January 22, 2024
The economy grew at an extraordinary 4.9 percent annual rate in the third quarter. The growth rate for the fourth quarter is likely to come in around 2.5 percent, putting growth for the year close to 3.0 percent, far above almost anyone’s forecasts.
At the same time, inflation has slowed more rapidly than had been projected. The personal consumption expenditure deflator grew at just a 2.6 percent annual rate in the third quarter. It is likely to slow further in the fourth quarter. Barring some unusual disruptions, inflation should slow further to hit the Fed’s target in 2024.
Consumption growth has continued to grow at a healthy pace in the third quarter, likely coming in just below 3.0 percent. Investment likely slowed in the quarter. Investment in non-residential structures will probably not show another double-digit increase, as the growth of factory construction has slowed. Equipment investment will likely show moderate growth. Investment in intellectual products may be a small positive, with more of a pickup in the first quarter as the effect of the strikes in the motion picture industry dwindles.
Is the Productivity Surge Continuing?
The most important data series for both long-run living standards and short-term inflation is productivity growth. We’ve had two consecutive quarters of extraordinary productivity growth, with productivity rising at a 3.6 percent rate in the second quarter and a 5.2 percent rate in the third quarter. It looks like we will again see another quarter of very good productivity growth, with output growing close to 2.5 percent and hours close to flat. (Payroll hours grew at just a 0.8 percent annual rate, while self-employment fell in the fourth quarter.)
The productivity data are highly erratic, so even if we get another strong quarter, it will be too early to say anything definitive. Also, we had a horrible year in 2022, so a strong year in 2023 would likely put us at just over a 1.5 percent rate since the pandemic. Given the disruptions created by the pandemic, this would be an impressive performance, but does not necessarily mean we are on a markedly faster growth path than before the pandemic.
Healthcare Costs Staying Under Control
After rising rapidly in the first decade of this century, healthcare costs slowed sharply in the second decade. Since the pandemic, they have actually fallen slightly as a share of GDP. It looks like this pattern continued into the fourth quarter of 2023.
The slower growth in healthcare costs matters both for the federal budget and the larger economy. The federal government pays for close to 50 percent of all healthcare spending through Medicare, Medicaid, and other government programs, so slower healthcare cost growth means lower deficits than would otherwise be the case. As an economic matter, the fewer resources going to health care, the more are available for other purposes.
Investment Growth Slows as Surge in Factory Construction Eases
An unprecedented surge in factory construction following the passage of the CHIPS Act and the Inflation Reduction Act led investment growth in the first three quarters. This growth has slowed in the fourth quarter. We will likely see modest growth in structure investment in the fourth quarter, but much less than the double-digit pace of the prior three quarters.
Equipment investment fell at a 4.4 percent annual rate in the third quarter, after growing at a 7.7 percent rate in the second quarter. We are likely to see a small decline in the fourth quarter. Investment in intellectual products grew at just a 1.8 percent rate in the third quarter, depressed in part by the strikes in the motion picture industry. We will likely again see modest growth in this component in the fourth quarter.
Residential Investment Will be Nearly Flat
After falling for nine consecutive quarters, residential investment grew at a 6.7 percent rate in the third quarter. Housing starts have slowed slightly in the fourth quarter, which is likely to translate into little or no change in residential construction for the quarter. There has been a modest decline in mortgage rates in recent weeks, which should provide a modest boost to construction and mortgage refinancing in the current year.
Net Exports to Be Little Changed
The trade deficit has been trending downward the last two years, primarily because the shift back from goods consumption during the pandemic to service consumption has meant fewer imports. With that shift largely completed, the positive effect on the trade deficit going forward will be more limited.
The major determinants going forward will be the value of the dollar and the relative growth of the U.S. and its trading partners. There has been little change in the value of the dollar against other currencies in recent quarters. On the other hand, the U.S. economy has been growing considerably more rapidly than those of most of our trading partners.
This is likely to translate into a stable or small increase in the trade deficit. However, this is not likely to be a major factor in fourth quarter GDP.
Government Spending Likely Continues to Grow at a Modest Pace
Government spending added 0.99 percentage points to growth in the third quarter. A major factor here was an unusual 8.4 percent jump in defense spending. Quarterly spending for defense is erratic, we are unlikely to see another jump of this size. For this reason, its contribution to growth is likely to be more modest.
State and local spending has been growing at a bit less than a 5.0 percent annual rate in the last three quarters. With many state and local budgets facing some stress, we will probably see somewhat slower growth in the fourth quarter.
Inventory Accumulation to be a Small Drag on Growth
Inventories added 1.27 percentage points to growth in the third quarter. While the rate of accumulation was not especially rapid, it followed a quarter of virtually no accumulation. We may see somewhat slower accumulation in the fourth quarter, meaning this component will be a modest negative for GDP.
Overall Picture: Another Solid Quarter
All the data to date suggest that the fourth quarter will again show solid growth with slowing inflation. It is a bit ironic that the economy will have another year of very strong growth in a year when most forecasters were predicting a recession.
It also looks increasingly clear that inflation is coming back to the Fed’s 2.0 percent target. The lag between market rents and rents in the price indices will delay this convergence, but we can be fairly certain that we will see it sometime in 2024.
