Time to call a spade a shovel

The US Bureau of Economic Analysis announced this morning that real GDP declined at a 0.9 percent annualized rate in the second quarter of the year. Since that's an advance estimate that will be revised twice in the weeks ahead, it amounts to little more than a rounding error. Still, coming after a 1.6 percent fall in Q1, it means that the US economy has now met the most commonly-used definition of a recession: two consecutive quarters of falling real GDP.

Official pronouncements out of Washington this week amounted to a heads-up about what today's data would show. First there was a bizarre attempt by a White House spokesman to move the goalposts on the definition of a recession; this was not a good idea. Then just yesterday, the FOMC statement accompanying the latest interest rate hike conspicuously focused only on the strong labour market as evidence of the robust economy, with no mention of other indicators.

Today's number does not show widespread weakness in the US economy. Much of the decline reflected inventory adjustments, as companies continue to struggle to balance supply and demand in the wake of the pandemic. There were also declines in government spending at both Federal and local levels, as well as in fixed investment. Importantly, personal consumption, which is always the major driver of US economic activity, rose in the quarter, as did exports. 

As the White House tried to point out ahead of the numbers, the call on whether the US is in recession is actually made by the National Bureau of Economic Research. That august body likes to take its own sweet time to make the call, and uses more criteria than just the "two consecutive quarters of decline" rule. Even so, that rule has become so entrenched in recent times that we may as well just accept that as far as most people are concerned, the recession is indeed here.

So how long will it last, and how bad is it likely to get?  It is important not to take too much comfort from the jobs market data, as the FOMC seems to be doing. Employment tends to be a lagging indicator of activity, so if GDP has indeed been falling since some time in Q1, then jobs numbers may be about to take a turn for the worse right about now. This makes the July non-farm payrolls data, due on August 5, a key data point to watch.

What would turn a minor downturn into a real problem for policymakers (and politicians) would be any sign that consumer spending is about to turn lower.  Inflation is the number one economic issue on the mind of Americans right now, and the rapid erosion of purchasing power is already set to take a bite out of non-essential purchases as consumers are forced to spend more on essentials such as food and gasoline. This underscores the importance of keeping inflation expectations under control, so that consumer confidence is not severely eroded. Perverse as it sounds, the steep rate rises seen in the last two months might represent the Fed's best shot at ensuring that the recession remains short and shallow.