Thursday, April 5, 2012

Lies, damn lies and statistics

This week’s release of US Federal Open Market Committee (FOMC) minutes have seen markets scale back expectations of a third round of quantitative easing (QE3). The minutes were more upbeat than they have been recently with the staff at the Federal Reserve bumping up their forecasts for both GDP and inflation. The more interesting point is they have reduced their estimate of the output gap, which means reduced scope for further easing.

There are a couple of quirks in some of the recent data that are quite fascinating. The first is one we have mentioned before: the fact that jobs growth in the payroll data has been lower than that in the household labour force survey (HLFS). It’s the latter that feeds into the calculation of the unemployment rate.

Previously we’ve put this down to the fact that the payrolls data from firms has not kept up with the significant change occurring in the US economy – the Schumpeter-esqe “creative destruction” - that has been expedited by the deep GFC recession. The payrolls data has not kept up with firms that have disappeared and, more importantly, the new ones that have started up. It’s interesting that the trend recently has been for monthly payroll out-turns to be revised progressively upwards.

Another statistical quirk has been the fact that Gross Domestic Product (GDP) has been growing at a slower rate that Gross Domestic Income (GDI). Both are perfectly valid measures of economic output with GDP adding up all the expenditure in the economy including consumption and investment, with GDI adding up the income including wages and salaries and profits of firms. While both measures vary from quarter to quarter, they should both be the same over longer time periods. Over the last six-month of 2011 the gap has started to open up again with GDI running higher.

Putting both quirks together, you get a picture of an unemployment rate that has fallen faster than the growth in official GDP would suggest. We tend towards the view that the HLFS jobs data and the unemployment rate are a good reflection of the labour market and that GDI is therefore likely to currently be a better estimate of growth than GDP.

How do you best reconcile the gap if you are the Federal Reserve? The answer is in the minutes: in its latest staff forecasts the Federal Reserve has “reduced its estimate of the level of potential output, yielding a measure of the current output gap that was a little narrower and better aligned with the staff’s estimate of labor market slack”. With regard to inflation, Fed staff have increased their forecasts on the back of higher oil and other commodity prices, but also to reflect “the somewhat narrower margin of economic slack in the March forecast”.

We continue to believe there is no imminent risk of the FOMC changing its forward guidance with regard to the current accommodative stance of monetary policy, but we agree with the interpretation of the minutes that further accommodation is less likely.