Economy Statement by Benjamin Harris, Assistant Secretary for Economy Policy, for the Treasury Borrowing Advisory Committee

Date:

Economy Statement by Benjamin Harris, Assistant Secretary for Economy Policy, for the Treasury Borrowing Advisory Committee

Introduction

Despite global and pandemic-related economic headwinds, the U.S. economy proved its resilience in the fourth quarter of 2022 with real gross domestic product (GDP) growing at a healthy 2.9 percent annualized rate.  Labor markets remained tight: employers added an average of 247,000 payroll jobs each month—a pace well-above that needed to maintain a stable unemployment rate—and the unemployment rate returned to the half-century low of 3.5 percent.  Moreover, inflation continued to slow: since peaking in June 2022, 12-month headline inflation (as measured by the consumer price index) has fallen by 2.6 percentage points, owing to sharp drops in energy prices and moderating non-energy goods inflation over the second half of the year.  Core inflation (excluding food and energy) slowed by less than headline, largely due to elevated shelter inflation—though timely measures of house prices and rents suggest a reprieve in the coming year.  Housing markets showed considerable weakening, correcting from pandemic-related imbalances and responding to tighter monetary policy.

Real Gross Domestic Product (GDP)

In the final quarter of 2022, real GDP rose 2.9 percent at an annual rate in the advance estimate, a solid gain that followed the third quarter’s 3.2 percent rise (see Table 1 – Real Gross Domestic Product).  Strong GDP in the second half of the year more than offset the mild contraction during the first half; as a result, real GDP was up 1.0 percent from the fourth quarter of 2021, following the 5.7 percent four-quarter pace in 2021.

Components of GDP can be grouped into four broad categories: private domestic final purchases (PDFP), government consumption and investment, net international purchases, and intermediate demand.  The first category, PDFP, is the aggregation of personal consumption expenditures (PCE), business investment, and residential investment.  In the fourth quarter, real PDFP growth slowed from 1.1 percent to 0.2 percent.  However, this measure is often substantially revised from the advance release.  For example in the third quarter, PFDP revised up by 1.0 percentage point from the advance estimate to the third.

The components of PDFP painted a mixed picture.  Household consumption slowed in the fourth quarter, reflecting easing demand amid a slow rotation of spending from goods to services.  Business fixed investment also slowed, as growth in the largest component (equipment) shifted negative.  By contrast, structures investment increased in the fourth quarter, turning positive after  six consecutive quarters of contraction.  Residential investment, however, continued to be a constraint to U.S. economic growth, largely due to less single-family construction and lower brokers’ commissions as housing markets corrected from pandemic imbalances and rising interest rates.

The other three categories of GDP all contributed to economic expansion.  Growth of total government spending was steady in the fourth quarter relative to the third.  Federal government spending increased at a faster pace as all categories of investment (structures, equipment, and intellectual property products) either turned from negative to positive growth or grew at a faster pace.  International trade also was a net positive to real GDP growth as the trade deficit decreased, led by lower imports of goods and increased exports of services.  In addition, the change in private inventories was the largest contributor to GDP growth, adding 1.5 percentage points to the annualized growth rate, largely due to inventory buildup in the manufacturing sector.

Labor Markets

Across a variety of measures, labor markets remained tight during last year’s final quarter, with some limited signs of modest easing (see Table 2 – Labor Market Indicators).  Although the pace of job creation slowed in the fourth quarter, monthly job gains, at an average of nearly 250,000 per month, still substantially outpaced the 2019 average of 164,000 per month.  The headline unemployment rate, meanwhile, remained at (or slightly above) the pre-pandemic, half-century low of 3.5 percent during the fourth quarter.  At the same time, the broadest unemployment rate—which includes those working part-time for economic reasons and those marginally-attached to the labor force—dropped to a record low of 6.5 percent in December (series dates from January 1994).

Labor markets continue to face an imbalance between labor supply and labor demand.  Labor force participation rates for all workers and older workers were unchanged from the third to fourth quarters, the participation rate for prime age (ages 25 to 54) workers moved somewhat lower.  The latest employment data indicate still-elevated demand for labor.  Although the number of job openings declined modestly in the fourth quarter through November, the pace of decline has slowed consistently since the second quarter.  Moreover, the separations, quits, and layoffs/discharges rates held essentially steady relative to the end of the third quarter—though all indicated easing demand on a year-over-year basis.

Prices and Wages

Inflation: Headline inflation, as measured by the consumer price index (CPI), was minimally changed in the fourth quarter (see Table 3 – Inflation and Wage Growth Indicators).  Although food price inflation slowed by about one-half in the fourth quarter, energy prices declined at a slower pace.  Still, energy prices in December 2022 had nearly returned levels before Russia’s illegal invasion of Ukraine.

