Economy Statement by Eric Van Nostrand, Acting Assistant Secretary for Economic Policy, for the Treasury Borrowing Advisory Committee July 31, 2023

Introduction

The U.S. economy continued to show resilience and strength in the second quarter of 2023.  Real GDP grew for the fourth consecutive quarter, picking up slightly from the pace in the first quarter.  Labor markets remained tight: payroll job growth was strong and unemployment rates remained near historically low levels.  Labor supply—particularly among prime-age (ages 25-54) workers—increased while labor demand cooled modestly, though high levels of job openings indicated that demand remains firm.  Although inflation remained elevated in the second quarter, it has eased over the past several months.  Measured year-over-year, headline inflation was the lowest since April 2021, reflecting a significant reduction in energy and food prices.  And while core inflation remains above the Fed’s target, price pressures on other goods have eased on balance.  Furthermore, inflation for housing rent as well as other core services has slowly eased.  While much remains uncertain, this progress indicates that a path toward a “soft landing” remains viable.

Even so, the U.S. economy faces important headwinds moving into the second half of 2023.  Slowing global economic growth has weighed on demand for U.S. exports, and geopolitical shocks could renew price pressures if supply chains are further disrupted.  Indeed, unwelcome upward shocks to inflation may introduce instability to parts of the financial system and endanger that soft landing toward which the U.S. economy is currently tracking.  To date, however, most economic indicators have been encouraging. Neither GDP nor other popular business cycle indicators suggest near-term contraction.  Only two indicators—real manufacturing and trade sales and industrial production—showing weakness specific to the manufacturing sector, but all others used by the NBER for business cycle dating have shown net growth, year to date. 

Real Gross Domestic Product (GDP)

In the second quarter of 2023, real GDP growth accelerated to 2.4 percent at an annual rate, picking up from a 2.0 percent gain in the first quarter (see Table 1 – Real Gross Domestic Product).  Stronger growth in business fixed investment (BFI) drove the acceleration, along with an upturn in private inventory investment, which was partly offset by a wider net export deficit and slower, but still positive, growth in household consumption and government purchases.

We decompose GDP into four components: (1) private final domestic purchases (PDFP), the most persistent and stable components of output including personal consumption, business fixed investment, and residential investment; (2) government consumption and investment; (3) net international purchases; and (4) intermediate demand (or change in private inventories).  Examined separately, each component delivers specific information about activity in various sectors that can be useful in predicting the future path of growth.  The PDFP measure is especially telling of the private sector’s capacity to drive self-sustaining growth and as such, can signal the direction of future economic performance.  In the second quarter, real PDFP growth slowed to 2.3 percent at an annual rate but still contributed 2.0 percentage points to total GDP growth—a robust figure given our supply-side growth.

First, we review changes in the components of PDFP.  Household consumption growth eased in the second quarter, largely reflecting a marked slowdown in demand for durable goods.  Goods consumption was led by purchases of recreational goods and vehicles, as well as gasoline and other energy goods, but purchases of motor vehicles declined in the second quarter, after a sizeable gain in the first quarter.  The rotation in spending from goods to services persisted.  Although consumption of services grew at a slower rate than in Q1, it still outpaced purchases of goods, with services adding nearly six times more to real GDP growth than goods consumption.  Services spending growth was largely due to housing and utilities, health care, and financial services and insurance—which together accounted for 1.0 percentage points of services growth.  By contrast, consumption of food services and accommodations declined for the first time since 2020.

Meanwhile, business fixed investment accelerated in the second quarter, reflecting a sharp swing in spending on equipment after two consecutive quarters of decline.  The reversal in equipment spending was led by increased purchases of transportation equipment.  Investment in structures remained very strong, even after slowing by about one-third from the double-digit advances in the previous two quarters.  Businesses continued to invest heavily in manufacturing factories and—to a lesser degree—other structures, which offset declines in spending in health care, power and communications, and mining exploration. 

The final component of PDFP, residential investment, continued to constrain overall GDP growth but at the same rate as in the first quarter.  Spending on other structures, a category that includes brokers’ commissions and home improvements, drove the decline.  By contrast, single-family home construction investment was positive for the first time since early 2022, while investment in multi-family buildings also increased.

