Americans have good reason to worry amid rapid inflation, and on Thursday they received another one. The US economy contracted in the first quarter of 2022 by 1.4%, the first decline since the pandemic recession in the first half of 2020. The question is whether this is, well, temporary, a sign of stagflation or the next.
The reason for optimism is that the downturn was largely due to shifting inventories and especially lower exports as the global economy struggles. Both consumer spending and business investment grew in the quarter but were outpaced by a decline in exports. A decrease in defense spending also deducted from growth. Shares rose sharply on Thursday, indicating that investors see a recovery ahead.
On the other hand, the deflation surprised almost every Wall Street economist. The consensus was for 1% growth or so. The decline also occurred despite historically easy monetary policy, with the Federal Reserve only beginning to tighten. Consumer spending on goods has been flat, and the pace of overall private investment has slowed.
The decline in GDP also coincided with an accelerating rise in prices. The GDP price index rose at an 8% annual rate, above 7.1% in the previous quarter. The Fed’s preferred measure of inflation, personal consumption expenditures, rose 7%, when its target was 2%.
The combination of slow growth and high prices is known as stagflation – a crisis of the 1970s that younger Americans did not experience. One quarter does not make for stagflation, but the trend is discouraging.
Also bad news is that real disposable income has fallen for a year. The nearby table tells the tale. The explosion of federal welfare payments increased disposable income in early 2021. But these payments, along with increases in nominal wages, have since been overshadowed by inflation. This is why most Americans say they are not satisfied with the economy despite strong employment growth.
Consumers have reason to feel poor, and they spend the savings they have accumulated during the pandemic. The savings rate fell to 6.6% in the quarter from 7.7%, worrying that the decline in real wages will cause consumers to spend less in the coming months. This could push the economy into a recession.
One of the clear messages to the White House and Congress is to avoid any shocks against growth policy. Even most Keynesians know that a slowing economy is a bad time to raise taxes. Democrats who want to avoid a recession under their watch would be wise to end talk of a “building back better” revival and ditch the new taxes. President Biden could also help by calling for the new regulation to be suspended.
Sorry to say, Mr. Biden does not understand the message. His statement on Thursday blamed the GDP contraction on “technical factors” and said the economy “remains resilient in the face of historic challenges”. The failure of this White House to adapt its domestic agenda to changing economic and political realities has been a puzzle for the ages. Senators Joe Manchin and Kirsten Senema could help their party by shutting down the entire BBB effort for good.
As for the Fed, the lesson is to continue on its new anti-inflation course. Backtracking now would undermine credibility with markets and consumers trying to win them back. One of the lessons from the 1970s is that a flash in the fight against inflation will lead to stagflation, in which the economy recovers from recession or near recession as high inflation persists. Then the Fed has to tighten again, and the cycle repeats itself. Better slay the dragon now.
The tragedy of Biden’s presidency is that it has to preside over a long post-pandemic boom. Instead, he went to meltdown to change the economy by creating a widespread and permanent state of entitlement. It may soon be politically collapsed.
The result has been high inflation, and now economic growth has slowed. If Mr. Biden does not change course, he will have little choice next year if anxious and frustrated voters remove Democrats from power in Congress.
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