The 2010Q3 GDP report: Investing in a silver lining

The third quarter GDP growth rate - 1.3% 1.0% at annual rates - is disappointing even though it wasn't entirely unexpected. But there was one important and encouraging piece of news hidden in the lackluster GDP numbers: fixed business investment has finally started to play a role in the recovery.

Here is how the main components of investment have evolved since 2000:

These are the interest-sensitive expenditures that counter-cyclical monetary policy is supposed to affect the most. And although residential construction responded to low interest rates in the latter half of 2009 and reached its pre-recession peak in 2010Q1, business investment bumped along the trough.

This has been a problem. The residential sector had done its part: further expansion carried the risk of driving housing prices and/or construction to unsustainably high levels, followed by a painful retrenchment. In speeches and interviews, the Bank commented frequently on its surprise that business investment had not bounced back, and urged firms to invest more while conditions were ripe.

Firms have finally started to respond. Expenditures on machinery and equipment have grown at an annualised rate of 26% in the first three quarters of 2010; two more quarters at this rate would bring it back to the pre-recession peak. Nonresidential construction has stayed slow, presumably because of the long lead times required for many projects.

So there is some good news in the 2010Q3 national accounts release. Of course, it would have been even better news if the headline GDP number were bigger.

Update: As Angelo Melino points out in the comments, the annualised growth rate was in fact 1.0%.

Comments

[Just visiting from Macleans]

Any indication that the quality of investment in machinery and equipment is any different than the 2008 peak?

[finance]

Stephen:

"Just visiting from Maclean" makes a valid point, we've been here before, and although there was an increase in Canadian productivity in 2009, it was not that much. My reading was that Q3 GDP growth was driven from consumers, far in excess if income growth. We would therefore expect a pull back by the consumer either in Q4 or Q1/2011.

although I will grant you that the underlying data in the Q3 GDP figures were better than the headlines, the recent reality for Canada is that economic data has been disappointing. Growth is off, inflation is rising.

The one really bright aspect has been the rise in tax revenues (they don't lie) and these have exceeded expectations (Ontario and Federal)

[Bob Smith]

"The one really bright aspect has been the rise in tax revenues (they don't lie) and these have exceeded expectations (Ontario and Federal)"

That's not terribly surprising, apparently Finance used very conservative estimates in making their forecasts for 2010 onwards. I wouldn't be surprised to see the government declaring that it's a year or two ahead of its deficit reduction targets in the spring budget

[Declan]

"it wasn't entirely unexpected"

Presumably that was a reference to my prediction of 1.3% in the comments to your last post. Time will tell if the Stephen Gordon model + housing market adjustment model continues to work... :)

[Angelo Melino]

According to Statistics Canada, "Expressed at an annualized rate, real GDP grew 1.0% in the third quarter". How do you get your figure of 1.3% growth?

[Stephen Gordon]

I have no idea. I didn't notice that bit in the press release, so I calculated what I thought was the annualised growth rate. I just re-did the math, and I got 1%, as in the press release. I'll add a correction.

[Erin Weir]

The same basic story, a rebound of investment in machinery and equipment amid lackluster GDP numbers, also applied to the second quarter.

[Stephen Gordon]

Yep, pretty much. It may be better to say that the good news is that M&E surge held up for another quarter.