"Core" GDP Suggests Economy Gained Momentum in Q1:2022

"Core" this and that is all the rage these days. Soon to be retiring Chicago Fed President Charlie Evans is now talking about a supercore CPI. What is that? A CPI that excludes all items that have increased in price? But I digress. The headline of the media reports of the Bureau of Economic Analysis (BEA) release of its first guesstimate of the annualized percent change in real GDP for Q1:2022 was "economy contracts by 1.4%". Oh my. Call off Fed interest rate hikes because the economy has one foot in the recession grave? I referred to this advance estimate of GDP as a guesstimate because the BEA does not yet have complete first-quarter data for net exports, inventories and residential investment. So, cool your jets. I will argue that the part of the economy that the Fed has the most influence on, real private domestic sales excluding inventories (or real private domestic final sales), apparently picked up in Q1:2022.

The advance estimate of first-quarter real GDP was held back primarily by real net exports and the change in real inventories for which, again, March data still have not been released. Real net exports held back first-quarter real GDP by 3.20 percentage points; the real change in private inventories by 0.84 percentage points. And for good measure, real government, combined federal, state and local, retarded first-quarter real GDP by 0.48 percentage points. With defense expenditures likely to be increasing and infrastructure spending gearing up, how much longer will government expenditures on goods and services be a drag on real GDP?

But if we look at real private expenditures for goods and services, excluding inventories, the spending most influenced by monetary policy, we find a different picture. This is just a fancy name for combined real personal consumption expenditures, real private fixed-investment expenditures, including business and residential investment. As shown in Chart 1, this measure of real aggregate spending grew at an annualized pace of 3.66% in the first quarter, up from the annualized pace of 2.57% in Q4:2021. The 2017 through 2019 median quarter-to-quarter annualized growth in real private domestic final sales has been 2.72 % (the thin blue horizontal line in the chart). So real private final demand grew in Q1:2022 faster than it grew during those pre-Covid glorious years when the US economy was great again.

Chart 1

So far, the discussion has been in real terms. Now, let’s get nominal. Real expenditures measure what you received in units of the good or service. Nominal expenditures measure the dollars you paid to get the units. So, let’s look at the behavior of nominal core GDP or nominal final sales to private domestic purchasers in Q1:2022. Plotted in Chart 2 are the annualized growth rates for quarterly nominal final sales to private domestic purchasers (the blue line) and real final sales to private domestic purchasers (the red bars). In Q1:2022, the nominal spending aggregate grew at an annualized rate of 11.50% compared to growth in the real purchases aggregate of 3.66%. The difference between nominal spending and real purchases approximates the inflation rate.

Chart 2

Where did the US private sector get the funds to purchase final goods and services at the annualized rate of 11.50% in the first quarter. Corporate profits data have not yet been released. But personal income data have been released. After-taxes, nominal personal income increased at an annualized pace of 4.85% in the first quarter. Nominal personal consumption expenditures plus nominal residential investment expenditures increased at an annualized rate of 10.58%. If your nominal expenditures are growing faster than your nominal after-tax income you either have to borrow more, save less or sell assets. We’ll have to wait until the middle of June for the Fed’s release of the Q1:2022 Financial Accounts (Flow of Funds) data to get a handle on this. But we know that the private sector has built up massive amounts of cash holdings since the federal government, effectively, started crediting households’ bank accounts with Covid-relief payments, financed by the Fed and the banking system. It is conceivable and, in fact, I predicted it (see "Households’ Extraordinary Cash Holdings Will Thwart Fed Tightening", March 14, 2022, at "Viewpoints" on Haver.com or on my LinkedIn page) that households would start to put this cash to work in order to try to maintain their purchases in the face of inflation outpacing their income growth. This is effectively households selling their cash assets.

Economists refer to the ratio of some aggregate spending measure to some money supply measure as the velocity of money. An increase in spending relative to money is referred to as an increase in the velocity of money. What this means is that the given money supply is turning over more rapidly to support the higher relative spending. Let’s see what happened to velocity of money in Q1:2022 with nominal final sales to private domestic purchasers in the numerator and the M2 money supply in the denominator. The blue bars in Chart 3 are the quarterly observations of this version of M2 velocity. The red line is the quarter-to-quarter annualized percent changes in this version of M2 velocity. Sure enough this version of M2 velocity increased in Q1:2022 , increased at an annualized rate of 3.19%.

Chart 3

In sum, contrary to the headlines accompanying the release of the advance estimate of Q1:2022 GDP, the US economy still has legs and can tolerate some Fed interest rate hikes before slipping into recession. How high the Fed can raise the federal funds rate before inducing a recession is a question I am not equipped to answer. There used to be a PBS show called "Wall Street Week" hosted by Louis Rukeyser. One of his regular guests was Martin Zweig, a money manger. Lou used to ask Marty at what level the stock market would top out. Marty used to reply by saying he didn’t know the numerical level right then, but when his indicators pointed to a top, he would tell Lou. Similar to Marty, I’ll tell you when a recession is imminent when my indicators suggest such.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.