Gross domestic product shrank again last quarter, confirming the widespread impression that the economy is lousy.
The Commerce Department on Thursday reported that economic output contracted at a 0.9 percent annual rate in the April through June period, which followed the 1.6 percent decline in the first three months of the year. As everyone now knows, that fits the bill for a common definition of a recession even if the official declaration from the National Bureau of Economic Research has not yet been made.
A big driving force in the contraction was businesses reducing the pace of inventory accumulation. This was enough to subtract two percentage points from GDP. And as massive retailers such as Walmart have made clear, it’s likely that this will continue to be a drag on the economy in the third quarter and perhaps even into the fourth, which means the economy is likely to continue to contract for the rest of year.
The contraction would have been even more severe if consumer spending had not kept growing in the quarter. Yet this source of strength for the economy softened in the spring—meaning the pace of spending growth slowed—and recent information indicates that it may be rolling over as consumers face higher interest rates and inflation exhaustion. Final sales to private domestic purchasers—regarded by many economists as a barometer of underlying demand—had grown three percent in the first quarter. In the second quarter, it did not grow at all. The third quarter may see final sales actually retreat—especially if the Fed keeps hiking interest rates—which would mean an even sharper downturn for GDP.
This is all the more remarkable because inflation accelerated in the second quarter, with June prices up 9.1 percent compared with a year ago. According to economic theory, inflation is supposed to be a sign of an economy overheating. We have inflation in an economy that is at stall speed. There’s no official arbiter of when we enter into a period of stagflation, but it is safe to say that’s what we experienced in the first half of 2022.
Friday will bring the final read on consumer sentiment. The expectation is for the University of Michigan gauge to remain unchanged from the deeply depressed level recorded at mid-month. It may even show some improvement since gasoline prices have stayed low. Perhaps the most important part of the report will be on inflation expectations. Has Fed Chair Jerome Powell convinced the public that he really will bring inflation all the way down to two percent in the foreseeable future? If not, the Fed may decide it needs a bigger hike than the 25-basis points markets are expecting in September.