FOMC’s Staff Is Wrong or Sloppy
By Pierre Lemieux
The great Don Boudreaux of George Mason University drew my attention to the Minutes of the Fed’s Federal Open Market Committee of June 12-13, in which the “Staff Review of the Economic Situation” contains the following lines (on page 4):
Net exports made a negligible contribution to real GDP growth in the first quarter, with growth of both real exports and real imports slowing from the brisk pace of the fourth quarter of last year. After narrowing in March, the nominal trade deficit narrowed further in April, as exports continued to increase while imports declined slightly, which suggested that net exports might add modestly to real GDP growth in the second quarter.
This is telling us that “net exports” (exports minus imports) bring a positive “contribution” to GDP growth when they increase (as they did in the first quarter of 2018), and a negative contribution when they decrease. This implies that exports “add” to GDP and that imports subtract from it, which is not true.
To confirm what the FOMC is saying, look the Minutes of its March Meeting, which related to the fourth quarter of 2017, when “net exports” had decreased (that is, imports had increased more than exports). The Staff Review of the Economic Situation says (on p. 3):
The change in net exports was a significant drag on real GDP growth in the fourth quarter of 2017, as imports grew rapidly.
Contrary to what the FOMC says, net exports or net imports cannot affect the calculation of GDP for the very simple reason that imports do not enter into GDP at all. By definition, GDP is domestic production (that’s the “D” and the “P” in GDP, or gross domestic product), so it includes only exports. Exports are part of GDP; imports are not.
I explained this accounting point in a 2016 Regulation article as well as in my EconLog post “Misleading Bureaucratese” (October 30, 2017). My new book (What’s Wrong with Protectionism? Rowman & Littlefield, 2018) repeats the explanation.
My argument is congruent with standard GDP accounting, in the United States as in other countries. It is summarized on page 2-9 of the Bureau of Economic Analysis’s Concepts and Methods of the U.S. National Income and Product Accounts (November 2017), from which I quote in another EconLog post. The BEA is the federal bureaucracy responsible for the US national accounts.
Protectionists claim that more imports imply less GDP because they view imports as substituting for domestic production (instead of being purchased by domestic production). This protectionist theory contradicts standard economic theory, but it is not logically invalid. However, claiming that imports reduce GDP as a matter of accounting is logically false.
One of the formulas for calculating GDP says (in a simplified form) that GDP = expenditures by residents + exports – imports. These last two terms may look like “net exports” but this is just a statistical artefact. Imports are subtracted in the formula for the only reason that that are inadvertently captured in the estimate the statisticians obtain for the expenditures by residents, and have to be removed because GDP is domestic production. This does not mean that imports are deducted from GDP, but that they are not part of it.
To better understand, consider the following analogy. Suppose the empty weight of your pickup truck is 3 tons. You put a payload—say, a chunk of rock—of 1 ton on the pickup bed. If you now weigh your pickup, the balance will indicate 4 tons, its loaded weight. Empty weight = loaded weight – payload. You can calculate the pickup’s empty weight by weighing it loaded and deducting the weight of the rock. You deduct the weight of the rock because it was already included in the weight of the loaded truck. It would be nonsensical to say that if you had loaded the truck with a heavier rock, the truck’s empty weight would have decreased. It is nonsensical because the loaded weight would have increased by the same amount, which would have cancelled the increase in the payload’s weight. In other words, it is not true that the weight of the rock is deducted from, or makes a negative contribution to, the empty weight of the truck; the weight of the rock is simply not part of the empty weight of the truck.
The error that imports count as a negative contribution to GDP is commonly made by journalists who know little economics or by politicians with an interest in blaming imports for lower GDP. How the FOMC can commit such an elementary economic error is puzzling. The Fed is probably the largest employer of economists in the US, and any of the latter should have known that the statement quoted above is either false or very sloppy.
When I was working on my Regulation article, I wrote to the BEA. I pointed out that their usual formulation in their public communications was misleading because it suggested that imports reduce GDP as a matter on accounting. In an email of June 19, 2015, the BEA argued that this is not what they mean to say. I quote from their email to me (emphasis mine):
The reason imports are a subtraction in the calculation of GDP (C + I + G + +X – M) is because imported goods and services are included in the value of consumer spending (C), business investment (I), and government consumption expenditures and gross investment (G). Because we only want to measure what is produced domestically, we therefore must subtract imports in the equation to ensure that imports do not enter into our value of domestic product (GDP).
The text in the GDP news release reads “imports, which are a subtraction in the calculation of GDP…”, correctly identifies imports as a subtraction in the calculation of GDP without saying it “contributes” to GDP in any way…
Why do Federal Reserve economists say the contrary, implying that imports (as part of “net exports”) contribute negatively to GDP?