An alternate measure of the health of the U.S. economy suggests the current pace of job growth can be sustained at least through the rest of the year.
A dramatic fall in the unemployment rate from 9.1 percent last August to 8.5 percent by year end despite sluggish overall growth had puzzled analysts. But data last Friday on this alternate growth gauge showed more strength in the economy late last year than was captured in gross domestic product, the conventional measure of growth.
GDP expanded at a 1.8 percent annual rate in the third quarter and by 3.0 percent in the fourth quarter. In contrast the alternate measure, gross domestic income, which measures the income side of the growth ledger, expanded at a much faster pace of 2.6 percent and 4.4 percent over the same periods. While they are both measures of economic activity, they are calculated from different data sources.
The surprise has been that non-farm employment has accelerated since November, and in the first two months of this year it has averaged 255,500, even though GDP growth is tracking around a 2 percent rate this quarter.
Slow GDP growth and faster job creation has perplexed analysts. Federal Reserve Chairman Ben Bernanke last week raised the issue and cited slow growth as reason to doubt that solid job gains would be sustained. Policymakers say that a widely accepted rule of thumb known as Okun's law requires GDP growth at a faster pace than that registered in the third and fourth quarters in order to lower the unemployment rate. They have struggled to explain the discrepancy.
Economists say the GDI number may hold the answer.
"Bernanke's position, which seems to be focused on the conventionally reported GDP growth estimate, is that employment gains have been stronger than they should have been and therefore they are likely to slow," said John Ryding, chief economist at RDQ Economics in New York.
"The alternative is that growth has been stronger than the GDP numbers suggest and employment gains are more likely to be sustained, which is our view. We have re-established the 200,000 trend (in monthly payrolls) that was emerging last year."
A range of other measures such as the Institute for Supply Management's manufacturing gauge and the Fed's industrial production data point to the economy performing much better this quarter than implied by GDP forecasts.
Sung Won Sohn an economics professor at California State University Channel Islands said the GDP is underestimating the strength of economic growth right now. "When I look at the economy, things are not as bad as what GDP would indicate."
Sohn, who is also vice chairman of clothing retailer Forever 21, said the strong GDI numbers were in sync with their sales.
"We are doing very well. If you look at GDI, it is consistent with the recent increase in employment," he said. "We continue to see fairly healthy growth in jobs and expect 200,000 gains in jobs every month for the balance of this year."
Some officials at the U.S. central bank, including Bernanke believe that one reason for recent solid job gains may be a bounce back from sharp cuts in employment by companies during the 2007-09 recession.
As such, they expect the gains to fizzle once companies have realigned their headcount. In the minutes of the Fed's March meeting released on Tuesday, officials believed that risks of a setback to the job market later this year were "non-negligible".
But economists, including those at Goldman Sachs and at least one at the Fed, believe that GDI is more useful for trying to gauge the economy's underlying momentum. And it would point to sustained job growth.
In a paper published in the spring of 2010 and now being updated to capture the recent developments, Fed economist Jeremy Nalewaik highlights the importance of GDI as a growth measure.
He studied business cycles going back 15 years, comparing initial estimates of GDP growth with GDI and concluded that there is considerable evidence to suggest that GDI better captures the business cycle fluctuations.
In other words, GDI and GDP can diverge from one quarter to other, but over the long run GDP tends to converge toward GDI.
GDI is published with the third revision of GDP, which falls two months after the initial estimate. It is calculated using corporate profits, compensation and proprietors income data, and updated based on tax returns
GDP on the other hand is calculated using the monthly reports on retail sales, business inventories, trade, residential construction and spending on capital goods and equipment.
Brent Moulton, Associate Director for National Economics Accounts at the Bureau of Economic Analysis (BEA), said when his agency revises growth data each year, there is a slight tendency for GDP to be adjusted towards GDI though it is not a golden rule.
"You can't say the GDI number is where the GDP number will be revised to because that does not hold."
Moulton said GDP was the BEA's featured measure because it was more timely and used survey data specifically designed for measuring national output.
"But we also think there is useful information in GDI. They both measure the same concept so we encourage people to look at both measures," he said.
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