July 26, 2021
We will again see another quarter of extraordinary growth, likely over 7.0 percent.
In most of the country, the reopening process was mostly completed by the end of the quarter. This reopening has led to rapid growth in the hardest hit areas like restaurants and air travel. Growth in service consumption is likely to be the strongest area of growth in the quarter.
A sharp rise in the trade deficit is constraining inflation.
This will likely be the first quarter where GDP exceeds its pre-pandemic level from the fourth quarter of 2019. If we exclude trade, GDP in the first quarter was already 0.8 percent higher in the first quarter than its pre-pandemic level. The trade deficit has soared in the last year and a half due to an 8.0 percent increase in goods imports and a plunge of 24.5 percent in our exports of services. The drop in services is largely due to a fall in international tourism, as well as a decline in the number of foreign students attending US colleges and universities. The rise in goods imports is a major factor restraining inflation, as inflation in the price of finished consumer and investment goods remains just over 1.0 percent.
The strong GDP growth means that the rapid pace of productivity growth is continuing.
Hours worked increased at roughly a 4.0 percent annual rate in the second quarter. If GDP growth comes in at over 7.0 percent, it means that productivity growth will be over 3.0 percent for the quarter. Productivity increased by 4.1 percent from the first quarter of 2020 to the first quarter of 2021. This compares to an annual rate of just 1.0 percent over the prior decade.
While it is unlikely that productivity growth rates of 3.0–4.0 percent will be sustained, even an increase to just 2.0 percent will seriously dampen inflationary pressures in the economy. With a 2.0 percent rate of productivity growth, the Fed’s 2.0 percent inflation target would be consistent with a 4.0 percent pace of annual wage growth. If productivity growth were to fall back to 1.0 percent, then a 4.0 percent rate of wage growth would imply either more rapid inflation or a shift of profits to wages.
Look to saving rates: Are people banking their pandemic checks?
We saw a massive increase in the saving rate through last year. This was due to the fact that many people were saving money as a result of not having to commute to work. Higher income households also cut back hugely on services like restaurants, gyms, and air travel. In addition, the pandemic checks put hundreds of billions of dollars in people’s pockets. In the case of middle- and higher-income households, this money was largely saved or used to pay down debts.
With the economy largely reopened, a big question is the extent to which these households are going to spend down the money accumulated during the recession. The saving rate had averaged 7.5 percent in the three years prior to the recession. If people are spending down the money accumulated during the pandemic, it would mean that the saving rate would have to fall below this level. If people are continuing to bank their savings, rather than boost consumption, it will mean that we have less to fear from the economy growing too rapidly in the near-term.
The saving rate for the first two months of this quarter averaged 12.9 percent. If people are beginning to spend down the money accumulated during the pandemic, then the saving rate for June should be considerably lower, pulling down the average for the quarter.
Is inflation growing in the Personal Consumption Expenditure Deflator (PCE)?
The Fed relies more on the core PCE deflator in assessing inflation than the consumer price index (CPI). The uptick in inflation in this measure has been more moderate than in the CPI. Over the year, from May 2020 to May 2021, the core PCE deflator has risen 3.4 percent. As with the CPI, this figure is distorted by base effects — prices fell sharply at the start of the pandemic. If we go back to February, the annual rate of inflation in the core PCE is just 2.4 percent.
It will be important to see if there is evidence of acceleration in the most recent data. Some of the problem sectors in the CPI, like used cars and car insurance, have a much lower weight in the PCE deflator. On the other side, medical care, where inflation has been quite tame, has a much higher weight. With the Fed target of a 2.0 percent average rate of inflation, there would be little basis for concern unless the PCE started to accelerate considerably from its recent path.
Comprehensive revisions and profit share.
The July GDP release will include comprehensive revisions to the data for 2019 and 2020. Profit data are often subject to large revisions. The profit share of corporate income had been on a downward path since 2015, with the 2020 share being the lowest since 2009. It will be interesting to see if this pattern holds up in the revised data.
Gross Domestic Product, 2nd Quarter 2021 (Advance Estimate) is scheduled for release by the Bureau of Economic Analysis on Thursday, July 29, 2021 at 8:30 AM Eastern Time.
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