Republicans in the House of Representatives are holding the federal government’s ability to pay its bills hostage to enact draconian cuts to a wide range of programs related to health care, science, housing and food security. The U.S. Treasury Department now warns that the federal government may be unable to pay all of its bills as early as June 1. The economy could suffer substantial losses if Congress fails to give the government the ability to make good on its past promises and pay what it owes to people and businesses.
The economy has so far proven to be remarkably resilient in the face of significant headwinds, most notably higher interest rates and heightened uncertainty over the political debt standoff. The Bureau of Economic Analysis reported that the economy grew at an annual rate of 1.1% in the first three months of this year than in the prior three months. Digging just a little bit below the surface shows an even stronger and strengthening economy – for now, at least. Most notably, households and businesses seem to be taking a longer term view, reflected in where they spent their money. This best illustrates the current resilience of the economic recovery.
Here is the basic overview of how the economy did in the first three months of this year. The Bureau of Economic Analysis reported last week that the economy expanded by an annual rate of 1.1% in the first quarter of 2023, down from the 2.6% recorded for the last quarter of 2022. By a separate measure meant to capture the key activities of the private sector – private final sales to private domestic purchasers (PFDP) – the economy actually accelerated. This measure leaves out changes in inventory buildup, exports and imports as well as government spending since all three parts say little about the strength and direction of the domestic private sector. Yet, this part of the economy grew at an annual rate of 2.8% in the first quarter after being flat in the last three months of 2022. The private sector gained steam at the start of the 2023.
The difference between gross domestic product (GDP) changes and the growth of the private sector – PFDP – in the last two quarters is best shown by the role that changes in inventory build ups have played in each quarter. At the end of 2022, businesses increased the rate at which they built up their inventories. This added 1.47 percentage points to the overall growth rate of 2.6%. That is, without businesses speeding up the rate at which they stock piled necessary goods, the economy would have only grown at 1.1% in late 2022. By the same token, businesses slowed the rate at which they increased their inventories in early 2023, which subtracted 2.26 percentage points from economic growth. GDP would have grown by 3.4% if businesses had continued to increase their inventories at the same rate as in late 2022. These swings in inventory spending obscured the underlying movements in the private sector economy in recent months.
Two points related to that private sector movement in the first quarter stand out as particular noteworthy. First, consumer spending sped up from 1.0% at the end of 2022 to 3.7% in the first three months of this year. The jump was especially pronounced in consumer durable spending such as cars from a decline of 1.3% to 16.9% in the most recent quarter. Consumer durable spending is a critical indicator of how households view the future of the economy. They increase their spending on larger, longer lasting products if they think that the economy will continue to grow and they hence will keep their jobs and earnings.
Second, in the same vein, businesses increased their investment spending on structures, especially manufacturing plants and mining operations, at double digit rates at the end of 2022 (15.8%) and in the first quarter of 2023 (11.2%). Businesses committing sharply larger amounts to long-term investments is also an indicator that companies see room for more growth in the near future.
The rest of the economy also showed some renewed strength. Take, for instance, the trade side of the ledger. For one, imports increased again after declining in the last six months of 2022. In early 2023, demand for several imports jumped, particularly for cars, car parts, petroleum and other durable goods such as appliances. The surging demand for imports shows again the strengthening consumer spending. At the same time, exports grew by 4.8% after falling by 3.7% at the end of 2022. A wide range of exports, including cars, planes, food items and other nondurables saw double digit gains in early 2023. More exports likely followed from increased global demand, providing an additional economic boost.
Further, it is possible that part of the resilient private sector activity may be related to more government spending. Government spending at all levels increased at a faster rate in the first three months of 2023 than in the last three months of 2022. Government spending added 0.81 percentage points to economic growth in the first quarter, up from 0.65 percentage points in the second half of 2022. The additional government spending may be related to increased hiring in state and local government that still lags behind its pre-pandemic level. In particular, governments need to expand their capacity to address many of the looming challenges in education, public health and transportation as well as to implement the additional infrastructure spending. As governments increase their capacity to provide vital services and improve the basis of a modern economy, they also provide incomes to private businesses as well as an additional buffer against the ongoing headwinds from higher interest rates and the political standoff in Washington, D.C. and thus some much needed economic certainty.
The economy has proven resilient — so far. Yet, House Republicans seem dead set on testing that resilience by creating unnecessary policy uncertainty. This uncertainty could cloud the outlook for consumers and businesses and slow their spending as a result. Moreover, the push to aggressively cut barebones government services could derail many of the necessary investments into people, businesses and communities. The recent strengthening of the economy could prove to be a short lived mirage, unless Republicans quickly and without conditions allow the federal government to pay all of its bills.
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