The release of the gross domestic product report for the second quarter of 2022 showed a second quarterly decline in GDP. If you were watching the news around then, you’ll remember there was a lot of commotion as to whether or not the US economy was in a recession.
While some economists agreed that the country was in a recession, many other economists and government officials pushed back. This may have confused you if you’re familiar with the “rule” that two consecutive quarters of negative GDP growth indicate a recession.
As it stands now, the US economy is still not in a recession, and with the advance estimate of GDP for the first quarter in 2023 scheduled for release on April 27th, the debate will likely continue.
Here is what you need to know about the economy and whether we are in a recession.
- GDP grew for the third quarter of 2022 by 3.2%, reversing the downward trend we had seen in the previous two quarters.
- The National Bureau of Economic Research (NBER) did not officially call a recession in 2022 because other economic indicators remained strong.
- Many economists believe the US will officially enter a recession later this year.
2022 GDP Reports
The Bureau of Economic Analysis (BEA), a part of the US Department of Commerce, published its initial third-quarter findings on the Gross Domestic Product (GDP) on October 27, 2022. It found that the total gross domestic product grew by 3.2%, reversing the downward trend of the year’s first two quarters. In the first quarter of 2022, GDP fell by 1.6%, and 0.6% in the second quarter.
GDP growth slowed in the fourth quarter of the year but remained positive at 2.6%. The BEA will release its advance estimate for the first quarter of 2023 on April 27, 2023.
Breaking Down the GDP Report
The GDP report contains various economic data over a specific period. It’s the monetary measure of the financial value of all the finished goods and services produced in the US and purchased by end users. Analysts measure US GDP quarterly and annually and use a formula that includes the following indicators:
- Personal consumption expenditures (C)
- Investment (I)
- Government spending (G)
- Net Exports (NX)
These four indicators are calculated in a simple formula that consists of C + I + NX + G = GDP. The total GDP for the fourth quarter of 2022 was $26.14 trillion. In quarter three, the total GDP totaled $25.72 trillion. The following is a breakdown of each indicator for the third quarter of 2022.
Personal Consumption Expenditures
The total personal consumption amount was $17.50 trillion. This accounts for everything from new domestic auto purchases, automotive gas, retail sales, transportation services, utilities, healthcare, food services, and more.
The total amount for all investments across all industries totaled $4.59 trillion in the third quarter of 2022. Investment covers industries that include auto manufacturing, residential and non-residential structures, oil and gas well drilling and exploration, intellectual property products, and farming, among others.
Net Imports and Exports
The net exports variable covers both imports and exports of goods. This category was responsible for a net loss of $901.4 billion in the third quarter, an improvement from a net loss of $1.035 trillion during the second quarter of 2022.
Understand that a net loss simply means that imports exceeded imports, also known as a trade deficit. If exports exceed imports, this is considered a trade surplus. Line items in the net exports category include US exports of goods, foods, feeds, beverages, capital goods, automotive vehicles, and related goods and services. Imports have the same items as exports.
Government spending represents consumption expenditures and gross investment in government-related groups and projects. The total amount for this input was $4.47 trillion for the third quarter. Some of the line items in the category include the cost of running the federal government as well as state and local governments, compensation of general government employees, and construction and maintenance of public structures.
Traditional Measure of Recession
Economists use GDP as a sign of whether the US economy is in a recessionary or growth period. Usually, a recession is defined as two consecutive quarters of negative growth in the GDP. However, despite two quarters of negative GDP, the Federal Reserve did not call a recession in 2022 because significant economic indicators did not signal a recession.
The Federal Reserve Bank of Dallas states that the two quarters of declining GDP is a rule of thumb for indicating a recession but is not an official definition. It also says that the National Bureau of Economic Research (NBER) Busines-Cycle Dating Committee defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
The Dallas Fed found that there wasn’t a recessionary environment for the first two quarters of 2022, even though they were both quarters of negative growth. Most indicators, mainly the labor markets and personal spending, contradicted the rule of thumb of two quarters of negative growth. These reports continued to show job market strength and a resilient consumer environment.
Other signals at the end of 2022 were mixed. This included a significant slowdown in housing starts, a cooling off of house prices, a weak stock market, rising wage reports, and a strong dollar. These showed that the economy had not slowed significantly during the first two quarters of 2022.
Is a Recession Still Possible?
A recession is still possible, and they occur with regularity. Many economists believe there will be a recession in 2023 because rates have continued to rise to combat high inflation. One of the causes of inflation is too much liquidity – or too much cash – flowing through the economy.
The Federal Reserve raises interest rates in response to inflation as a tool to draw money out of the economy and create a “soft landing” for prices across all industries. The ultimate goal of an interest rate hike is to slow down the rate at which consumers and industries reach for their wallets to buy goods and services.
It’s an unpleasant concept because it results in loss of income, but the Fed has to balance both sides of an inflationary and recessionary environment. Allowing either environment to go on for too long results in more economic pain, which is much harder to correct.
Most economists expect the Federal Reserve to increase interest rates again in 2023, just one more time, before letting them decrease. There’s a concern that another increase in interest rates will result in job losses across all industries, put more people out of work, and start the domino effect leading to a recession.
What exactly happens when the Fed increases interest rates?
When the Fed increases the Fed funds rate, it influences the rate at which banks borrow and lend money from each other overnight. Banks have to meet certain reserve requirements related to how much cash they keep on-hand relative to the amount deposited with them.
Therefore, banks are incentivized to save money and not borrow as much from each other when the Fed increases interest rates. This causes some banks to raise yields on savings products, encouraging consumers to deposit more money with them. It also causes the cost of short-term borrowing rates to increase.
Interest rates charged by credit cards tend to move with interest rates, too, so your debt will become more expensive when the Fed increases rates. If you’re invested in bonds, too, you likely know that rising interest rates drive down bond prices. This is because most bonds pay a fixed interest rate. If new bonds advertise higher yields to consumers, existing bonds will appear less valuable, and demand for them will decrease.
Inflation in 2023
If you followed the news in 2022, you inevitably saw reports of high inflation and low consumer spending. 2022 was a particularly difficult year for consumers, as stimulus money, the Russia-Ukraine war, and lingering supply chain issues from Covid increased prices.
Inflation peaked in June 2022 at 9.1%, leading the Fed to institute an extremely aggressive rate hike campaign. The most recent inflation data from March 2023 showed the annual inflation rate decreasing to 5.0%. Oil and food prices have been able to decrease over the last year, but shelter costs have remained high.
Many economists are hopeful that the recession in 2023 will be mild and point to the easing inflation rates as a hopeful sign that supply and demand are stabilizing. Still, 5.0% is well above the 2% target inflation rate the Fed aims for. It’s likely the Fed will institute one more rate hike this year to keep prices from going back up.
OPEC recently announced another cut to its daily oil output, leading some to express anxieties over oil prices going back up. Only time will tell exactly what will happen and whether the NBER will end up calling a recession this year.
The Bottom Line
GDP growth in 2022 was negative for the first two quarters but turned positive in the latter half of the year. This led to widespread confusion over whether or not the US economy was in a recession.
Multiple signals are needed to officially call a recession, not just two consecutive quarters of negative GDP growth. It remains unclear if other economic indicators will show weakness in the overall economy. All that investors can do is monitor the reports as they are released to gauge the health of the US economy.