GDP is shrinking. Does a declining economy mean a recession is coming? – Grid News

ADVERTISEMENT

GDP is shrinking. Does a declining economy mean a recession is coming?

So often narrow economic statistics come out that tell us things like: How are job numbers? How is inflation? But gross domestic product growth might be one of those few numbers that gets at telling us how the economy is doing overall.

If you look at the number today — a 1.4 percent decline at an annualized rate — it looks like the economy is tipping into recession. But this figure, which is slightly worse than what many economists expected but not entirely unanticipated, may not provide the full picture of how the economy was doing in January, February and March, let alone how it’s doing now.

Yes, contraction always looks bad, but the previous GDP number, whose final estimate was released last month, was 6.9 percent. That number was likely unsustainable (the quarter before that’s GDP growth rate was 2.3 percent), and was likely pushed over the top by businesses building up inventories, which is calculated as part of the GPD growth rate.

Still, the overall economic numbers are mixed. Employment is recovering at a fairly rapid pace along with wages, but inflation is startlingly high. There’s also the possibility that the economy could continue to be beset by crises and shocks that the traditional economic policy tool kit may be less able to handle, like continued shutdowns in China along with the unpredictable course of Russia’s war with Ukraine.

ADVERTISEMENT

Politics and Ideas Editor Kay Steiger asked Domestic Economics Reporter Matthew Zeitlin what all this means. This interview has been edited for length and clarity.

Kay Steiger: Let’s back up for a second. What does the GDP number measure? And how do people use it?

Matt Zeitlin: GDP is supposed to measure overall economic output for a country in a given time period. It’s then “annualized,” which tells you how much GDP would have grown (or shrunk) if it had done so at that pace for the whole year. GDP itself is made up of consumption (buying stuff), business investment, government spending, and then the balance between exports and imports. It’s typically used to measure overall economic activity.

KS: But economic activity is so high! What does the -1.4 percent mean?

MZ: To be consistent, you have to take GDP at face value. But you can look at the component parts to get an understanding of how we ended up at 1 percent.

ADVERTISEMENT

The Bureau of Economic Analysis, which calculates the GDP figure, said something interesting in its release Thursday morning. “The decrease in real GDP reflected decreases in private inventory investment, exports, federal government spending, and state and local government spending, while imports, which are a subtraction in the calculation of GDP, increased. Personal consumption expenditures (PCE), nonresidential fixed investment, and residential fixed investment increased.”

This means that when it comes to people buying and businesses making investments, that stuff all grew. What shrunk was the balance between imports and exports, government spending, and something called “change in private inventories.” This final category shrunk by almost 1 percent after growing by over 5 percent in the fourth quarter of 2021.

Inventories are basically anything a business needs to “facilitate the production and distribution of goods and services.” So when businesses buy stuff up to sell, or components to manufacture products, or even raw commodities, those are inventories; GDP then measures the change in these inventories. And in this quarter, the change in inventories was short of what it was in the fourth quarter of 2020.

KS: Why is that inventory number so low?

MZ: Part of the reason that big GDP number has come down is because businesses pumped up their inventories last quarter, and it slowed down quite a bit this quarter.

Inventories don’t just have to grow for GDP to grow quarter to quarter, but inventory growth has to increase, otherwise, that component of GDP growth goes down. For the last six months of 2021, this contributed to GDP growth, but took away from it this quarter.

This figure is widely acknowledged by forecasters and analysts as being incredibly volatile, but, the Bureau of Economic Analysis, which does the GDP statistics, cautions that it “play[s] a key role in the timing, duration, and magnitude of business cycles, as unanticipated buildups in inventories may signal future cutbacks in production, and unanticipated shortages in inventories may signal future pickups in production.”

So, it’s not nothing, but it’s not necessarily everything. Other measures of economic activity — like “final sales to domestic purchasers,” which combines what consumers buy and investment made by businesses but strips out inventories — were more robust, growing at 3.7 percent.

KS: What about exports?

MS: This was the other key factor responsible for GDP growth being negative this quarter. According to the Bureau of Economic Analysis, net exports (the difference between exports and imports) was responsible for dragging down GDP by 3.2 percent. This means that consumers were still buying stuff, but more of it came from abroad, possibly because of supply problems at home.


ADVERTISEMENT

KS: Still … the economy shrinking seems bad! Does this mean there’s a recession coming?

MZ: Whether or not a recession occurs this year or next year probably cannot be divined from one quarter of GDP statistics. It will instead depend on two key factors: how aggressively the Federal Reserve tries to cool off the economy through increasing interest rates and what happens in the rest of the world — whether it’s the continued Russian war in Ukraine leading to persistent hikes in food and energy prices or a prolonged covid shutdown in China further disrupting global supply chains.

And if you look at this GDP report, you can see evidence that something is happening with consumption that may be linked to inflation or supply shocks.

For example, even though private consumption was up, it actually fell for “nondurable goods” — these are things like food or gasoline — which may have been affected by price hikes. This could be a sign that consumer purchasing power is weakening or that consumers are shifting away from their post-covid embrace of goods and are going back into buying services, consumption of which grew over 4 percent.

KS: What should we look for on GDP growth moving forward?

ADVERTISEMENT

MZ: Predictions are very difficult to make, especially about the future. What we can say is that GDP probably won’t increase at the 5.7 percent rate it did in 2021. Analysts polled by the Conference Board have projected that GDP will grow at 3 percent, while some have predicted the economy will tip into a recession next year.

Thanks to Lillian Barkley for copy editing this article.

  • Matthew Zeitlin
    Matthew Zeitlin

    Domestic Economics Reporter

    Matthew Zeitlin is an economics reporter at Grid focused on the domestic impact of major stories such as coronavirus, the supply chain and economic volatility.

  • Kay Steiger
    Kay Steiger

    Managing Editor

    Kay Steiger is the managing editor at Grid.