The advance estimate of first quarter GDP was released today. The topline number is 600
Personal consumption spending and government spending were the main growth drivers. But gross private domestic investment fell by a whopping 12.47%, decreasing GDP growth by 2.34 percentage points. Many have focused on the change in business inventories as they contributed −2.26 percentage points. I’ll talk about that later at length. But that’s not the real problem. Nonresidential investment fell by 0.71% and residential construction fell by 4.16%. This does not bode well for future growth. Nonresidential investment spending today builds the offices, factories, warehouses, other structures, and equipment that creates new goods and services in the future. Residential construction builds new housing, which is kind of important.
First, a warning. This is the advance estimate. As more data is gathered and analyzed, there will be two revisions to this estimate, with roughly one month between the releases. These revisions are occasionally significant. More often the future estimates will be roughly the same order of magnitude as the advance number.
Let’s dig into the numbers. In the following tables, I’ve added two columns. The first is the quarter over quarter growth rate. The second annualizes this quarterly growth. In my discussion I’ll use only the annual rate. Everything else is straight from the Bureau of Economic Analysis and the Bureau of Labor Statistics.
Personal consumption expenditures (3.70%) and Federal government spending (7.82%) had the largest growth. Within consumption, spending on durables increased by an eye-popping 16.89%. My guess is that households bought big-ticket items – houses, major appliances, cars – anticipating more interest rate increases. If my speculation is correct, it’s important. Households may finally have figured out how interest rates affect the total cost of buying a big-ticket item.
The growth in Federal government spending is led by non-defense spending (10.29%). This probably reflects the massive hiring. For example, the IRS has been given the budget to hire 80,000 new agents. Social welfare programs are also booming, led by the “Inflation Reduction [sic] Act.”
Federal Government Employment
So I headed over to the Bureau of Labor Statistics website. Their employment data includes several government categories. Again, using annualized growth rates, in the first quarter Federal government employment rose by 4.10%. The US Postal Service (USPS) is included in Federal employment. Luckily BLS breaks out USPS employment and all non-USPS jobs. USPS employment rose by 5.34%. Non-USPS rose by 3.76%. This is pretty conclusive. Much of the first quarter growth is rooted in Federal government hiring. Here’s the data (converted from monthly to quarterly).
Earlier I noted the sharp decrease in business inventories. This could be good news or bad news. Some have speculated that this implies businesses underestimated demand, produced too few goods, and had to make up the difference by selling inventory. Economists call that an unplanned inventory decrease and it’s usually good news. Businesses are likely to increase production in the future to rebuild their depleted inventory stocks.
But suppose this was a planned inventory decrease, If businesses expect a recession, they are likely to cut production and sell off inventories. The decrease in output causes income and spending to fall. Voila! They forecast a recession and, sure enough, they got one! This is one of the oldest models of a self-fulfilling prophecy.
So which was it? I don’t know. But my educated guess is a little of both. Demand was higher than expected. But businesses are also expecting a recession. They may not be as eager to rebuild inventories as we might expect. I put the probability of a recession at 75%, probably starting in the second quarter. This weekend’s FDIC takeover of First Republic Bank does not bode well for the next few quarters.
Contributions to GDP Growth
Growth rates are fine, but they don’t show the complete picture. Even though Federal government spending and Federal employment grew a lot, the denominator matters. In fact, personal consumption is 70.89% of GDP. Gross private domestic investment and government spending are 17.66% and 17.21% respectively. But Federal spending is 6.91%, about 10% of consumption. We expect consumption spending to have a much bigger contribution to GDP growth than federal government spending. Here’s the data:
Sure enough, personal consumption contributed 2.48 percentage points to the 1.10% overall GDP growth. Government spending overall contributed 0.81 percentage points, with the Federal government contributing 0.49 percentage points. This diminishes the importance of Federal government hiring. Nevertheless, Federal hiring was still a contributing factor.
But wait – 2.48 + 0.81 = 3.29. In other words, consumption and government spending imply GDP growth of 3.29%. The difference, of course, is gross private domestic investment, dragging GDP growth down by 2.34 percentage points. (Remaining differences are caused by the foreign trade account.)
Here’s the really bad news. The GDP deflator rose at an annualized rate of 4.05%. The price deflator for personal consumption expenditure (PCE) rose even faster, 4.16%. The PCE is the Fed’s favorite inflation gauge. Even worse, the service part of PCE rose at 5.95%. The services sector tends to be very labor intensive. This piece of inflation may indicate rapidly rising wages.
If only the PCE growth was the full extent of the problem. The deflator for gross private domestic investment was up 4.44%. Delving into the details, the deflator for nonresidential investment rose by 6.96%, with residential investment falling by 1.90%. The costs of business construction, equipment, and intellectual property rose. The cost of building housing fell.
The only other main driver of inflation was – you guessed it – the Federal government. The price deflator rose by 3.24%. One way to hire more employees is to pay them more.
What Does It All Mean?
This data puts the Fed in a real bind. Continuing to raise interest rates will further dampen economic growth, increasing the chances of a recession. But 4% inflation is still double the Fed’s target. I expect the Fed to make yet another mistake and not raise interest rates at the FOMC meeting starting Tuesday, May 2. This will allow inflation to proceed, even if it won’t increase. And current interest rates are high enough to continue the current slowdown. I hope the Fed has the cojones to raise rates and continue the fight against inflation.
Bureau of Labor Statistics, Series ID’s CES9091912001, CES9091912001, CES9091912001, and CES9091912001. (Accessed April 27, 2023)
U.S. Bureau of Economic Analysis, “Table 1.1.6. Real Gross Domestic Product, Chained Dollars,” Advance Estimate, (accessed April 27, 2023).
U.S. Bureau of Economic Analysis, “Table 1.1.2. Contributions to Percent Change in Real Gross Domestic Product,” Advance Estimate, (accessed April 27, 2023).
U.S. Bureau of Economic Analysis, “Table 1.1.4. Real Gross Domestic Product,” Advance Estimate. (accessed April 27, 2023).