News about the economy usually highlights Gross Domestic Product (GDP), a measurement familiar to even the most casual follower of economic news. Most of us know that one of the traditional benchmarks for a recession is two straight quarters of negative GDP.
The latest GDP estimate says the economy contracted the equivalent of 0.6% per year in the second quarter of 2022 after shrinking at an annualized rate of 1.6% in the first quarter of the year. Though the second quarter decline was less than the originally estimated shrinkage of 0.9%, this second straight quarter of negative GDP should mean we are in a recession, right?
Maybe not.
In addition to GDP, there’s another measure of the economy, Gross Domestic Income (GDI). In looking at economic activity, GDP measures spending and GDI measures income. For every dollar spent to pay for some good or service—a restaurant meal, a car, a doctor’s visit—a dollar of income is earned for delivery of that good or service. Measure all the spending and you have GDP; measure all the income in the country—for people, businesses, governments—and you have GDI.
Usually, GDP and GDI are close to matching in measuring economic rise and fall. However, in contrast to GDP’s negative message so far this year, GDI shows that the economy hasn’t been shrinking at all.
Gross domestic income increased 1.8% in the first quarter of 2022 and grew again by 1.4% in the second quarter of 2022. The average of GDP and GDI showed a rise of 0.4% in the second quarter following a 0.1% increase in the January to March period. The average for the first six months of 2022, rising at an annual rate of 0.2%, is more consistent with a slowing economy than one in recession.
Two Measures, Two Views
How is this divergence possible? Well, while GDP and GDI may be economic twins, they are not identical.
The most significant component of GDI is wages and salaries. Historically, roughly 50% of GDI goes to workers. Since one person’s spending is another’s income, in principle GDP and GDI should be the same. However, because they are based on different data sources, GDP and GDI can sometimes differ enough to give conflicting readings on the economy’s direction.
The story being told by GDI so far is consistent with other data showing that the economy is still growing, though more slowly than it did in 2021. At the same time, high inflation has people feeling that they are losing ground. According to GDI, the economy is growing slowly. According to GDP, it may be in a recession.
The GDP figures suggest a downturn in economic momentum during the first half of the year. Under the surface, there’s more at play, including the impact of volatile categories such as imports and inventories; but overall, consumer spending has decelerated. The back-to-back negative quarters have not only fueled fears of an imminent recession, but also led some to believe it was already under way.
The GDI figures, however, point to growth within a more gradual cooling. These figures paint a picture of an economy supported by a robust labor market and resilient consumer spending, though one that’s starting to feel the pinch of the worst inflation in a generation.
What’s Really Happening?
The official term for the divergence between GDP and GDI is statistical discrepancy, and this discrepancy usually isn’t large. The early pandemic year of 2020 saw a similar divergence between the two measurements emerge, and that difference was attributed to the fast-moving, chaotic economic changes the country was undergoing. While the gap narrowed in 2021, it has widened in 2022.
The divergence matters because both numbers can’t be right. Which measurement is showing the real situation?
The U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) reports focus on GDP, but GDI deserves notice, especially since scholarly research suggests that when initial estimates of the two measures differ notably, GDP tends subsequently to be revised towards GDI, not the other way around. Indeed, the BEA itself reports the average of GDP and GDI as an alternative measure of domestic production.
Some economists believe the figure on income is likely to be closer to the mark because the government collects more detailed data on income. Both the BEA, which produces the numbers, and the private nonprofit National Bureau of Economic Research—the semi-official arbiter of when recessions begin and end in the United States—recommends looking at an average of the two indicators.
By that measure, economic output grew in both the first and second quarters, and growth accelerated somewhat in the spring.
Conclusion: What Happens Next?
The BEA will release its annual update on Sept. 29, which will include revised statistics for GDP and GDI for the five years through the first quarter of 2022. The first estimate of third-quarter GDP will be released on Oct. 28.
Data released at the end of August showed an economy being pulled in different directions. Consumer spending grew faster in the second quarter than initially calculated. Corporate profits, which fell in the first quarter of the year, rebounded in the second. Personal income also rose, powered by the strong job market.
Yet other parts of the economy show signs of weakness. Businesses pulled back investments in equipment and buildings in the second quarter. Construction activity and home sales have fallen sharply as higher interest rates have made it more expensive to borrow.
What happens next will depend a great deal on the behavior of inflation during the next few months.
According to the Federal Reserve’s preferred measure, the annual inflation rate decreased to 6.3% in July from 6.8% in June, thanks in part to falling energy prices. Many financial-markets participants have been hoping that the inflation slowdown will be sustained and that the Fed will be in a position to slow its campaign of interest-rate increases.
But a rebound in energy prices due to the conflict in Ukraine or other factors could forestall any sustained improvement in inflation. In late August, Fed chair Jerome Powell warned that “a single month’s improvement falls far short” of what the Fed needs to conclude inflation is returning to the Fed’s 2% target.
If inflation doesn’t recede and the Fed responds with additional, aggressive interest-rate increases, then the U.S. might be on the cusp of an unambiguous downturn that everyone can agree to call recession.
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