As the Federal Reserve signals its intention to raise interest rates soon to battle rising inflation, it’s been easy to overlook how well the economy performed over the past year — and especially during the final quarter.
Real gross domestic product (GDP) grew by a seasonally adjusted annual rate of 6.9% in the fourth quarter of 2021, according to the Bureau of Economic Analysis. That marked the fastest pace of growth since the massive bounce back from the pandemic-induced recession in the third quarter of 2020, and faster than in any quarter prior to the pandemic since the second quarter of 2000.
For the entire year, real GDP ended 5.7% higher in 2021 compared to 2020, the highest rate of growth since 1984.
While the initial headlines were encouraging, the details of the report were more underwhelming, and additional data for the month of December revealed a loss of momentum heading into the new year.
Specifically, although we typically care most about consumers, whose spending accounts for roughly two-thirds of GDP, the buildup of business inventories was the largest contributor to economic growth in the fourth quarter of 2021, accounting for 70% of the gain. The pandemic disrupted factory activity across the world as workers fell sick or were otherwise unable or unwilling to work, creating shortages in the U.S. of many products, including both final goods and component parts that are used in manufacturing other goods.
Combined with robust demand generated from people hunkering down with lots of stimulus-fueled cash and limited options to spend, whatever materials and finished products that firms already had on hand were easily depleted by early 2021. But the return of some factory activity to American shores helped ease supply chain bottlenecks somewhat during the second half of the year, and outsize demand slowed somewhat, allowing firms to restock their shelves.
This increase in inventories was the largest factor in the strong GDP growth registered in the fourth quarter. That might give us pause when looking at potential growth in the first quarter this year. While inventories may continue to grow in the short term — after all, we continue to face a severe shortage of microchips and automobiles — they’ll eventually return to normal levels, causing a drag on real GDP growth in future quarters.
Private domestic investment excluding inventories, government and net exports were nonfactors in real GDP growth in the fourth quarter of 2021, while consumer spending contributed 2.3 percentage points of the 6.9% growth of real GDP in the fourth quarter of 2021, with spending on services contributing much more than goods, a hopeful sign of a return to more normal times.
Evidence of any impact the spread of the omicron variant had on economic growth in the fourth quarter of 2021 is difficult to see in the quarterly report. But monthly data released on real consumer spending show it to have fallen by 1% in December and by 0.2% in November. Spending on goods, both durable and nondurable, fell for the second month in a row in December, while spending on services continued its trend higher, now within 0.7% of pre-pandemic levels.
Consumers pulled back on discretionary items that have been affected by rising inflation, such as jewelry, clothing, furniture and furnishings, and household appliances. While prices for nondiscretionary goods have also risen, households are often not able to pull back on those items as easily. The overall slowdown in spending suggests that economic growth in the first quarter of 2022 will be relatively weak.
With regard to prices, the personal consumption expenditures price index grew by 0.4% in December, ending the year 5.8% higher than in December 2020. That marked the fastest pace of growth since 1981. Higher prices ate into incomes in December, which even in nominal terms were moderating at the end of the year. Real disposable personal income fell by 0.2% in December and ended the year 0.2% lower than in December 2020.
The rapid spread of omicron, inflation and worries about what the Federal Reserve will do this year and next are weighing on consumers. The University of Michigan’s consumer sentiment for January fell by 3.4 percentage points to 67.2, its lowest level in more than a decade. Assessments of both current conditions and expectations of future conditions have headed lower over the last three months as the pandemic lingers, prices keep rising and financial markets swing in response to developments, or lack thereof, in fiscal and monetary policies.
What We’re Watching ….
Omicron became news in December 2021, with the spread of infections through the middle of January. This wave of COVID-19 caused fewer disruptions than earlier waves, but people for the most part still needed to quarantine if they tested positive, and layoffs during this period were higher. These impacts are likely to be reflected in the January jobs report that is set to be released on Friday. Expectations of job growth are all over the place, ranging from a gain of 180,000 jobs to a loss of 150,000. The report will include revisions from the annual benchmarking process and new population controls for the household survey, so the wide range is understandable. The unemployment rate could edge lower yet again, but there’s no indication that the labor participation rate, which is stuck at just below 62%, will improve.
The good news — for workers, anyway — is that labor shortages are driving wages higher, so we’ll expect to see that trend continue in this report as well.