Rumors of Stagflation in First Quarter GDP

Pedestrians walk along Washington street in Hoboken, New Jersey, April 7.


Jeenah Moon/Bloomberg News

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

The case for optimism is that the contraction was largely attributable to shifting inventories and especially falling exports as the world economy struggles. Consumer spending and business investment both grew in the quarter but were exceeded by the export plunge. A decline in defense spending also deducted from growth. Equities rose sharply on Thursday, which suggests investors see a rebound ahead.

On the other hand, the contraction caught nearly every Wall Street economist by surprise. The consensus was for growth of 1% or so. The decline also occurred despite historically easy monetary policy, as the Federal Reserve has only begun to tighten. Consumer spending on goods was flat, and the pace of gross private investment declined.

The GDP decline also coincided with an accelerating rise in prices. The GDP price index rose at an 8% annual rate on top of 7.1% in the previous quarter. The Fed’s preferred inflation measure, personal consumption expenditures, rose 7%, when its target is 2%.

A combination of slow growth and rising prices is known as stagflation—that 1970s affliction that younger Americans haven’t experienced. One quarter does not make stagflation, but the trend isn’t encouraging.

Also bad news is a year-long decline in real disposable income. The nearby table tells the tale. A burst of federal welfare payments produced a disposable income arises in early 2021. But those payments plus increases in nominal wages have since been overwhelmed by inflation. This is the reason most Americans say they’re unhappy with the economy despite strong employment growth.

Consumers have caused to feel poorer, and they are spending down the savings they accumulated during the pandemic. The savings rate fell to 6.6% in the quarter from 7.7%, and a concern is that the decline in real wages will cause consumers to spend less in the coming months. That could tip the economy into recession.

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

Sorry to say, Mr. Biden isn’t getting the message. His statement from him Thursday blamed shrinking GDP on “technical factors” and said the economy “continues to be resilient in the face of historic challenges.” The failure of this White House to adapt its domestic agenda to changing economic and political reality is a puzzle for the ages. Sens. Joe Manchin and Kyrsten Sinema can help their party by shutting down the whole BBB effort for good.

As for the Fed, the lesson is to stay on its new anti-inflation course. Pulling back now would undermine the credibility with markets and consumers it is trying to win back. One lesson of the 1970s is that blinking in the anti-inflation fight will lead to stagflation, as the economy rebounds from a recession or near-recession with inflation still too high. Then the Fed has to tighten again, and the cycle repeats itself. Better to slay the dragon now.

The tragedy of the Biden Presidency is that it should be presiding over a long post-pandemic boom. Instead it went for broke to transform the economy by creating a vast and permanently larger entitlement state. And politically broke it soon may be.

The result has been soaring inflation, and now declining economic growth. If Mr. Biden won’t change course, he will have little choice next year if anxious and frustrated voters toss Democrats out of power in Congress.

Wonder Land: Biden and the party’s progressives think spending money will earn voter gratitude. Not this time. Images: Getty Images Composite: Mark Kelly

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