January 26, 2023
GDP growth was in line with expectations, with the economy expanding at a 2.9 percent annual rate, down slightly from the 3.2 percent rate in the third quarter. Inventory accumulation was the largest single factor, adding 1.46 percentage points to the quarter’s growth. Service consumption added 1.16 percentage points, while a smaller trade deficit added 0.56 percentage points. Housing was a major drag, with residential investment subtracting 1.29 percentage points from growth.
The quarter is likely to again show a healthy rate of productivity growth. Payroll hours increased at a 1.1 percent rate in the quarter. A sharp rise in people reporting they are self-employed is likely to raise hours growth to around 1.5 percent, leaving productivity growth in the range of 1.4 percent. This compares to reported declines in productivity in the first half of 2022. The turnaround in productivity will help alleviate inflationary pressure going forward.
Consumption Growth Moderates in Fourth Quarter
Overall consumption grew at just a 2.1 percent annual rate in the fourth quarter, down from a 2.3 percent rate in the third quarter. Goods consumption continued to be outpaced by services, rising at a 1.1 percent annual rate, compared to the 2.6 percent rate for services. This reverses the shift to goods consumption seen during the first years of the pandemic.
The rise in goods consumption follows three quarters in which it declined. The biggest factor in the turnaround was vehicles, with sales rising at a 7.4 percent annual rate. This is mostly a story of supply chain issues being resolved. Sales growth is likely to be moderate in future quarters.
On the service side there were no obvious standouts. The category of housing and utilities grew moderately, after a sharp decline in utilities led to a fall in the third quarter. Health care consumption added 0.39 percentage points to the quarter’s growth. Nominal spending on health care services actually fell slightly as a share of consumption, continuing a pattern seen since the start of the pandemic.
Decline in Housing Reverses Most of the Pandemic Increase
Residential construction fell at a 26.7 percent annual rate, only slightly smaller than the 27.1 percent drop in the third quarter. This was the seventh consecutive quarter of decline. This drop has largely reversed a surge in the sector early in the pandemic that raised its share of GDP from 3.8 percent in 2019 to a recent peak of 4.8 percent.
As the figure below shows, the share for the fourth quarter was down to 4.0 percent. On the positive side, there is not much further room to fall. Housing starts are still at or above pre-pandemic levels. Due to supply chain issues slowing construction, the number of housing units still under construction is near pandemic peaks. The services associated with mortgage refinancing are included in this component. With the pandemic boom having collapsed to near zero, there is no further room for decline. This means that housing will be a far smaller drag on growth in 2023.
Mixed Story with Investment
Non-residential investment edged higher at a 0.7 percent annual rate in the quarter, as modest growth in investment in intellectual products offset a 3.7 percent rate of decline in equipment investment. Structure investment also grew at a 0.4 percent rate, the first rise since the first quarter of 2021.
We are likely to see investment grow at a modest pace in the quarters ahead. The decline in equipment investment was entirely attributable to a 23.4 percent rate of decline in information processing equipment. That is not likely to be repeated, but spending throughout the sector is likely to be weak on recession fears. There could also be some falloff from the 5.3 percent growth rate for investment in intellectual products.
On the plus side, investment in structures has likely bottomed out, after sharp declines in spending on office construction and hotels. With spending on factory construction increasing rapidly, this component should be a strong positive in 2023.
Trade Again Adds to Growth
Exports declined at a 1.3 percent annual rate, but that was less than the 4.6 percent drop in imports. As a result, trade added 0.56 percentage points to growth in the quarter. Trade is usually one of the areas hit hardest by interest rate hikes, as higher rates raise the value of the dollar and make U.S. goods less competitive.
That has not been the case thus far. First, the dollar rose sharply in 2021 and early in 2022. It actually has been falling in recent months as other central banks also aggressively hike rates. The other reason we are seeing an improvement in the trade balance is the shift from goods consumption, many of which are imported, to service consumption. This shift is likely to continue, which together with the fall in the dollar, could mean that trade continues to be a modest net contributor to growth going forward.
Government Spending Grows at a 3.7 Percent Rate, Adding 0.64 Percentage Points to Growth
The growth in government spending in the fourth quarter was almost the same as in the third quarter. This follows decline in the prior five quarters. Spending is now normalizing after the sharp pandemic related jump in 2020. We are likely to see somewhat slower growth in 2023, but the sector should still be a modest positive for growth.
Picture on Inflation Continues to Improve
The core PCE rose at a 3.9 percent rate in Q4, down from 4.7 percent in Q3. This is still well above the Fed’s 2.0 percent target, but we know that rental inflation will be slowing sharply in coming months.
This report also provides some indication that wage growth is moderating. Labor compensation grew at a 4.9 percent annual rate in the fourth quarter. If we assume that hours grew at a 1.5 percent rate, that translates into a 3.4 percent pace of growth in the average hourly wage. This would be very much consistent with the Fed’s 2.0 percent target. This is especially true with productivity growth in the range of 1.5 percent.
The Economy Looks Strong Going Into 2023
On the whole this should be seen as a very positive report. There is more evidence that inflation is moderating. The largest source of weakness, residential investment is virtually certain to be far less of a drag in future quarters. Investment growth may weaken, but should still be positive. Consumption growth is likely to remain moderate, in part due to the 8.7 percent cost-of-living adjustment to monthly Social Security benefits in 2023.