Does the First Quarter Decline in GDP Mean the U.S. is Heading for a Recession?

Decline in GDP

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In last Saturday’s news roundup Credit Sesame reported on the U.S. Bureau of Economic Analysis’ (BEA) announcement that the country’s Gross Domestic Product (GDP) declined by 1.4% in the first quarter of 2022.

GDP is a broad measure of economic activity. It indicates whether the economy is growing or shrinking, and the pace at which changes are occurring. 

The GDP fluctuates from quarter to quarter, but this drop of 1.4% was below analyst expectations of a 1% gain. While this does not mean the U.S. is heading into a recession, it may be cause for concern. Here’s what to watch for next.

Negative GDP Growth in the First Quarter of 2022

GDP takes into account spending by consumers, businesses and governments (federal, state and local). It also includes the net amount of imports and exports. 

Significantly, GDP numbers are quoted on an inflation-adjusted basis. This after-inflation measurement is called “real GDP.” The recent surge of inflation not only requires more economic growth to stay ahead of rising prices, but it’s likely to make quarter-to-quarter GDP numbers more erratic. 

Another important thing to note before drawing too many conclusions from one GDP announcement is that this was just an advance estimate of GDP. Because so much data goes into calculating GDP, the BEA revises its estimates as more information becomes available. 

To be able to provide a timely estimate of GDP but then make its measurement as accurate as possible, the BEA issues three estimates of GDP each quarter.

  1. Around a month after the end of the quarter.
  2. About two months after the end of the quarter.
  3. Nearly three months after the end of the quarter.

The GDP estimate generally changes about half a percentage point one way or the other between the first and second estimate. So, last week’s estimate may not be the definitive measure of economic activity in the first quarter of 2022. Even so, the negative estimate is a warning sign worth noting for a several reasons.

  1. Other than the recession precipitated by the start of the pandemic in early 2020, this is the first negative quarter for GDP since the first quarter of 2014.
  2. The -1.4% change in GDP is an abrupt decline from the robust 6.9% growth rate in the previous quarter.
  3. Three out of the four quarters of 2021 featured GDP growth rates in excess of 6%.

The decline in economic activity in the first quarter may indicate that the phase of rapid recovery from the pandemic-induced recession of early 2020 is now over. 

A Setback, Not a Recession

While this negative quarter of GDP is a meaningful setback, it is not yet a recession. 

Recessions are periods of negative growth based on the length and depth of declines in GDP. A single quarter’s worth of mildly negative GDP is not enough to be considered a recession.

Not only is it just one quarter’s worth of data, but -1.4% is a very slight decline when you take into account that GDP numbers are reported on an annualized basis. The BEA uses the quarterly change in GDP to calculate the rate of change it would represent if it continued for a full year. 

The -1.4% annual rate of decline means that the economy shrunk by 0.36% in the first quarter. It was a negative number, but just barely.

Also, keep in mind that the change in GDP is only negative after adjustment for inflation. However, that rising inflation rate complicates decisions about addressing the economic setback. 

Complicating the Fed’s Decision

The first quarter GDP announcement came less than a week before the scheduled May 3-4 Federal Open Market Committee meeting. Those meetings are where the Fed considers changes to interest rates and other monetary policy decisions.

It’s widely expected that the Fed will raise interest rates at that meeting in an effort to slow inflation. It’s unlikely that the Fed will allow a slight decline in first quarter GDP to deter it from taking that action. Still, the situation highlights the tough choice between controlling inflation and encouraging economic growth.

The Fed often describes its mission as trying to strike a balance between promoting job growth and limiting inflation. When job growth is weak, the Fed may lower interest rates to encourage spending and investment. When inflation is rising, the Fed may raise rates to slow the pace of spending.

Employment growth has been strong for well over a year now and inflation has been rising quickly. That makes raising interest rates seem the logical course of action. Where the dilemma comes in is that the sudden downturn in the economy may be a sign that the job market’s about to weaken.

If that’s the case, then raising rates too abruptly could make the problem worse. However, the Fed has gotten behind the curve when it comes to curbing inflation. That appears to leave them little choice other than to raise rates.

What to Watch Next

The Fed will announce its decision about interest rates on May 4. On May 6, the Bureau of Labor Statistics will release its jobs report for the month of April.

If it turns out that job growth remained strong, a rate hike will look like it was clearly the right move to make. 

On the other hand, if the job growth turns out to have weakened significantly, it would suggest the economy is slipping into a worst-of-both-worlds phase of weak growth and rising prices.

In the 1970s, the combination of economic stagnation and inflation was known as “stagflation.” If the current economy is in for a revival of stagflation, it gives the Fed a very tough choice between raising rates to restrict inflation and keeping rates low enough to encourage growth.

Rising prices and weakening job prospects is also a worst-of-both-worlds scenario for consumers. That combination would make this a good time to rein in spending and reduce debt. That’s the best way to protect against both rising prices and lower job security.

Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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