The central theses
- Thursday's GDP report presented a paradox of sorts: the economy is growing in all the right places (e.g. the labor market), but also in the wrong places (prices).
- The report worried some investors and economic observers who fear the U.S. could enter a period in which rapid growth slows while the cost of living continues to rise, known as stagflation.
- Economists said the report's details showed the concerns were unfounded.
- But it makes the job of Federal Reserve officials more difficult as they try to rebalance economic growth and inflation when deciding whether to cut interest rates.
In the post-pandemic period, the US economy has had clear advantages and disadvantages: a good labor market and rapid economic growth, but at the expense of stubbornly high inflation.
But Thursday's gross domestic product (GDP) report hinted at the possibility that this rapid growth is slowing as the cost of living continues to rise rapidly – a combination of a stagnant economy and inflation known by the synonym “stagflation.”
Many economists downplayed concerns about possible stagflation. In recent months, the economy has seemed headed for a “soft landing” from the post-pandemic inflation spike rather than an economic crash, and many experts believe the economy is still on that path even as things improve bumpier.
Thursday's data contained some warning signs. GDP grew at an annual rate of 1.6% in the first quarter, falling well short of economists' average forecast of 2.2%, while inflation, as measured by personal consumption expenditures, rose from 1.8% in the previous quarter rose 3.4%, exceeding expectations.
The “disappointment” lies in the details
However, some economists examined the details and found that the picture was not quite as bleak as it seemed at first glance.
“You will hear a lot about stagflation today. Ignore it.” Ian Sheperdson, chief economist at Pantheon Macroeconomics, wrote on social media platform X.
On the one hand, the slowdown in GDP growth was influenced by an increase in imports. Because of the way GDP is calculated, imports detracted from GDP, but still suggested that people had enough money to buy goods abroad.
In fact, consumer spending on services is rising even as households appear to be cutting back on expensive items, economists at Wells Fargo Securities said in a research note.
In other words, GDP “disappoints for all the right reasons,” Gregory Daco, chief economist at EY Parthenon, posted on X.
Additionally, Daco pointed out that the high inflation numbers were largely driven up by the cost of “financial services,” which are influenced by stock prices rather than broader inflation trends.
Federal Reserve rate hikes “aren’t working”
Since March 2022, the Federal Reserve has been fighting inflation by raising its key interest rate, driving up borrowing costs, to cool the economy and discourage spending – even at the risk of triggering a recession. Even with interest rates currently at a 23-year high, the economy could be on track to continue its rapid growth, for better or worse.
“Higher interest rates are expected to cool consumer demand,” Tim Quinlan and Shannon Seery Grein, economists at Wells Fargo Securities, wrote in a commentary. “The problem for the Fed is: It doesn’t work.”
The Fed's preferred inflation indicator will be released Friday morning, providing another opportunity to assess the impact of high interest rates. Fed officials have repeatedly said they need more confidence that inflation is moving toward the central bank's 2 percent target before cutting interest rates.
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