Economists Plot A New Take on GDP

There may be a better way of calculating one of the most-watched economic indicators.

Two unidentified women walk past a huge video $100 bill during a tour of the 'Money in Motion' exhibit at the Philadelphia Federal Reserve Bank July 2, 2003, in Philadelphia.
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Here's a startling thought: What if all of those quarterly GDP numbers have been wrong all this time?

Some economists think that's exactly the case, and they're doing something to fix it. On Monday, the Philadelphia Federal Reserve Bank announced it was launching an initiative called GDPplus, in which it produces its own alternative measures of GDP.

The new GDP measure comes from a May 2013 paper by five economists who say their method produces a measure that is "new and superior" to the figure produced each quarter by the Commerce Department.

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Explaining exactly what these economists say is wrong means understanding how GDP is usually calculated. GDP, as everyone remembers from Economics 101, is calculated via a very simple equation:

Y = C + I + G + (X - M)

...which, as a reminder for those of us who slept through Economics 101, means that GDP equals consumer spending, investment, government spending, and exports, minus imports. (To be fair, this measure of GDP is "wrong" anyway in the sense that it is an estimate of total spending in all of those areas, with the same sort of margin of error associated with any economic estimate.)

Meanwhile, the Commerce Department also calculates alongside GDP a measure called Gross Domestic Income, or GDI. Though less closely scrutinized than GDP, GDI should in theory equal GDP, says one Philadelphia Fed economist, as all of the expenditures on goods and services are also incomes for factories and stores.

"If you were to measure the payments to the factors of production, that would include wages and salaries, rents, and interest, and then there's something left over for corporate profits and something that's closely related that we call proprietors' income," says Tom Stark, assistant director and manager of the Philadelphia Fed's Real-Time Data Research Center. "If you were to add all those up, it should be the case that they equal exactly what people spend on products" – or, in other words, all of the elements in the GDP equation.

Simplified, one man's (or firm's) spending is another's income.

However, the two figures almost never match up because the government gets its income and expenditure data from different sources. Last quarter, the two managed to be close, with GDI growth at 2.6 percent and GDP growth at 2.5 percent. But at the end of last year, for example, GDI (or in the below chart, GDI_P) grew by 4.9 percent, which would be considered a remarkably strong economic growth rate in the current environment. Meanwhile, GDP (or GDP_E) that same period grew by just 0.1 percent, a crawl.

(Federal Reserve Bank of Philadelphia)

GDPplus aims to blend GDP and GDI together. As the above chart shows, it's a much less volatile measure. And at any given time, it may also estimate that the economy is growing far faster or far slower than the headline GDP figure indicates.

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One of the economists who created the measure says the new measure simply makes the broadest use of existing data.

"It's not that one is true and the other is false," says Frank Schorfheide, a professor of economics at the University of Pennsylvania. "It's more that they're potentially both contaminated by some measurement error." Putting the two together mitigates some of that error.

Schorfheide and his colleagues recommend that their measure be used as the national benchmark. That may be slow to happen, but when the government gives us a first look at the third-quarter GDP figures this Thursday, it may at the very least be wise to look more closely at the numbers.

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