Why 2Q22’s Advanced GDP Estimate is Not a Recession Indicator

For context let’s first review the basics. Real GDP is the inflation adjusted monetary value of all final goods and services produced, and sold, within a country during a quarter. It’s made up of four primary categories:

1. Consumer spending
2. Business spending
3. Government spending
4. Net Export

Although it’s easy to react to a headline number, the devil is in the details for these large data dumps. Yes, it’s true that the advanced estimates for Real GDP were negative for the last two quarters, but the underlying data that resulted in those numbers has been anything but traditionally seen during the “name brand” recessions. Typically negative GDP is marked by negative Consumer Spending (first category mentioned above). Notably, this category has stayed positive through both negative estimates of GDP this year. This fact, along with the data that shows aggregate consumer savings remain high, debt/disposable income ratios are near all time lows, and the labor market is strong, shows the consumer (the foundation of our economy) remains healthy. If this number were to be negative, then the recessionary light would start flashing yellow.

Now that we have addressed the first and most important category of GDP, let’s talk about the categories behind the negative readings. Namely, in Q1 it was Net Exports (fourth category mentioned above) and in Q2 it was Change in Private Inventory (a large part of the second category mentioned above). Without those being so dramatically negative, Real GDP would have been quite positive actually. We will ignore the third category, Government Spending, as that tends to be immaterial.

So, let’s jump into this idea further, if Q1 Real GDP was negative because Net Exports were negative why is that not bad? Well, Net Exports is negative when we import more than we export. It’s a sign of strong demand (a good sign for the larger economy). We subtract the net number as these items are not officially produced in the U.S. and so we cannot account for them in our own production.

Next, Q2 Real GDP was negative because companies had to draw down their inventory to meet high/excess demand. When companies sell inventory that was produced during a previous quarter, during this quarter, we cannot attribute it to this quarter (see GDP definition above), and therefore must subtract it from Real GDP. Again, this imbalance resulted in overall Real GDP to be negative, but it really shows demand is strong.

TLDR: GDP is not a monolith and the contributions of each category matters. Consumer spending is still growing and the negative headline numbers were caused by categories that actually reinforce this fact.