Thinking about the disappointing Q3 GDP report

By James Pethokoukis

At the start of 2021, Wall Street was expecting an exceptionally boomy year, including the third quarter, the results of which were released today. Even as recently as this summer, expectations were running high with a consensus real GDP forecast of around 7 percent, annualized. Instead, the economy grew at just 2.0 percent last quarter, disappointing even the much-reduced consensus forecast of 2.8 percent growth. There doesn’t seem to be much debate about what happened. This explanation from JPMorgan economist Michael Feroli is typical (bold by me):

This was a little below expectations and a significant step down from the 6.5% pace registered in the first half. Some slowing from the stimulus-boosted growth of earlier in the year seemed inevitable, but that slowing was exacerbated by supply chain issues as well as a modest headwind from the Delta variant. The supply chain woes were evident in the motor vehicle sector—which subtracted 1.4%-points from the headline GDP number—and more generally in the 5.7% growth in GDP prices, which meant every dollar spent translated into less real output. The lingering pandemic headwind was apparent in real service spending, which, although it expanded at a 7.9% pace, still hasn’t even reached the pre-pandemic level from 4Q19.

If you’re looking for a silver lining to this report, it might be more educational than economic. So much of the public policy debate, both during the pandemic and before, has been about the lack of demand in the economy. But what about the economy’s supply side? Right now we are seeing what happens when demand outstrips an economy’s productive capacity: high inflation, shortages, and slower business activity. All the more reason to think hard about the economy’s potential productive capacity over the long run, even after these supply-chain disruptions work themselves out. This from economist Jason Furman at the Peterson Institute for International Economics should be seen as warning to policymakers as they consider various tax, regulatory, and investment ideas:

In addition, the pandemic itself may have lowered potential output. Business investment fell during the pandemic and remains low. To the extent that this investment is permanently lost, the economy will have less productive capital, permanently reducing output. The cumulative reduction in business fixed investment over the course of the pandemic totals about 3 percent of the capital stock which would be expected to reduce the level of output per hour by about 1 percent. In addition, dramatically reduced immigration and some labor force scarring have further lowered potential output. Some factors could go the other way, including the possibility of increased productivity and the possibility that output was below potential just prior to the pandemic. 

Again, I hope all these advances we’re seeing lately in biology, energy, and space translate into higher productivity growth. But Washington should assume the worst and pursue better policy that deeply considers innovation impacts has a big role to play going forward. In the area of taxation, for instance, I urge you to check out my recent podcast chat with AEI scholar Kyle Pomerleau.

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