This is what an overheating economy looks like. Growth in the first three months of the year contracted at a 1.4% pace as Americans turned to imports to meet torrid demand that is simply unsustainable.
While the grim top-line number belies strong domestic productivity-enhancing business investment and solid consumer spending, this data reinforces the idea that price stability is a precondition of maximum sustainable employment and virtuous growth.
For those who think this data will cause policymakers at the Federal Reserve to hesitate on their plans to push the policy rate well above the terminal rate of 2.5% by the end of the year, think again. First-quarter growth data underscores that policy direction and will most likely add to the urgency at the central bank to move decisively.
Beneath the headline
The top-line decline in growth was driven by a significant slowing in inventory building and a large increase in the trade deficit.
Inventory building slowed to $158.7 billion in the first quarter from a $193.2 billion pace, resulting in a 0.84% drag on growth during the first three months of the year. The trade deficit dampened growth by 3.2% during the first 90 days of the year.
Beyond those numbers, the growth data looked quite strong as one would anticipate in an overheating economy. Consumer spending increased by 2.7%, fueled by a 4.1% increase in durables and a 4.3% increase in demand for services. Spending on non-durables declined by 2.5%.
Gross private investment expanded at a 2.3% rate while fixed investment advanced at a 7.3% pace and nonresidential investment increased by 9.2%.
The silver lining beneath the dour top-line data is that productivity-enhancing investment in equipment increased by 15.3% and intellectual property investment jumped by 8.1%.
Residential investment advanced by 2.1% and investment in structures declined by 0.9%. This business investment underscores something we have been noting for some time: Activity in the real economy remains rock solid and will result in a productivity boom inside the American economy.
Given the policy challenge posed by inflation, rising productivity on the margin will dampen pricing pressures in the coming years and boost living standards once the central bank creates the condition for the return of price stability.
Exports declined by 5.9%, while imports increased by 17.7%, driven by an increase in demand for foreign goods of 20.5% and a 4.1% increase in internationally provided services.
Government consumption declined by 2.7%. Federal spending dropped by 5.9% which was mostly a function of an 8.5% decline in outlays on national defense and a 2.2% drop in non-defense spending.
