Month: April 2023

By Paul Gomme and Peter Rupert

The BEA announced that Q1 real GDP increased 1.1% at an annual rate. Many in the press have, obviously, noted the declines over the last two quarters indicates the economy is slowing. Indeed, today’s report “undershot” expectations that were around 2%. However, the underlying components were a bit more mixed and the strength of the economy might be in the eye of the beholder. Real consumption spending increased 3.7%, the largest increase over the last 7 quarters, and disposable personal income rose 8.0%.

The output identity, Y = C + I + G + X – M, tells us the uses of output (the “demand” side). If output growth is down, then one or more of the right-hand side components must be down. From above, consumption growth rose from 1.0% in the fourth quarter to 3.7% in the first quarter. Growth in government spending likewise rose, from 3.8% to 4.7%. However, real investment spending fell 12.5% in the first quarter compared to a 4.5% increase in the fourth quarter. Within real investment, real inventories grew 0.4% (up from -3.7%), non-residential structure investment grew 11.2%, and residential structure investment fell by 4.2% (although this decrease was an improvement over the very negative growth rates for this category late in 2022).

While it has become standard in the U.S. to annualize the quarterly growth in GDP, one could also look at the year-over-year growth rate. Now, Q1 does not look so bad relative to the past few quarters and, in fact, has actually increased over the previous quarter.

The Personal Consumption Expenditure Price Index (PCE) rose 4.2% in the first quarter compared to growing 3.7% in the previous quarter, obviously high above the FOMC’s 2.0% target.

These developments lead to a murkier monetary policy outlook. Output growth has slowed, perhaps reflecting the cumulative effects of monetary policy tightening over the past year. Yet, PCE inflation is still well above the Fed’s 2% target (see also the CPI and PPI), and consumption growth actually accelerated in the first quarter. In previous posts, we have noted that the labor market is still quite strong, with an historically low unemployment rate, and roughly two job openings for every unemployed person. Given that, there is nothing new to dissuade the FOMC from another rate hike or two.

By Paul Gomme and Peter Rupert

According to the Establishment Survey from the Bureau of Labor Statistics , employment increased by 236 thousand in March 2023. While this increase is the smallest thus far for 2023, it’s close to the average for the second half of 2022. The BLS also revised the change in employment for February up from 311 thousand to 326 thousand, and revised its reading for January down from 504 thousand to 472 thousand.

The BLS also reported that even though employment was up, average weekly hours were down, so that total hours worked fell 6.8 million hours in March which follows on the heels of a 4.1 million hour decline in February. The chart below shows considerable variation in the change in hours worked.

Private sector employment was up 189,000 and the government sector added 47,000 jobs. The private service sector added 196,000 jobs while the goods producing sector shed 7,000 workers. The largest gain in the service sector came from Leisure and Hospitality, adding 72,000 jobs.

Commentators have noted the decline in average hourly earnings, down 4.24% compared to March of 2022. This has been portrayed as a positive development for policymakers. The reason for this positive portrayal is that if higher inflation expectations become entrenched, then workers will want higher wages (to compensate for the higher inflation) which may lead to wage-price spiral in which wage increases feed to price increases which, in turn, feed into further wage increases, and so on. However, as with our commentary on inflation, year-over-year wage changes (the ones discussed by commentators) are slow to pick up changes in trend. And, as with annualized monthly inflation rates, month-to-month changes in average hourly earnings can be quite noisy; indeed, the annualized percentage change over the month actually rose 3.3% compared to 2.5% for the previous month. A 3 month average of monthly earnings growth smooths out some of the monthly fluctuations while, at the same time, picking up changes in trend in a timely fashion.

