A global public health crisis resulting in a 31.4% decline in gross domestic product in the second quarter of last year has turned to expansion because of sustained robust fiscal aid and unorthodox monetary policy.
The U.S. economy grew by 6.5% in the second quarter, marking the start of the current business cycle and the return to an above pre-pandemic level of overall economic activity. The 6.5% increase, reported by the Commerce Department on Thursday, is the second-best quarter since 1983 and may mark the apex of the current cyclical expansion.
The composition of the growth was nothing short of virtuous. Household consumption rose by 11.8%, outlays on equipment grew by 13%, intellectual property by 10.8% and software investment increased by $13.8 billion—all of which helped drive the growth. These strong numbers imply that both the quality and strength of growth are much better than that indicated by the top-line advance of 6.5%.
Rising outlays on productivity-enhancing capital expenditures bode well for growth in the future and improved living standards.
Rising outlays on productivity-enhancing capital expenditures—software, equipment and intellectual property—bode well for growth in the future and improved living standards. The robust pace of equipment investment marked the sixth straight quarter of large double-digit increases, and intellectual property had the third straight double-digit quarter of growth.
This should provide material comfort to Federal Reserve officials who are considering when to announce a reduction the central bank’s $120 billion in monthly asset purchases, which we think will occur at the December meeting of the Federal Open Market Committee.
We think that a slower-than-expected pace of growth and the virtuous composition of that growth should provide some relief to those concerned about the prospect of the economy overheating. It is highly likely that the current constraints on global supply chains will simply not persist.
Moreover, the fading of fiscal support, which began in the second quarter with a decline of 1.5%, should also assuage some worries about inflation. Yes, inventory accumulation pushes that growth forward, but one should not discount the productivity-enhancing nature of the current composition of growth and how that will dampen inflation over the medium to long term.
The inventory question
The major drag on growth and the primary reason that the top-line figure of 6.5% came in below consensus forecasts was the 1.1% decline ($77.8 billion) in inventory destocking.
While the lack of inventory accumulation played a role in keeping down the large top-line gains, supply chain constraints will ease and production bottlenecks will clear. That in turn will bolster domestic industrial production and manufacturing, which will push growth forward into later this year and early next year.
Although there will be plenty of talk around growth peaking in the current quarter, once inventory accumulation begins we could very well see a quarter of growth that is stronger than the current 6.5% or the revised 6.3% in the first three months of the year.
Looking forward, we expect sustained growth above the 1.8% long-term trend through next year and likely into 2023 because of the nearly $3 trillion in savings accumulated by American households and long-awaited wage growth that is taking place down the income ladder.
The long echo of the pandemic has resulted in households building up precautionary savings that will take some time to unwind. We expect a smoother path of consumption than some economists envision, which will boost growth next year and in 2023. That will, in our forecast, be the difference between higher rates of growth and the return to trend growth late next year or in 2023.
Alternative metrics of growth, like the top-line GDP estimate, were robust, with real final sales up by 7.7%, gross domestic purchases increasing by 6.7%, final sales to domestic purchasers jumping by 7.9% and final sales to private domestic purchasers advancing by 9.9%.
Household consumption was bolstered by a 9.9% increase in outlays on durable goods, a 12.6% gain in non-durable goods and a 12% increase in demand for services.
Gross private investment declined by 3.5%, with fixed business investment rising at a 3% pace. Outlays on nonresidential investment climbed by 8% with investment on structures falling by 7%.
Residential investment declined by 9%, which was clearly a function of the supply shocks that moved through the economy in general and the residential investment ecosystem in particular. With costs of materials used in production already declining—lumber prices are down 54% since the May peak—that will turn noticeably in the current quarter and through the remainder of the year.
Government consumption declined by 1.5%, with federal spending down by 5%. State and local spending advanced by 0.8%. Outlays on national defense dropped by 0.8%, and nondefense spending increased by 10.4%.
The external sector resulted in a 6% increase in demand for exports, and U.S. imports were up by 7.8%. Imports of goods were up by 5.8% and imports of services rose by 19.3%. Exports of goods were up by 5.7% and exports of services increased by 6.7%.
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