Is the U.S. Economy Actually Shrinking?

Official statistics from the Bureau of Economic Analysis show the US economy contracted by -1.6% in the first quarter and then again by -0.9% in Q2.¹ Technically speaking, two consecutive quarters of negative GDP growth meets the technical definition of an economic recession, but whether or not the U.S. was contracting is a different story. A key measure of economic output suggests the recession was avoided, at least for now.²

To understand how the economy could have been plateauing or even expanding slightly, it is important to note that there are two ways to measure economic output: gross domestic product (GDP) and gross domestic income. When all transactions in the economy are taken into account, there are essentially two sides to the ledger to consider. On one side are all of the individuals and businesses spending money to purchase goods and services. All of this spending is captured in the GDP figure.

On the other end of those transactions, however, there are businesses and other individuals earning income and delivering the goods and services. This is known as Gross Domestic Income, or GDI. The data gathered in GDI is made up of corporate earnings, wages, self-employment income, interest, and rent.

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In most quarters and years, GDI and GDP readings track fairly closely to one another, with slight but not necessarily exaggerated discrepancies in every print. In 2022, however, the discrepancy has been notably wide – in the first half of the year, GDP was said to have contracted at a -1.1% annual rate, while GDI showed an increase of 1.6% year-over-year. Higher wages and a boost in self-employment income and rents likely drove the growth.

A common practice in the macro-analytical world is to average the GDP and GDI readings to provide a better idea of how the economy may be faring. By that measure, the first half of 2022 saw a very modest expansion of 0.2%, which suggests a recession did not take place after all. And since a recession is defined as a broad and sustained contraction in overall activity, we are of the mindset that GDI painted a clearer picture of the economy over the last six months than GDP, especially when considering how tight the labor market remains.

The second quarter saw robust job growth, rising wages, and consumer spending that held up remarkably well despite inflationary headwinds. In Q1, we believe there were some features of the GDP calculation that masked underlying activity. Specifically, there were three main detractors of the GDP headline figure:

1. Trade Deficit – imports are subtracted from GDP figures while exports are added. Imports often make their way into other parts of GDP, most notably in consumer spending, which is the reason they detract from GDP. But investors should not get too fixated on trade deficits as a measure of an economy’s overall health. What matters more is total trade, which gives a better indication if more goods and dollars are trading hands overall.To that point, total trade was up solidly in Q1. The imports of goods soared 11.5% to $294.6 billion, while the exports of goods also rose 7.2% to $169.3 billion. The fact that imports rose at a much faster clip than exports is a negative for GDP calculations but does not necessarily signal trouble in the economy. In fact, trade has subtracted from U.S. GDP growth for the last six quarters, which has been a strong period overall for growth.
2. Slow Inventory Investment – one of the main drivers of Q4 2021’s robust 6.9% GDP figure was inventory investment by businesses. Many companies – fearing additional supply chain snags in the new year and anticipating higher demand – stocked up on products. The inventory buildup in Q4 was enough to add over 5% to headline growth, a pretty massive contribution. It makes some sense, then, that in Q1 2022 companies would not need to keep up that same pace of inventory investment, which ultimately meant that inventory investment subtracted -0.84% from GDP. That’s an over 6% difference from one quarter to the next, which was not very typical.
3. Falling U.S. Government Spending – finally, government spending fell in Q1 and Q2 as the stimulus measures tied to the pandemic have largely run their course. Government spending fell at a -2.7% annualized pace, which in Q1 2022 meant subtracting 0.48% from the headline GDP figure. This part of the GDP equation did not come as a surprise to anyone watching closely – the fading effect of pandemic stimulus spending is widely known.

This is not to say that the US will avoid recession altogether – some leading indicators like the Conference Board LEI and the 10-year / 3-month US Treasury bond yield curve are getting close to outright flashing recession. With the Federal Reserve committed fully to tightening financial conditions, it seems very possible that a recession could be in store in the second half of 2022 or early next year. Market volatility today may be pricing-in this possibility.

Bottom Line for Investors

Whether or not the US economy entered a recession in the first half of 2022 is a declaration ultimately made by the National Bureau of Economic Research (NBER). In deciding whether to characterize the economic slowdown as a recession, they consider a wide range of factors beyond GDP, like productivity, gains or losses in the jobs market, and wages. They also consider GDI, which paints a different picture of the US economy than the one we’re seeing today.

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¹ BEA, U.S. Economy at a Glance. 2022.

² Wall Street Journal. August 29, 2022.

³ Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

⁴ Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

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