Some good news in the bad GDP revision

Good description of the surprise in the GDP numbers in FT's Alphaville. I am actually more positive on the number given the revision was from a drawdown in inventories. If the much of the slowdown in inventory driven, there is greater chance for upside gains in future quarters.

Quick tutorial

The real interest in gross domestic product(ion) (GDP) is as a measure of output. But it can be measured three-ways: output; expenditures (consumer spending,business investment, government spending, imports, exports etc); or incomes (wages, profits, taxes). Analytically these three items must amount to the same figure. But in practice it is easier to measure expenditures and incomes than it is to measure output (how do you count widgets produced, let alone add up apples and pears).

So government statisticians focus on measuring expenditures and work back to output (later they cross check both numbers by measuring incomes from tax returns etc, but they are not available until 12-15 months later). The problem is how to account for output that is produced in one period but consumed in another (ie inventories). If output > expenditure in one period, it means inventories are rising. When inventories are rising, measuring expenditure will tend to underestimate output. If output < expenditure, it means inventories are falling. Measuring expenditure will tend to over-estimate output.

In practice, the government does not measure the LEVEL of inventories, but the RATE OF CHANGE. If inventories are rising FASTER, then output is growing faster than expenditure.
If inventories are rising SLOWER (and in the limit falling), output is actually growing more slowly than spending

As a result, the GDP figures can be broken down into two components:

HEADLINE GDP GROWTH = FINAL SALES (=FINAL EXPENDITURES) + RATE OF CHANGE IN INVENTORIES

Inventory changes are usually self-correcting within one or two quarters (ie if inventories begin to rise faster than normal one quarter, that will usually be followed by production cuts and inventory falls the following quarter as businesses try to reduce stocks back to the desired level).

In that sense, the FINAL SALES figure provides a more stable idea of the output trend.

What happened with the Q4 GDP estimates, is that the FINAL SALES figure did not change much (revised down from -5.9% to -6.4%) but the government made a massive change to the INVENTORIES figure (revising inventories from a rise of $6.2 billion to a fall of $19.9 billion).

So the inventory shift produced a huge revision in the HEADLINE GDP figure, revised from -3.8% to -6.2%.