The other three categories of GDP made mixed contributions to the overall expansion in the second quarter.  After two quarters of rapid growth, total government spending growth slowed significantly in the second quarter, owing to a sharp pull-back in federal non-defense consumption expenditures.  Other federal government spending growth held relatively steady, while state and local government spending growth decelerated modestly.  International trade was a net negative contributor to real GDP growth as exports of goods fell markedly amid slowing global economic growth; total imports also fell sharply, but less rapidly than did exports.  Meanwhile, the change in private inventories, which can exhibit wide swings from quarter to quarter, made a small contribution in the second quarter, adding 0.1 percentage points to growth after subtracting 2.1 percentage points from first quarter GDP growth.  The build was led by durable goods in both wholesale and manufacturing–as well as retail trade, particularly inventories of motor vehicles.

Labor Markets

The labor market remained tight during the second quarter of 2023, even as the signs of easing which began late last year also became more noticeable (see Table 2 – Labor Market Indicators).  The pace of payroll job creation slowed to 244,000 jobs per month, down from the first quarter average of 312,000 per month.  Nonetheless, even this slower pace is more than adequate to maintain a stable rate of unemployment.  In fact, the headline unemployment rate returned in April to January’s half-century low of 3.4 percent, before edging up to 3.6 percent at the very end of the second quarter—still very near historical lows.  The ”underemployment” rate, or “U-6”—which includes those working part-time for economic reasons and those marginally-attached to the labor force—moved up to 6.9 percent at the end of the second quarter, or 0.4 percentage points above the record low of 6.5 percent set in December 2022 (series dates from January 1994).  Nonetheless, this rate is still well below the 2019 average rate of 7.2 percent.

The gap between labor supply and demand in the economy continued to narrow in the second quarter. The supply of labor consolidated gains seen in the first quarter: after moving up noticeably to 62.6 percent by the end of the first quarter, the labor force participation rate (LFPR) for all workers remained at that level throughout the second quarter.  Some groups of workers saw sizeable increases in participation, while others moved out of the labor force.  The LFPR for prime-age workers made substantial gains, rising to 83.5 percent by the end of the second quarter—a 21-year high.  Notably, the LFPR for prime-age women rose to the highest rate on record at 77.8 percent (data starts in 1948).  By contrast, participation by older workers dropped 0.3 percentage points over the second quarter, from 38.6 percent in March 2023 to 38.3 percent in June – or 2.0 percentage points below the 40.3 percent rate posted in February 2020—though the decrease is consistent with broader demographic trends.  Overall, the supply of labor has increased of late while the demand for labor has moved somewhat lower.  The number of job openings has trended down since March 2022: as of May 2023 (latest available data), there were 1.6 jobs per unemployed worker, the lowest ratio since October 2021—though still well above the pre-pandemic ratio of 1.2 vacancies per unemployed worker.  The decline in this ratio signals improvement in the balance between labor supply and demand.  Meanwhile, weekly unemployment insurance claims moved higher in the second quarter—though they remain at historically low levels.  On average, initial claims averaged 241,000 in the second quarter, up 9.5 percent from the first quarter.  Meanwhile, continuing claims were up 3.2 percent from the first quarter at 1.79 million, again near historically low levels.

Prices and Wages

Inflation: Inflation slowed further in the second quarter.  As measured by the consumer price index (CPI), average monthly inflation was 0.3 percent in the first quarter, dropping to 0.2 percent during the second quarter (see Table 3 – Inflation and Wage Growth Indicators).  Average monthly food inflation in the second quarter was one-third the pace in the previous quarter, partly reflecting lower prices for eggs, various meats, and dairy and related products.  Meanwhile, energy prices have been declining on net since June 2022, with energy prices falling 0.8 percent on average per month in the second quarter. The outlook for energy, however, is uncertain.  Saudi Arabia again tried to bolster oil prices in early July with an extension of production cuts through August.  Yet rising production by OPEC and non-OPEC members—for example, U.S. crude oil production is on track to hit a new record-high level in 2023—has undermined sustained price increases, as had slowing global growth and energy demand.

Excluding energy and food, disinflation among other goods and services has been slow overall, given sustained upward pressure from rent of housing services.  Over the second quarter, core inflation averaged 0.3 percent per month, down from 0.4 percent in the first quarter of 2023.  Core goods prices accelerated in the second quarter, related to an early-quarter surge in used car and truck prices.  However, upstream price pressures, as captured by producer and import prices, receded at faster rates in the second quarter, which may augur toward further slowing in consumer prices in coming months.  For core non-housing services, inflation slowed significantly in the second quarter—roughly one-fourth of the first quarter pace—in part due to deflationary pressures among tourism and recreation services.  Meanwhile, inflation for rent of housing services continues to exert upward pressure on core inflation, albeit at a slightly slower pace in the second quarter.  The slowing trend, which started in October 2022, may not be sustained.  Upward pressures on inflation could renew within the next year as market measures of rents have started to increase in recent months and house prices have risen steadily since early 2023.  Changes in rents and house prices are generally reflected in the CPI roughly a year later.

