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Rumors of stagflation in first quarter GDP

Pedestrians walk along Washington Street in Hoboken, New Jersey, on April 7th.


Jeenah Moon / Bloomberg News

Americans have good reason to be apprehensive during the rapid inflation, and on Thursday they received another. The US economy shrank by 1.4% in the first quarter of 2022, the first decline since the pandemic lockdown recession in the first half of 2020. The question is whether this is temporary or a sign of stagflation or an impending recession.

The rationale for optimism is that the decline was largely due to shifting stocks and especially declining exports while the world economy is struggling. Consumer spending and business investment both rose during the quarter, but were surpassed by the export dive. A decline in defense spending also deducted growth. Shares rose sharply on Thursday, suggesting investors are seeing a recovery ahead.

On the other hand, the fall surprised almost all Wall Street economists. Consensus was a growth of 1% or so. The decline also happened despite a historically light monetary policy, as the Federal Reserve has only begun to tighten. Consumer consumption of goods remained unchanged and the pace of gross private investment declined.

The fall in GDP also coincided with an accelerating rise in prices. The GDP price index rose by 8% annually on top of 7.1% in the previous quarter. The Fed’s preferred inflation target, personal spending, increased by 7% when the target is 2%.

A combination of slow growth and rising prices is known as stagflation – the suffering of the 1970s that younger Americans have not experienced. A quarter does not yield stagflation, but the trend is not encouraging.

Bad news is also a year-long drop in real disposable income. The nearby table tells the story. A barrage of federal welfare payments produced an increase in disposable income in early 2021. But these payments plus increases in nominal wages have since been overwhelmed by inflation. This is why most Americans say they are dissatisfied with the economy despite strong growth in employment.

Consumers have reason to feel poorer and they are spending down on the savings they accumulated during the pandemic. The savings rate fell to 6.6% in the quarter from 7.7%, and one concern is that the fall in real wages will cause consumers to spend less in the coming months. It could bring the economy into recession.

An obvious message to the White House and Congress is to avoid any anti-growth policy shocks. Even most Keynesians know that a declining economy is a bad time for a tax increase. Democrats who want to avoid a recession on their guard would do well to end the talk of reviving Build Back Better and rejecting new taxes. President Biden can also help by calling for a moratorium on new regulation.

Sorry to say, Mr Biden does not understand the message. His statement Thursday blamed declining GDP on “technical factors” and said the economy “continues to be resilient to historic challenges.” The inability of the White House to adapt its domestic agenda to the changing economic and political realities is a puzzle of the times. Sens. Joe Manchin and Kyrsten Sinema can help their party by shutting down the entire BBB effort forever.

As for the Fed, the lesson is to stay on its new anti-inflation rate. Retiring now would undermine the credibility of markets and consumers as it seeks to win back. One lesson from the 1970s is that flashes in the anti-inflation struggle will lead to stagflation as the economy returns from a recession or near-recession with inflation still too high. Then the Fed must tighten again and the cycle repeats itself. Better to kill the dragon now.

The tragedy of the Biden presidency is that it should preside over a long post-pandemic boom. Instead, it went wrong to transform the economy by creating a huge and permanently larger state of entitlement. And political bread it may soon be.

The result has been rising inflation and now declining economic growth. If Mr Biden does not want to change course, he will have no choice next year if anxious and frustrated voters throw Democrats out of power in Congress.

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