NGDP really does drive RGDP: YoYs vs QoQs

A James Alexander post

If you are sensible about macroeconomics then you must be highly skeptical of macroeconomic data. You must focus on trends in data and not on any point data. Looking at quarterly figures you would ideally want to use Year on Year growth rates. You don’t want to be confused by “noise” from estimated seasonal adjustments, early data releases based on incomplete inputs, or just simple errors.

Obsessed with looking for the very latest trends the US habit of annualizing Quarter on Quarter growth rates seems particularly mad, and maddening. By all means report actual QoQ growth rates but don’t annualize them. The actual growth rate is QoQ non-annualized, even if a very small number.

In a perfect world of perfect data annualizing QoQ might make a bit more sense, especially if you were a central bank trying to maintain the stability of nominal growth. Rapid swings in QoQ growth rates might be a bit of a warning that your policy might be wrong. It would also matter more on the downside than the upside as too fast nominal growth causes little damage and is relatively easily corrected.

The Fed worries about having to suddenly “slam on the brakes” to prevent overheating and thus causing too rapid a slowdown, but this just smacks of bad driving habits. In any case, economies don’t crash from growing too fast but from having the brakes “slammed on”. Brakes can be gently applied and calm economies down, any confident driver will tell you that.

On the downside, however, real economic damage can be caused by either braking when you should have your foot on the accelerator, or failing to spot the car has run out of fuel. Either of these things happening while you are managing nominal growth can cause recessions involving high unemployment and real lost output. So, if your speed gauge suddenly drops it may be just a temporary problem with the speedometer, the road surface or traffic, but it may also indicate a more fundamental problem. Average speed or YoY growth is the long run goal but near term deviations to the downside should be watched closely.


In the third quarter of 2003 NGDP hit a high of 9.3% YoY growth. Annualized QoQ ran at 5.3%. From that YoY high point NGDP growth gradually trended down and down, hitting 4.4% in fourth quarter of 2007, with QoQ annualized hitting 3.2%.

The Great Crash in NGDP QoQ in First Quarter 2008

In the first quarter of 2008 NGDP continued to trend down on a YoY basis to a worrying low 3.1%, but on a QoQ annualized basis it had crashed to a negative 0.5%. Of course, the YoY rate should have been ringing alarm bells from a few quarters, especially the drop below trend in 1Q08, but it was also “caused” by the negative QoQ reading  – a shrinking nominal economy, or deflation.

Since the end of the recession in 2009 we know NGDP has been too low, growing at between 2.5%-4.5% YoY. But we have also seen some really wild swings in QoQ annualized growth rates. These have ranged from a low of 0.2% in first quarter 2011 to a high of 6.7% in second quarter 2014. Despite the usual seasonal adjustments there appears to be a high degree of seasonality still in the data. Many have commented  on the RGDP apparent seasonality, with the first quarter often being the weakest and the second quarter the strongest. But there appears far worse seasonality in the NGDP data. The “first quarter weakness/second quarter strength” phenomenon is very, very visible in the QoQ annualized figures.

More intriguingly, the second quarter strength in 2015 needs to be beaten by some heavy margin in order for the base effect not to drag down YoY growth even more heavily than the already slowing trend. In fact, QoQ NGDP growth in the current second quarter needs be a record-busting 7.8% if  both the current Atlanta Fed GDPNow projection of 1.8% QoQ annualized RGDP is right and the GDP deflator maintains its current level of 1.3%. It may happen, of course, but seems highly unlikely given three monetary policy indicators.

  1. Although in some sense the doves on the FOMC are in the ascendancy, it is only delaying “normalization”. The Fedborg’s drive to raise rates seems inexorable.
  2. Monetary policy has been tightening passively since the end of QE3 and actively in December 2015.
  3. The US monetary base has been shrinking since the start of the year at roughly -3% YoY.

If NGDP drives RGDP then a print of 4% QoQ, for example, in the second quarter NGDP and a stable deflator of 1.3% would imply a negative -2% QoQ annualized print for RGDP.  The YoY trends for RGDP and NGDP would still be downwards but positive at 1.4% and 2.7% respectively.

The market will not like the big negative print in RGDP. Of course, on the way to it being reported there would have to be many surveys and data points suggesting that result and the two major public “nowcasts” from Atlanta Fed and New York Fed would be flashing red alerts. The actual market response would then be dependent on the expected response of the FOMC. I would expect it to be slow to react and certainly not do enough, but predicting the reaction is not at all easy.

I have no idea if NGDP QoQ annualized will drop to 4% in the second quarter, but it doesn’t seem implausible given first quarter trends and the stance of monetary policy. It could be an interesting couple of months.

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