Readers of this blog know that inflation has generally been running higher than earnings growth. In previous posts, we have plotted average hourly earnings along side various price levels. Here, instead, we present real average hourly earnings: earnings divided by measures of the general price level. So that these measures are all comparable, we divide the consumer price index (CPI) by its average for 2012. The choice of 2012 is motivated by the fact the personal consumption expenditures (PCE) price index is already set to equal 100 in 2012. The chart below expresses average hourly earnings in 2012 dollars. Both CPI measures exhibit declines since 2021: For the overall CPI, average hourly earnings have declined by roughly $1 per hour, while core CPI records a decline of $0.42 per hour. Alternatively, using the PCE price index, earnings fell by $0.36 per hour; using the Fed’s favorite price index, core PCE, earnings have been essentially flat since the start of 2021.

The Household Survey from the BLS showed a 577,000 increase in employment. Moreover, the labor force, the participation rate and the employment to population ratio all increased. The unemployment rate fell from 3.57% to 3.50%. The Jobs Opening and Labor Turnover Survey still shows significant job openings even though they have come down some over the last few months.

Overall, the employment report shows a still-strong labor market, albeit there are signs of slowing in some areas. The Fed seems to have calmed inflation at this point and, depending on what unfolds over the next month or two, there may be a pause in raising rates since monetary policy tends to work with a lag.

By Paul Gomme and Peter Rupert

The BEA announced a downward revision from 2.7% to 2.6% in the third and final estimate of Q4 GDP. The revision primarily reflected downward revisions to exports and consumer spending. The final estimate for 2022Q4 GDP did not change the overall stance of the US economy.

Several sources picked up on the fact that the PCE price index, the primary inflation index cited by the Fed, fell. CNBC reported: “On a 12-month basis, core PCE increased 4.6%, a slight deceleration from the level in January.” The New York Times remarked,

The measure of inflation most closely watched by the Federal Reserve slowed substantially in February, an encouraging sign for policymakers as they consider whether to raise interest rates further to slow the economy and bring price increases under control.

The Personal Consumption Expenditures Index cooled to 5 percent on an annual basis in February, down from 5.3 percent in January and slightly lower than economists in a Bloomberg survey had forecast. It was the lowest reading for the measure since September 2021.

NYT, March 31, 2023

However, as we remarked in an earlier post, measured inflation is sensitive to the time horizon over which it is computed. Annualized month-to-month inflation rates are quite volatile; year-over-year inflation is much smoother, but is slow to reflect changes in trend inflation. And it’s trend inflation that policymakers, among others, are concerned about. Yet, identifying trend inflation is difficult. One approach is to average monthly inflation rates over a few months. In the figure below, we include the 3-month average of monthly inflation rates which is our attempt to balance the desire to smooth monthly inflation rates while capturing changes in trend in a timely fashion.

The Fed tends to focus on so-called core PCE inflation for which the volatile food and energy components are removed. Presumably, the reason for looking at core PCE inflation is that it gives a better read on trend inflation. To be sure, core PCE inflation is less volatile, as shown in the chart below. Nonetheless, this measure continues to exhibit large fluctuations when measured on a monthly basis. And, it should not be surprising that the annual (year-over-year) inflation rate is smoother, but slow to reflect changes in trend inflation. Again, we include the 3-month average of monthly inflation rates.

One way to think about the problem of extracting a measure of trend inflation from the data is that observed inflation is composed of trend inflation and an ‘error’ which reflects issues in measuring trend inflation. In the jargon of the profession, we face a signal extraction problem: we are trying to extract the signal (trend inflation) from noisy data (measured inflation). Averaging monthly inflation rates over some horizon (for example, over 3 months, as above) can be thought of as canceling out the positive and negative error terms in this signal extraction problem. (Again, using some jargon, ideally the errors are uncorrelated over time, or independently and identically distributed.)

Finally, what are the policy implications of the latest PCE price index numbers? As mentioned above, some commentators have noted that PCE inflation was down in February relative to January. True enough when looking at either the monthly inflation rate, or the year-over-year inflation rate. However, the 3 month average inflation rate is up. It is hard to make a strong case that there has been a change in trend inflation. In any event, all of the gauges of inflation presented above continue to run well above the Fed’s stated 2% target.