Meltdown 101: Measuring the gross domestic product

[October 31, 2008]  NEW YORK (AP) -- Gross domestic product, the broadest measure of the economy, is essentially the nation's economic report card. When it shrinks, as it did Thursday, worries about a recession spike.

GDP is the market value of everything produced by labor, plants and properties in the U.S. -- a total of $14.4 trillion for the third quarter, according to the Bureau of Economic Analysis, a division of the Commerce Department.

That means a $5 meal from a Houston taco stand, a $500 spa visit in New York and a $50 million shipment of U.S.-built cranes from the Port of Los Angeles are all supposed to be baked in.

GDP's growth or decline has become shorthand for whether the economy is healthy or faltering. It's crucial to setting monetary policy, such as short-term interest rates, and determining whether we've fallen into a recession.

Thursday's GDP was weak, shrinking at a 0.3 percent annual rate in the July-September quarter -- the worst reading since the third quarter of 2001.

Here are some questions and answers about how the GDP comes together.

Q: What's included in GDP?

A: All domestic consumer and government purchases, private domestic investments and the net of everything we export minus everything we import. (Since we import more than we export, our "net export of goods and services" is a negative number, subtracted from the total. In the third quarter, that figure was negative $706.7 billion.)

Your taxes and tuition payments, your grocery, utility and medical bills, your bus fare, movie tickets, mortgage or rent, your car payments and gasoline should all be included. Pay your housekeeper off the books? That should be there, too, in an estimate under "services."

Also included is every penny the government spends domestically -- whether a Florida town council buys new notepads or the Air Force orders new U.S.-made fighter jets.

The calculations also attempt to quantify economic disruptions. In the third quarter, that meant estimating the decline in manufacturers' shipments of aircraft during the Boeing Co. strike and the income restaurants, hotels and other businesses missed because of Hurricane Ike.

Once the Bureau gathers the disparate elements of GDP, it calculates the percentage growth (or decline) in the economy. Then it subtracts the current rate of inflation, stripping out the appearance of growth higher prices could create.

Q: What are the largest components of GDP?

A: The largest component is personal spending, which accounts for roughly two-thirds of GDP. Third-quarter GDP tumbled because consumer spending showed the largest drop in 28 years.

The next largest component is government spending, which accounts for about 20 percent of GDP, followed by private domestic investment, such as office construction.

Q: How important is GDP in determining whether we're in a recession?

A: GDP is the most important of many factors weighed by the National Bureau of Economic Research, a nonpartisan group of economists that's the nation's official arbiter of recessions.

The group's Business Cycle Dating Committee views GDP as "the single best measure of aggregate economic activity," according to its most recent statement on its recession dating procedure, released in October 2003.

A common definition of a recession is two consecutive quarters of declining GDP, but the committee weighs other factors, too, including changes in real income, employment, industrial production and both wholesale and retail sales. The last official recession was from March 2001 to November 2001, a period when GDP did not decline for two consecutive quarters.

Q: After a quarter's GDP is released, can it change?

A: Yes. Thursday's number was, in essence, the first draft of the third quarter's GDP. The Bureau of Economic Analysis puts together these "advance" estimates less than a month after the quarter closes -- less time than a 10-branch bank has to file its quarterly statements.

The Bureau totals data from July through September, but much of the September data in Thursday's advance reading was estimated. Many categories also included preliminary August data that may later be revised. Estimated categories include residential and nonresidential construction, changes in retailers' inventories, net exports and net imports and state and local government's new construction.

The next third-quarter reading will come in late November with the release of "preliminary" GDP, which is calculated when more detailed and comprehensive data is available. On average, the change from the advance reading to the preliminary reading is plus or minus half a percentage point.

"Final" estimates are released three months after a quarter has ended. The average change from the first advance reading to the final estimate is 0.6 percentage points.

The bureau does annual revisions each summer, using newly available data, which cover the quarters of the three most recent calendar years. Finally, the bureau does "benchmark" revisions at five-year intervals.

The annual and benchmark revisions are where the largest changes can take place. The average change from the advance estimates is plus or minus 1.2 percentage points -- enough to turn what appeared to be a quarter of minor growth into a quarter of significant contraction, or a quarter of minor contraction into a quarter of serious decline.

Q: Where does all this data that's used for the GDP come from?

A: Some of it is government data, such as inflation estimates. Some is publicly reported data, such as corporate profits. Some of it is estimated by the bureau until it gets better numbers. For instance, the bureau estimates personal income data, and for a good reason: Thanks to privacy concerns and interagency tussles, it is illegal for the Internal Revenue Service to share personal income data with the Bureau of Economic Analysis until that data is three years old.

[Associated Press; By ELLEN SIMON]

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