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What does it mean that the economy contracted a 32%?

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Texas Border Business

Teo Sepulveda

By Teo Sepulveda,

The answer to the question in the title is in fact odd. That the economy contracted 32% means that the economy contracted 9.5% in 3 months and 32% in annualized basis. This indicates that if in the next 12 months, the economy contracted 9.5% every three months, then our economy would have produced 32% less final goods and services than a year before. 

Predictably, the fact that the economy contracted 9.5% from April to June, but it was reported as a 32% contraction created tremendous confusion inside and outside of the US. But let us set the context. The size of the USA economy had reached a peak size of $21.2 trillion in December 2019 and it tends to increase at an average rate of 3% per year, so discussing percent changes is simpler for comparisons across time and across countries. 

Also, even when the data we collect represents the change in economic activity in a period of one or three months, we tend to annualize our macroeconomic data because annualized parameters have a looking-forward function. For example, during ordinary times, the economy grows at a typical rate of 0.9% on average every three months, what we call a quarter for short. When we annualized this parameter, it happens to be 3.03% because we use a forward-looking compounding method. The idea behind annualized data is that if the economy continues to grow at the common rate of 0.9% every three months, in 12 months the economy will grow 3.03%. So, annualized data is more of a forward-looking indicator or pattern, than a primarily present indicator. This allows us to look forward and direct our projects accordingly.

Now we move to the most current data. The numbers are clearly grim, and we were expecting them to be grim. The size of the economy was $21.7 trillion in December 2020 and we had a total of 152 million people employed. However, by the end of March, our economy contracted 1.26% and total employment also contracted to 151 million. Then by the end of June, total employment fell to 138 million. This was a decrease of 8.28% in total employment from 151 million to 138 million. So, we were not surprised that our economy contracted 9.5% more from April to the end of June. However, the Bureau of Economic Analysis reported this parameter in an annualized form. They reported an economic contraction of 32.9% because 32.9 % is the compound result of 9.5% decreases during four straight quarters. So no, the economy did not contract 32.9% from April to June, it contracted 9.5%. 

Finally, it is obvious now why this created tremendous confusion in the public. The 9.5% figure tells us things are in no way great. But it was expected. The positive sign that I can leave you with, however, is that after the lowest point of total employment in April, 130 million workers from a peak of 152 million up until February, May, and June provided a rebound in total employment to 133 million and 138 respectively. Therefore, it seems that a recovery is on its way. But evidently, as different regions of our nation face the necessity to go into lockdown, the pace of the recovery can be slowed down, and we need to prepare accordingly.

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Teo Sepulveda is an Economist at South Texas College

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