More Tricks Than Treats in Third Quarter GDP

The specter of a coming economic slump haunts the return to growth shown in U.S. economic data for the third quarter.

The economy grew six-tenths of a percent in the third quarter, a 2.6 percent annual rate of growth after adjusting for inflation, the Commerce Department said Thursday. This is the first recorded annual rate of growth for gross domestic product this year, after the economy shrank at a 1.6 percent rate in the first quarter and a 0.6 percent rate in the second quarter.

The topline growth was roughly in line with consensus expectations, which is a bit of a relief after having so much economic data that has come in not just above or below expectations but out of the range of forecasts altogether. It’s tempting to say that this is an indication that forecasters are getting better at understanding our economic conditions or that conditions are becoming less unpredictable. But we’re reminded of the old adage about a stopped clock getting the time right twice a day. It’s too early to announce an end to the era of errant forecasts.

The growth in GDP is largely attributable to trade, one of the components of the broad measure of the economy that tends to be volatile from quarter to quarter. In the first quarter, net exports subtracted 3.2 percentage points from GDP. In the most recent quarter, it added 2.8 percentage points. As we pointed out in yesterday’s digest, many of those who downplayed the first quarter contraction relied on the role trade had played and described it as only a “technical” contraction. This formed a key part of the argument against the idea that the economy was in a recession in the first half of the year. We looked but did not find any of the usual suspects describing this as only a “technical” expansion.

Government spending also played a large role in contributing to GDP in the third quarter, in part because of surging defense spending most likely related to support for Ukraine in its war with Russia. The government spending component of GDP is very different from budgetary spending as it is seen by the Congressional Budget Offices. It excludes transfer payments and is comprised only of the government buying things and paying people. Federal government spending rose an annual rate of 3.7 percent, with national defense spending up at a 4.7 percent rate. This meant that federal spending kicked GDP up by 0.23 percentage points, including the 0.17 percentage point contribution from national defense.

President Joe Biden delivers a speech at the Lockheed Martin facility that manufactures the Javelin anti-tank missiles that Biden is giving Ukraine on May 3, 2022, in Troy, Alabama. (Peter Zay/Anadolu Agency via Getty Images)

The domestic private sector economy is slouching toward recession. Economists refer to below trend but positive growth as a “growth recession.” Without a doubt that describes the domestic economy in the third quarter. Personal consumption expenditures rose at a 1.4 percent annual rate, down from two percent in the second quarter. As a result, they contributed just one percent to GDP. Spending on goods declined, with both durable goods and nondurable goods spending falling in real terms. Services spending grew but at a slower pace than earlier, suggesting an incomplete handoff from goods to spending. That’s an indication that services is unlikely to offset the drag from goods over the next few quarters.

Inventories are another component of GDP that swings wildly and sometimes misleadingly. A faster build-up of inventories makes a positive contribution to economic growth, but it can reflect an underlying weakness if businesses are accumulating inventories because they overestimated consumer demand. That appears to be what happened with the big inventory build-up in the fourth quarter of last year. In each subsequent quarter, inventories have been trending down. In the most recent quarter, the decrease in private inventory investment primarily reflected a decrease in retail trade, likely a sign that businesses are becoming cautious ahead of the expected recession.

Perhaps one of the most telling lines in the GDP report is something called final sales to private domestic purchasers. This strips out the effects of trade, government, and inventories to get at domestic economic activity. This grew at a barely visible 0.1 percent rate in the third quarter. That tells us that it will not take much for real domestic economic activity to slip into a contraction. This likely reflects the weight of falling real wages and depressed consumer sentiment on domestic spending.

In short, despite third quarter growth, the GDP report contains more tricks than treats. Beneath its mask of expansion, it suggests that the question before us is not on whether the economy will fall into a recession but when it will.

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