Monthly Economic Review: September 2022

Measurements, measurements on the wall, which is the fairest of them all?
2022 September Monthly Economic Review

As we come to the end of the summer, economic indicators are signaling an unsteady U.S. expansion in the face of several headwinds. These include persistent inflation, tighter financial conditions caused by the Federal Reserve’s interest rate hikes, a volatile stock market, slower-moving consumer spending, business wariness and geopolitical stress around the world. These factors are all contributing to the debate on whether the economy is already in a recession, but key indicators disagree on whether we are there yet.

During the second quarter, gross domestic product shrank by an annual rate of 0.6 percent following a 1.6 percent decline in the first quarter, according to the Bureau of Economic Analysis. Consumption spending was up 1.5 percent but underlying trends for the second quarter still reflected an overall slowing of the economy.

There are many ways to take the temperature of the U.S. economy. The most common and the one generally accepted as the best measure is GDP, which measures spending on output. But an alternative is gross domestic income, which grew 1.4 percent year over year in the second quarter following 1.8 percent growth in the first quarter – a sharp contrast to the drop in GDP. Why the difference? While GDP conceptually measures the value of everything produced, GDI measures the value of everything earned in the production of output, including wages, rent, interest and corporate profits. In theory, growth in GDI should be identical to growth in GDP. That’s because one person’s spending is another’s income. Nonetheless, there is always a discrepancy between the two for a host of reasons, including the construction of each and the fact that the data isn’t always in final form. In fact, GDI is not reported for about a month after GDP so the BEA can gather key data on profits of all corporations.

Since there is a large difference between estimates of GDP and GDI, did the economy expand in the first half of 2022 or did it contract? That is difficult to determine, but we will likely have a better idea at the end of September, when GDP data for the past five years will be revised. The BEA plans to release the results of its annual update of the National Economic Accounts, which include the National Income and Product Accounts and the Industry Economic Accounts, on September 29. The update will cover the first quarter of 2017 through the first quarter of 2022 and will result in revisions to GDP, GDP by industry, gross domestic income and related components.

Two consecutive quarterly declines in real GDP typically mark a recession, but that is not the official definition. The Business Cycle Dating Committee of the National Bureau of Economic Research, the official arbiter of expansions and recessions, takes a broader approach. In addition to GDP, the committee looks at job gains, personal income, industrial production, business and retail sales, and hours worked. Because of data revisions such as those noted above, the committee delays its decisions on whether a recession has occurred, typically waiting until months after the fact in order to have accurate data. (The 0.6 percent decline in second-quarter GDP, for example, compares with an initial report of a 0.9 percent decline, while the 1.5 percent increase in consumption was first reported as 1 percent.) It is noteworthy that the committee specifically looks at both expenditure-side and income-side estimates of economic activity – GDP and GDI rather than just GDP alone. So it would not be surprising if the committee is having a difficult time accurately measuring the economy’s performance given the significant difference in the two numbers and the potential for changes to the data.

Inflation is big and the Fed is maintaining an aggressive stance in fighting it by increasing interest rates, with the possibility of another rate hike of 0.75 percent squarely on the table this month. Inflation is an overhang from the pandemic and the Fed is attempting to slow demand so it can align with still-weak supply. The challenge is that there are constraints, and it will take time to get to the Fed’s desired inflation target. Even a rate increase of 0.5 percent would still be viewed as ongoing tightening and not necessarily a sign that inflation has peaked. If the Fed goes with a lower rate increase, it would reflect concern about the risk of overtightening and precipitating an economic downturn.

All eyes remain on the consumer and what is happening in retail is very important. While topline U.S. Census Bureau data showed that retail sales were flat month to month in July, core sales as calculated by NRF (excluding gasoline stations, automobile dealers and restaurants) were up 0.8 percent from June, showing a sign of resilience as lower gas prices led to higher spending in many areas. A lot of uncertainty remains. While consumers have become more cautious and cooled their spending in the first half of 2022, households continue to spend and are contending with inflation by using credit cards more, saving less and drawing on savings built up during the pandemic. Consumer stamina will be the big question going forward and the Fed will be looking to see if its policies are working to reduce overall demand. What happens next will depend on the behavior of inflation. Nonetheless the Fed has an unconditional commitment to bring down inflation and Chairman Jerome Powell has acknowledged that doing so will not be painless: “Without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all,” he said recently. “The burdens of high inflation fall heaviest on those who are least able to bear them.”

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