Despite back-to-back quarterly gains, GDP fell by 3.5% for the year, the most since 1946.
By Manuel Gutierrez, Consulting Economist to NKBA
As expected, the nation’s output experienced further recovery in the fourth quarter of 2020. Total Gross Domestic Product grew by 4% in the quarter, reaching $18.8 trillion adjusted for inflation. In current dollars, GDP reached $21.5 trillion in the fourth quarter of 2020, up 5.8% from the previous quarter.
There is a 1.8 percentage point difference between the real 4% growth adjusted for inflation and the nominal 5.8%. That is, the overall price increase for all goods and services produced in the U.S. last year was 1.8%.
Note that this 1.8% inflation rate, generally known as the “GDP deflator,” is not the same as the Consumer Price Index (CPI), the common gauge of inflation. As the name implies, the CPI includes only products purchased by consumers, while the GDP deflator also includes goods and services purchased by businesses, government, etc.
Figure 1 illustrates that despite last quarter’s GDP gain and the sizable 33% jump in the third quarter, total output of $18.8 trillion is still $474 billion short of the $19.3 trillion level it attained in the fourth quarter of 2019.
On an annual basis, GDP actually fell by 3.5% last year compared to 2019 (Figure 2). This is a bigger drop than the 2.5% contraction in 2009, the only other year since 2000 when GDP fell. This is the largest drop in nearly eight decades — in 1946, GDP was off by 11.6%, following the end of WWII, when the U.S. government radically reduced military spending by nearly two-thirds from levels maintained during the war years. Although consumer and business spending each rose rapidly that year, by 12% and 45%, respectively, it was not sufficient enough to compensate for the massive drop in government spending. The long-term average GDP growth of 3.3% is highlighted in Figure 2 by the horizontal gray line. Note that GDP growth this century has exceeded the long-term average only once, in 2005.
The two principal components of GDP, Consumptionand Business Investment, also contracted last year. Both fell by a similar magnitude, with consumption off by 3.9% and business investment by 4%. (Figure 3.)
As indicated on the chart, consumption spending has fallen only three times this century, in 2008, 2009 and last year. However, last year’s 3.9% drop is significantly worse than what occurred in the previous two instances.
The shortfall in consumer spending last year was caused by a steep 7.3% decline in the use of services — directly related to the pandemic. Service businesses such as restaurants and movie theaters suffered significantly. On the other hand, consumer purchases of goods actually rose by 3.9% for the year.
The other component, business investment, fell by 4% last year. Although this is a significant decline, it is not nearly as large as the 14.5% drop experienced in the last recession, which took place in 2009.