Inflation as measured by the PCE price index assigns different weights for different components and uses a different methodology in its calculation than the CPI.  Nonetheless, the drivers of both measures of inflation and the patterns in the second quarter are broadly similar.

Wage Growth: Measures of wage growth in the private sector increased in the second quarter, even after adjusting for inflation.  Average hourly earnings rose at a 4.7 percent annualized rate from March through June 2023, faster than pre-pandemic gains but still slower than the outsized paces registered through most of 2022.  After adjusting for inflation, real average hourly earnings increased, posting broad-based and positive annualized growth in the second quarter after easing slightly in the first quarter.  But an alternative measure of wage growth, the Employment Cost Index (ECI), suggests that wage pressures did moderate in the second quarter.  Over the four quarters through the second quarter of 2023, the ECI for private sector wages and salaries was slower by more than a full percentage point than the rate over the previous four quarters.  Wage growth in goods-producing industries slowed dramatically in the second quarter, while that in service-producing industries was stable relative to the first quarter at an elevated rate.  The ECI controls for employment shares among industries and occupations, making it a better reference for wage growth. 

Housing Markets

The current cycle of interest rate increases has weighed noticeably on housing market activity.  Even so, signs of stabilization began appearing in the first quarter of 2023 and persisted into the second quarter—with some metrics suggesting the sector has turned.  For example, the National Association of Homebuilders’ confidence index has improved consistently since December.  Moreover, the survey started signaling a favorable outlook in June 2023 for the first time since mid-2022.

New Residential Construction: On balance, new home construction was positive in the second quarter, but demand appeared to be diverging between the single-family and multi-family sectors (see Table 4 – Housing Market Indicators).  New single-family home construction continued to firm, given low inventories of existing homes available for sale.  Growth of single-family building permits—which precede future single-family construction—remained strong in the second quarter, growing slightly faster than in the first quarter.  The decline in multi-family permits continued, however.  Reversing the pattern in the previous quarter, growth in single-family starts was robust and offset a decline in the volatile multi-family sector.

Nonetheless, the multi-family sector is poised for future growth: the backlog of new multi-family units (those authorized but not started) remains at an elevated level, roughly 70 percent higher than at the end of 2020.  As a share of the total residential construction backlog, the multifamily sector accounted for roughly half, up from roughly 40 percent in mid-2021.  Moreover, although the total inventory of homes under construction declined modestly in the first and second quarters, the number of multi-family units under construction continued to climb, reaching a fresh record high in the second quarter; and completions for multi-family homes rose further above pre-pandemic norms.

Homes Sales and Inventories: After growing solidly in the first quarter, sales of total existing homes declined in the second quarter and were also down by nearly 20 percent over the year ending in June 2023. Moreover, the number of existing homes available for sale fell by nearly 7 percent over the year ending the second quarter—well below similar time periods before the pandemic and suggesting an ongoing reluctance among homeowners to exchange their low-rate mortgages for materially higher rates along with elevated home prices.

Meanwhile, sales of new single-family homes have risen for four consecutive quarters, with growth accelerating to 2.9 percent in the second quarter from 0.2 percent in the previous quarter.  The upward trend in sales for the past year has weighed more heavily on the inventory to sales ratios for new homes.  From a post-pandemic peak of 10.1 months in July 2022, the ratio dropped to a 15-month low of 7.2 months of supply in May 2023 and, for the second quarter as a whole, stood at 7.5 months. 

Home Prices and Rents: Home price inflation accelerated markedly in the second quarter, rising back above pre-pandemic trends (see Table 5 – Home Price and Rent Indicators).  From June 2022 to December 2022, both primary measures of house prices declined on net, but they began increasing again early in the first quarter of 2023, reflecting the combination of low inventories and solid demand.  Both the S&P/Case-Shiller index and the FHFA purchase only-index rebounded noticeably in the second quarter to date (April and May).  As of May 2023, the S&P/Case-Shiller’s national home price index was within 1 percent of the June 2022 peak, while the FHFA’s measure reached a fresh record-high reading.

