The main story in the first quarter is likely to be a sharp slowing in GDP growth from the extraordinary 6.9 percent pace of the fourth quarter of 2021. The biggest factor in this slowing will be a slower pace of inventory accumulation. Inventory growth added 5.3 percentage points to GDP growth in the fourth quarter. Inventories are expected to continue growing in the first quarter. However, the growth in inventories (GDP growth is driven by the change in the amount of inventory growth) is almost certain to be slower in the first quarter than in the fourth quarter, meaning that it will be a net negative for the first quarter GDP. This should leave first quarter GDP growth near 2.0 percent.
Consumption Growth Still Strong
We are likely to see consumption growth in the neighborhood of 3.0 percent in the first quarter. This figure is a bit misleading since it will be driven almost entirely by strong growth in January (especially in vehicle sales), followed by much weaker growth in February and a likely decline in March.
This matters in terms of the economy’s momentum going forward since consumption was likely growing at a much more sustainable pace at the end of the quarter than at the beginning. The slowdown is due to slower real income growth (real wages are just treading water right now) and satiation of durable goods purchases. People who bought a car in 2020 and 2021 will not be buying a new one in 2022.
The rise in mortgage interest rates also matters here. Refinancing has fallen through the fall, as few people can save money by refinancing with a 5.0 percent mortgage rate. The refinancing boom was feeding into consumption in 2020 and 2021; that is no longer the case. Also, with home sales falling, people will be spending less money furnishing a new home.
Saving Rates Remain High
One of the big issues in the economy’s future is the extent to which households spend down the savings they accumulated during the pandemic. The inflation hawks have argued that people will spend them down, meaning that saving rates should be lower than normal. Thus far, we have not seen this happening to any substantial extent. The saving rates had been close to the 7.5 percent average for the three years prior to the pandemic. This is likely to continue to be the case in the first quarter.
Investment Remains Solid
All three components of investment should be strong in the first quarter. Equipment investment has generally been strong through the recession, although it weakened in the last two quarters, in large part due to supply chain problems. It should show double-digit growth in the first quarter.
Structure investment fell in the last three quarters and seven of the eight pandemic quarters. It should turn around and show a modest positive in the first quarter. Investment in intellectual products has been strong throughout the pandemic. It should grow at close to a double-digit rate in the first quarter.
Residential Construction Will Weaken as a Result of Less Mortgage Refinancing
Housing starts are expected to be strong in the first quarter. However growth in residential construction is likely to be limited due to supply chain issues and a sharp falloff in mortgage refinancing. On the supply chain side, builders are being limited by their ability to get materials. While housing starts have been running near a 1.9 million annual rate, completions have been running at just over a 1.3 million annual rate.
The sharp falloff in mortgage refinancing will reduce the fees and commissions associated with mortgage issuance, which are a large part of the residential construction category. This falloff mostly occurred in February and March, but it was likely large enough to be a substantial drag on growth in this category.
Trade Will Again be a Drag on Growth
Net exports have fallen in the last six quarters. This will again be the case in the first quarter, as real exports have fallen in the first quarter, and real imports rose at a substantial rate. Clearly supply chain issues are slowing both sides of this measure, but the extraordinary growth in the US economy is pulling in imports from around the world. Trade subtracted 0.23 percentage points from growth in the previous quarter. It will likely have a larger negative impact in the first quarter.
Government Expenditures
Government spending fell at a 2.6 percent annual rate in the fourth quarter, subtracting 0.46 percentage points from the quarter’s growth. The biggest factor in this drop was a 6.0 percent rate of decline in federal defense spending, the fourth straight quarter of decline. The timing of defense spending is always erratic, so it is likely to turn positive in the first quarter, even without spending associated with the war in Ukraine.
State and local spending fell at a 1.6 percent annual rate after rising at a 4.9 percent rate in the third quarter. Here too, spending patterns have been erratic. We will probably see modest growth in the first quarter.
GDP Growth and Inflation
After the turbulence associated with the pandemic shutdowns and the reopening, we are now settling down to a more normal rate of growth. The pandemic will still have a substantial impact in this quarter, with the omicron wave having a noticeable effect on restaurants and other services. Unless we get hit with a new variant, the impact of the pandemic should be limited going forward.
Growth looks to be at a sustainable rate. The optimistic story is that this will allow for the resolution of supply chain problems that drove inflation in the last year. The pessimistic scenario is that higher inflation has become embedded in the economy, but the problem is clearly not a too rapid pace of growth.
CEPR produces same-day analyses of government data on inflation, employment, GDP and other topics. Follow @DeanBaker13 on Twitter to get his quick-take analysis of government data immediately upon release.
