross Domestic Product, meaning that if our economy is just replacing capital destroyed by Katrina, gross production will increase. But also during Katrina, federal defense spending—part of the government portion of GDP—rose dramatically. Defense spending includes much of the costs to government from hurricane relief ... Specifically, defense spending rose 10 percent in the 3rd quarter, only to fall 13.1 percent in the 4th quarter. That means the 3rd quarter GDP number was “artificially” high thanks to these added costs of rebuilding and spending, and the percent change in the 4th quarter was “artificially” low as spending and rebuilding subsided.

If, on the other hand, we examine Net Domestic Product (NDP)—which accounts for huge capital stock losses from natural disasters—one can see a much different picture of the recent economy. NDP fell dramatically in the 3rd quarter—an 8.4 percent annualized decline—but rose dramatically in the 4th quarter by 12 percent. Contrast that with GDP, which increased at a rapid pace of 4.1 percent in the 3rd quarter, yet only rose by 1.1 percent in the 4th quarter.

Take a look at the chart below of the quarterly growth rates in GDP and NDP since 2003 and the timing of when the two indicators diverge. The first large divergence comes in the 3rd quarter of 2004 ... when we saw the destruction caused by Hurricanes Ivan and Charley. During the 3rd quarter of 2004, defense spending rose by 13.8 percent, spiked by the hurricane relief expenses, and then only increased by 0.8 percent in the 4th quarter.

The second large divergence between the two indicators appeared in the 3rd quarter of 2005 with Hurricanes Katrina and Rita. Notice too from the chart that this phenomenon does not occur in 2003 as its hurricane season was very light relative to other years. Hurricane Isabel was the only big storm of the 2003 season and only struck land as a Category 2 storm.

Click on figure to enlarge

Here's the same two series for a slightly longer time period, since 1990:

The magnitude of the changes in NDP growth recently look unusually large, but a longer view of the two series shows that changes of this magnitude are not unprecedented:

However, though subsequent data revisions may change this, the difference between the two series is unusually large:

I'm not sure what to make of the inceasing volatility in the difference between the two growth rates.

    Posted by on Saturday, January 28, 2006 at 01:05 AM in Economics | Permalink  TrackBack (0)  Comments (12)


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