October 25, 2022
Gross Domestic Product (GDP) Third Quarter 2022 (Advance Estimate) is scheduled for release by the Bureau of Economic Analysis on Thursday, October 27, 2022, at 8:30 AM Eastern Time.
After two consecutive quarters in which the Commerce Department reported the economy shrinking, we should be back to a healthy growth pace in the third quarter, with the economy showing growth of 2.5–3.0 percent. Most components are likely to show modest growth in the quarter, with net exports likely being the largest contributor. Imports in July and August were well below the average for the second quarter. Residential investment is likely to be large, continuing the sharp decline from the second quarter.
GDP Growth, Productivity, and Inflation
There are many reasons to be skeptical of the drops in GDP reported for the first two quarters, and it is possible that these declines will be smaller or even turn positive with further revisions. However, there is no doubt that growth was weak in the first half of 2022. This weak growth, coupled with strong employment growth, implied declining productivity.
The most recent data show productivity declining at a 4.1 percent annual rate in the second quarter and a 7.1 percent rate in the first quarter. This is the largest two-quarter decline ever reported. The reasons for this drop are not clear; the surge in omicron probably explains part of it, as does the rapid turnover in the labor market. Supply chain disruptions were likely a major factor.
Regardless of the cause, the decline in productivity in the first half of 2022 was a major source of inflationary pressure. Employers, who were getting less output for each hour of work, were seeing their costs soar.
With the data on employment and hours, a moderate rate of GDP growth will imply a return to normal rates of positive productivity growth. This will help alleviate the inflationary pressures that businesses were seeing in the first half of 2022.
Consumption Continues to Grow at a Healthy Pace
Consumption grew at a 2.0 percent annual rate in the second quarter. It is likely to grow at comparable pace in the third quarter, driven by growth in durable goods and services, with nondurables continuing to contract. In the case of durable goods, strong growth in recreational goods, such as computers and TVs, is likely to offset the weakness in car sales.
In the case of services, health care spending is likely to be the most important factor. Health care spending has actually shrunk as a share of GDP since the start of the pandemic. In the second quarter of this year, it was 0.7 percentage points less, measured as a share of GDP, than in the fourth quarter of 2019. Since it was projected to grow roughly 0.2 percentage points a year, this put spending 1.3 percentage points below the share projected back in 2019. That effectively frees up $325 billion a year to be spent in other areas.
Residential Investment Falls Sharply Due to Higher Mortgage Rates
Residential investment fell at a 17.8 percent annual rate in the second quarter, subtracting 0.93 percentage points from growth in the quarter. It will again fall sharply in the third quarter, albeit not as rapidly. Construction is being held up by the fact that a huge number of homes have been started but not completed because of supply chain issues. Workers are still needed to finish these homes, so employment has continued to rise in the sector, even as starts have plummeted.
It is also important to remember that the fees associated with mortgage issuance appear in this category. With the huge refinancing boom coming to an end, this will be a drag on the growth in residential investment in the quarter.
Nonresidential Investment Maintains Healthy Growth Path
We will see a similar story in nonresidential investment to what we have been seeing for the last couple of years, where growth in investment in intellectual products and equipment was offset by a decline in structure investment, leading to modest growth in this category. There was a small decline in equipment investment in the second quarter, likely due to supply chain problems. Growth should again be positive in the third quarter.
Net Exports Will Provide a Boost to Growth
Net exports had been a drag on growth through most of the recovery, as the trade deficit expanded with the pandemic-driven shift to goods consumption. Imports are now declining rapidly, even as exports rise at a modest pace of growth. This means that the deficit will shrink further in the third quarter, with the foreign sector contributing at least a percentage point to growth in the quarter.
This story will almost certainly turn around in the fourth quarter or the first quarter of 2023, as the higher dollar, coupled with a likely recession in our major trading partners, will reduce exports. Imports may continue to fall if the US economy sinks into recession. Even in that scenario, we are unlikely to see a major boost to growth from a falling trade deficit.
Inventory Growth Returns to Normal
Inventories were a big drag on growth in the second quarter, as we went from an extraordinary rate of accumulation in the first quarter to a more normal one in the second quarter, knocking 1.91 percentage points off the quarter’s growth rate. We will likely see a comparable pace of accumulation in the third quarter, meaning inventories will have relatively little impact on growth.
Third Quarter Looks Like a More Normal Economy
The third quarter data is likely to look something like a normal healthy economy. We should be past the big swings in net exports and inventories that drove the economy in prior quarters. We also should see a modest positive growth rate after two quarters of negative growth.
In principle, this is the sort of GDP report we should be happy to see at this point in a recovery. However, with the Fed continuing to hike rates, and most of the impact of past rate hikes yet to be felt, this could be the last good report we see for a while.