January 24, 2023
After two consecutive quarters of negative growth in the first half of 2022, the economy grew at a strong 3.2 percent annual rate in the third quarter of the year. We should expect to see a comparably strong fourth quarter, with both consumption and non-residential investment showing healthy growth. A smaller trade deficit should also provide a boost to growth. Residential investment is likely to again be a drag on growth, but likely less than in the third quarter.
Productivity and Inflation
The positive growth in the third quarter meant that productivity was again in line with its pre-recession trend, even if the 0.8 percent annual rate was still low. Productivity is poorly measured and subject to large revisions, but there is no doubt that productivity growth was terrible in the first half of last year. This was a big factor contributing to inflationary pressures.
The likely explanations for weak productivity are the large number of people changing jobs and also supply chain problems. The former meant that businesses had many new workers who required some training before they were fully up-to-speed. The latter issue meant that businesses might have often ended up with workers sitting around doing little because they didn’t have a needed part or material input. People missing workdays due to the Omicron wave likely also reduced productivity in the first half of 2022.
Job changes have slowed sharply from the first half of this year, although they are still higher than pre-pandemic levels. For the most part, we have gotten through the pandemic supply chain problems. This means that we should again be seeing decent productivity growth and less pressure on prices.
The index of aggregate hours increased at just a 1.1 percent annual rate in the third quarter. This would imply productivity growth of close to 2.0 percent, although a large reported increase in self-employment will reduce this number. In any case, we will be seeing a respectable positive rate of productivity in the quarter, which will alleviate inflationary pressures going forward.
Consumption Still Strong, Shift to Services Continues
We should see consumption growth between 2 and 3 percent in the quarter. Retail sales growth was weak in November and December, but that followed a big jump in October. Durable goods consumption in particular is slowing considerably. This is in part due to the sharp slowing in home purchases, meaning fewer appliances bought by people moving into a new home. Also, many people who bought big ticket items earlier in the recovery are not about to buy them again. The jump in interest rates is also reducing demand.
However, this is being largely offset by increased spending on services. Service consumption grew at a 3.7 percent annual rate in the third quarter. The growth rate will again be over 3.0 percent in the fourth quarter.
Non-Residential Investment Still Strong
Non-residential investment grew at a solid 6.2 percent annual rate in the third quarter. It is likely to show comparable growth in the fourth quarter. There is likely to be some slowing in equipment spending, but we should see a positive figure for non-residential structures for the first time since the first quarter of 2021.
Real spending on structures had fallen almost 25 percent from its pre-pandemic level, with even sharper drops in areas like office buildings and hotels. Construction in these areas is bottoming out now. Other sectors, notably manufacturing, are seeing strong growth, which should lead to positive growth in the structure component in the fourth quarter and going forward. The layoffs being reported in large tech companies, coupled with weakness in the entertainment industry, is likely to mean slower growth in the intellectual products component, but this will probably not show up in a big way in the fourth quarter.
Residential Construction Levels Off
Residential investment fell at a 27.1 percent annual rate in the third quarter, subtracting 1.42 percentage points from growth in the quarter. While there may still be some decline in the fourth quarter, it will be far smaller and have less impact on GDP.
While housing starts have continued to decline, the number of housing units under construction has actually increased modestly, as supply chain problems created a huge backlog. Also, a big factor in the decline in residential construction was the plunge in mortgage refinancing, since the services involved are included under residential construction. With refinancing having already bottomed out in the third quarter, it will not be a major negative factor in the fourth quarter.
The Trade Deficit Will Have Little Impact on Growth
There was a 14.6 percent jump in exports in the third quarter, coupled with a 7.3 percent drop in imports. This added 2.86 percentage points to growth in the quarter. We are likely to see falls in both exports and imports in the fourth quarter, with little net change in the real trade deficit. A big part of the jump in exports was oil and natural gas exports to Europe, as it built up stockpiles for the winter. This will not be repeated. Goods imports are dropping as consumers shift spending back to services, which means less demand for all goods, including imported ones.
Trade is likely to be a mixed picture going forward. The European economies will be weak, as central banks jack up interest rates. However, the dollar has fallen sharply in recent months, which will make U.S. goods more competitive. Also, the end of China’s zero-Covid policy will mean stronger growth there and increased demand for US exports.
Inventories Will Provide a Boost to Growth
We saw extraordinarily rapid growth in inventories in the fourth quarter of 2021 and first quarter of 2022 as companies sought to rebuild stocks that were depleted due to supply chain problems. The rate of accumulation slowed sharply in the second and third quarters, subtracting 1.91 and 1.19 percentage points from growth, respectively.
With the third quarter pace of accumulation unusually slow, we are likely to see a modest boost to growth from inventories in the fourth quarter. In any case, they will not be the large negative they were in the prior two quarters.
Economy Will Look Very Healthy in the Fourth Quarter
With a strong GDP number and solid productivity growth, the economy will look very good going into 2023. The wave of layoffs by large tech companies and the possibility of further rate hikes by the Fed are major causes for concern. However, for the near-term the economy will get a boost from the large cost-of-living adjustment for Social Security, in addition to the rise in real wages in the second half of 2022. Also, the drop in the dollar should provide some boost to net exports. At the moment, it is hard to see evidence of a looming recession.