Shelter cost growth continued to ease slightly for non-owners according to official statistics—but from elevated levels—while measures of new rental agreements showed an upturn.  Growth in the CPI for rent of primary residence slowed to 6.2 percent at an annual rate in the second quarter – still rapid, but roughly two-thirds the pace seen in each of the final two quarters of 2022.  However, the CPI for rent is a lagged measure, trailing prices from rental unit listing services by about four quarters.  These services showed that rental inflation more than doubled in the second quarter, after decelerating from summer 2021 through the first quarter of this year, as would-be buyers chose renting over rising mortgage rates and high home prices, amidst a dearth of available supply available for sale. 

Risks to the Outlook

Risks to the Banking System: The banking system is sound and well-capitalized, but financial instability remains an important risk to monitor.  Higher interest rates continue to pose heightened risks of asset/liability mismatch for banks.  Moreover, uneven banking system exposure to commercial real estate loans may put pressure on some smaller banks.  The U.S. government is committed to taking actions to maintain financial stability.

Inflation: Although inflation has fallen from the highs of mid-2022, it remains well above pre-pandemic rates and the Federal Reserve’s target.  The paths of energy and food prices remain highly uncertain and face further risk from weather and geopolitical developments in the months ahead. Adverse shocks—including related to Russia’s ongoing brutal war in Ukraine, on both energy and food prices—could result in temporary boosts of near-term headline inflation.  Secondary effects could filter into core components of inflation over time.  Excluding food and energy prices, core inflation is likely to stay above the Federal Reserve’s 2-percent target throughout 2023, reflecting elevated inflation for housing rent as well as other core services.  Inflationary pressures from rent are expected to ease in the coming months based on slowing in rents for new lease agreements, although recent data suggest potential upside risk for rent inflation in the coming months.  Core services excluding rent of housing inflation is also likely to remain elevated through 2023 but is expected to continue easing in response to higher interest rates.

Interest Rates and the Housing Market: Although higher mortgage rates have reduced affordability as well as transaction volumes, home prices remain substantially above the pre-pandemic trend.  Risks have shifted as the housing market has stabilized.  Largely due to low supply, house prices have started increasing.  Combined with higher mortgage rates, this means the market faces greater risks in terms of affordability and reduced dynamism.  It also implies a risk that higher rents could lead to more persistent rental inflation.

Geopolitical Risks: Russia’s war in Ukraine continues to add uncertainty to the medium-term outlook.  In addition, uncertainty about China’s economic prospects has created concern about global demand in the coming months. At the same time, central banks around the world are continuing to tighten monetary policy to fight high global rates of inflation.  A potential slowdown in global economic activity may feed back into the U.S. economy by weakening international demand for U.S. goods and service exports.

Conclusion

The American economy remains strong, bolstered by President Biden’s economic plan and Secretary Yellen’s approach to modern supply-side economics.  Over the past two and a half years, the Biden-Harris Administration has made significant investments to lower costs and strengthen our economy.  These investments will boost economic potential and make our economy more resilient to risks.

Table 1 – Real Gross Domestic Product

Source. Bureau of Economic Analysis, Gross Domestic Product (Advance Estimate), Second Quarter 2023.
* Percentage point contribution to GDP growth.

Table 2 – Labor Market Indicators

Sources. Bureau of Labor Statistics, The Employment Situation – June 2023; Job Openings and Labor Turnover – May 2023.
¹ The U6 measure is the broadest measure of unemployment, and includes those marginally attached to the labor force as well as those working part-time for economic reasons.

Table 3 – Inflation and Wage Growth Indicators

Sources. Bureau of Labor Statistics, Consumer Price Index – June 2023; The Employment Situation – June 2023; Employment Cost Index – June 2023. Bureau of Economic Analysis, Personal Income and Outlays, June 2023.
¹ For CPI, 12-month growth is not seasonally adjusted.
² Imputed from CPI Data.

Table 4 – Housing Market Indicators

Sources. Census Bureau, Monthly New Residential Construction, June 2023; Monthly New Residential Sales, June 2023. National Assocation of Realtors, Existing-Home Sales.
¹ Units at the end of the period, levels not at an annual rate

Table 5 – Home Price and Rent Indicators

Sources. Standard & Poor’s, S&P CoreLogic Case-Shiller Home Price Indices. Federal Housing Financing Agency, Home Price Index (HPI) Monthly Report. Zillow, Housing Data. Bureau of Labor Statistics, Consumer Price Index – June 2023.
* 12-month percent change not seasonally adjusted.