Is a Drop in GDP a Recession Signal?

Gross Domestic Product (GDP) is a quarterly economic report that is the broadest measure of goods and services. GDP contracted at an annualized pace of 1.4% in the first quarter, according to the U.S. BEA. Per Investor’s Business Daily, a 1.1% rise was forecast.

To begin with, the unexpected decline highlights the difficulty economic forecasters are having in today’s environment. It’s not the first time prognosticators missed big.

Practically speaking, does the decline mean the economy is entering a recession?

If we review the underlying numbers, a near-term recession is unlikely. About 85% of Q4’s strong 6.9% growth rate was generated by a surge in inventories per the U.S. BEA.

In Q1, consumer and business spending accelerated versus Q4, which is encouraging. Furthermore, spending on services, which are benefiting from the reopening, was strong.

Q1’s contraction occurred amid a slowdown in inventory growth, a big drop in exports, and a dip in defense spending per U.S. BEA data. Besides, we experienced quarterly declines in 2011 and 2014 without falling into a recession.

If we average Q4 with Q1, it probably paints a more realistic picture of overall economic growth.

But inflation remains a problem, as the graphic below illustrates. Nominal GDP expresses values by obtaining activity using current prices. Keeping things simple, if a company sells 10 items at $10 one month and 10 items at $11 in the next month, activity is up from $100 to $110.

Real GDP, however, adjusts for inflation. It measures the quantity of goods and services but adjusts for changes in prices. In our simple example, ‘real’ sales would remain unchanged.

Real GDP, which fell at an annual rate of 1.4% in Q1, is about $500 billion above the pre-pandemic peak. But given rising inflation, nominal GDP has soared and is over $2 trillion above the pre-pandemic peak, i.e., rising prices are having a big influence on nominal GDP.

In summary, Q1 didn’t reflect weakness in consumer or business spending. In fact, it was just the opposite. Government stimulus helped in a big way last year. The strong GDP numbers early in the recovery are unlikely to repeat.