Don’t Take the Surprising Drop in G.D.P. at Face Value

Buoyed by strong job growth, American households continued to spend amply in the first three months of this year, and U.S. businesses invested heavily in new equipment, particularly in information technology. Over-all sales generated by the private sector increased at a healthy annual rate of 3.7 per cent, which augurs well for the rest of the year.

That is an accurate description of the strong first-quarter G.D.P. figures, released by the Commerce Department on Thursday morning: personal consumption increased at an annualized rate of 2.7 per cent, and nonresidential private fixed investment in equipment rose at a rate of 15.3 per cent. But this isn’t the version that was the focus of news headlines and Republican talking points. The report also showed that the inflation-adjusted gross domestic product, the broadest measure of the economy’s output, declined at an annual rate of 1.4 per cent in the period from January to March. That’s the first drop in G.D.P. since 2020—and it created another political problem the White House, which can’t seem to catch a break on the economic front. How could G.D.P. have declined when consumers and businesses both spent significantly more than they did in the previous quarter? To answer this question, you have to consider what G.D.P. consists of—the over-all production of goods and services in the U.S.—and how it is measured. In the most recent quarter, three specific factors depressed the headline growth figure considerably.

First, a good deal of the extra spending was on goods and services produced outside the U.S., which added to the trade deficit rather than G.D.P. Despite all the stories about supply-chain problems overseas and clogged ports at home, a lot of imported products—such as computers, clothes, and semiconductors—still managed to make their way here. Imports of these goods rose by more than twenty per cent at an annualized rate, while the value of goods that America exported fell by nearly ten per cent. If you add services, such as tourism and financial services, total imports rose at a rate of 17.7 per cent, and total exports fell at a rate of 5.9 per cent. These developments alone knocked the G.D.P. growth rate down by 3.2 percentage points, according to the Commerce Department.

Another negative factor was a runoff in inventories, goods that businesses keep on hand for restocking purposes. Although changes in inventories don’t generate any sales at the time that they are made, government statisticians count them in G.D.P. on the ground that they are part of what the economy produces. In the fourth quarter of last year, many businesses built up their inventories to prepare for the holiday season and avoid snafus; this helped boost the headline G.D.P. growth rate to a bumper 6.9 per cent. In the latest quarter, this process worked in reverse, reducing the headline figure. A lot of businesses, particularly those in the auto industry, ran down their inventories. According to the Commerce Department, this factor reduced the growth rate of G.D.P. by close to one percentage point.

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The third factor that reduced G.D.P. growth in the first quarter was a fall in government spending, particularly at the federal level, where the decline was close to six per cent at an annualized rate. Some of this drop can probably be accounted for by the running down of the $1.9-trillion American Rescue Plan, which Congress passed last March. However, the G.D.P. release noted that the fall in government spending “primarily reflected a decrease in defense spending,” which tends to bounce around from quarter to quarter. The decline in government spending reduced the growth rate of G.D.P. by another half a percentage point, the Commerce Department calculated.

If you add these three volatile factors affecting G.D.P. together, they reduced the headline growth figure by roughly 4.5 percentage points, which explains why it came in negative even though underlying spending by households and businesses was strong. It should also be noted that in the first three months of the year employers created nearly 1.7 million jobs, and the unemployment rate fell from 3.9 per cent to 3.6 per cent. In other words, the headline G.D.P. figure was misleading. “Cutting through the noise, the U.S. economy appeared generally robust,” Greg Daco, the chief economist at EY-Parthenon, a consultancy, noted, and the economics team at Goldman Sachs pointed to the G.D.P. report’s “much firmer” internals.

In the coming quarters, the inventory restocking and fall in military spending are likely to reverse themselves—which should be positive for G.D.P. growth. What will happen to the other special factor—the trade balance—is more difficult to say. Given the COVID lockdowns in China and the economic fallout from the war in Ukraine, there is a lot of uncertainty about the prospects for imports and exports, which reflect international trends. If the global economy slows down sharply this year, which seems increasingly likely, that will certainly impact growth in the U.S.

The big economic question is what will happen to spending by households and businesses—the bedrock of the economy—as the Federal Reserve moves to raise interest rates, last year’s stimulus continues to diminish, and high inflation rates continue to eat into purchasing power. Already, there are signs that some types of interest-sensitive spending are being affected: with mortgage rates rising, existing-home sales fell in February and March.

On Friday, the Commerce Department is set to release more information on personal spending and incomes in March. The figures for February showed a shift in spending toward bars and restaurants and hotels, as Americans weary of being cooped up socialized and travelled more. Judging by packed airports and rising hotel-occupancy rates, this trend appears to be continuing. Despite the G.D.P. report and Republican claims, the economy is still recovering from the pandemic. Where it goes from here is an open question.

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