Core goods prices made a negative contribution to headline and core CPI inflation, reflecting the ongoing recovery in supply chains as well as softer consumer demand.  Upstream price measures, such as the producer price index and the import prices index, also remain subdued, suggesting that improving supply chains should continue to ease price pressures.  Prices for core non-shelter services slowed in the fourth quarter, with the pace of growth roughly half that of the third quarter.  The health care insurance CPI, which is imputed from retained earnings (i.e., profit margins) of health insurance companies, has declined since September, explaining a large part of the slower growth in core non-shelter services prices.  Shelter inflation, meanwhile, continues to contribute the largest share to both core and headline inflation.  Although data from rental unit listing services signal that rents for new tenants have come down since the summer—and most house price indices have decreased or leveled off since May 2022—it will take several quarters for shelter inflation to reflect lower costs.

Inflation as measured by the PCE price index—the preferred measure of the Federal Reserve—assigns different weights for different components and uses a different methodology in its calculation than the CPI.  Nonetheless, the drivers and movements of both measures of inflation are similar.

Wage Growth: Adjusted for inflation, wages increased through both quarters of the second half.  Although real and nominal private-sector wage growth moderated in the fourth quarter, average hourly earnings (AHE) still rose at solid rates from September to December.  The AHE measure of wage growth is not composition-adjusted, though, meaning it does not control for employment shares among industries and occupations.  The Employment Cost Index (ECI) for private sector wages/salaries, which is composition-adjusted, grew faster than AHE during the first half of 2022 but decelerated in the third quarter, matching nominal AHE growth.  The ECI for the fourth quarter will be published on Tuesday, January 31.

Housing Markets

The housing market began cooling in the spring of 2022, soon after the Federal Reserve started tightening monetary policy to bring down inflation.  Sectoral retrenchment persisted into the fourth quarter as markets continued to correct imbalances that arose during the pandemic.  Despite the ongoing correction, home construction and new home sales are relatively consistent with pre-pandemic activity in 2018 and 2019.

New Residential Construction: On net, new home construction weakened over the quarter (see Table 4 – Housing Market Indicators).  Total and single-family building permits—which are leading indicator of future construction—decreased at a faster rate, presaging headwinds in coming quarters.  Although construction bottlenecks eased further in the fourth quarter, the backlog of new construction (units authorized but not started) remained near historical highs.  In addition, the number of total housing starts were lower, on net, over the quarter, suggesting that little progress in reducing construction backlogs in the near-term.  (Although single-family starts increased in December, they have fallen by 25 percent over 12 months.)

The inventory of homes under construction increased to a new high in the fourth quarter.  Construction bottlenecks, though easing, may explain part of the increase in the number of homes under construction.  In 2021, it took, on average, over 7 months for a unit to be completed once started.  (Completion time data for 2022 will be published in March 2023.)  Meanwhile, housing completions decreased modestly in the fourth quarter.  Despite adjusting for typical seasonal variations, completions are volatile on a monthly basis, in part due to weather.  Nonetheless, completions returned to growth after decreasing in 2021.

Homes Sales and Inventories: The pace of decline in existing home sales accelerated in the fourth quarter—almost doubling for both total and single-family homes—and sales were down by fully one-third over the year ending in December.  Despite lower sales, the number of existing homes for sale decreased over the quarter, suggesting that potential sellers are locked into low mortgage rates and may be subsequently reluctant to move.

In contrast to existing homes, sales of new single-family sales rose over the fourth quarter, after falling by nearly 35 percent from December 2021 to September 2022.  The faster pace of sales caused the new homes inventory-to-sales ratio to decrease from a post-Great Recession peak of 10.1 months in September to 9.0 months of supply in December.

Home Prices and Rent: Home prices remain above the pre-pandemic trend, though the two primary measures of prices either decreased or were relatively flat in the fourth quarter (see Table 5 – Home Price and Rent Indicators). As measured by the S&P/Case-Shiller indices, home prices declined for the second consecutive quarter—though the pace of decrease slowed by roughly half.  The FHFA measure was little changed, following a moderate decrease in the third quarter.

Shelter costs for non-owners remain elevated in the consumer price indices, but real-time market data suggest recent declines in rents.  The CPI for rent of primary residence measure was essentially steady at 9.4 percent at an annual rate in the fourth quarter.  However, measures from rental unit listing services signal that rents for new tenants have come down from their highs over the summer.  The CPI for rent lags these data by about four quarters.

Risks to the Outlook

Debt ceiling: On January 19, 2023, the outstanding debt of the United States reached the statutory limit.  Once at the debt limit, Treasury began taking extraordinary measures to prevent the United States from default on its obligations.  These measures are expected to be exhausted sometime after early June 2023.  Even just the threat that the U.S. government might fail to meet its obligations may cause severe harm to the economy by eroding household and business confidence, injecting volatility into financial markets, and raising the cost of capital—among other negative impacts. 

COVID-19: The fourth quarter saw COVID-19 continue to transition from pandemic to endemic, with fewer reported cases and hospitalizations.  As of mid-January 2023, over 80 percent of the U.S. population have received at least one dose of the COVID-19 vaccines, although less than 20 percent of people ages 5 or older have received an updated, bivalent booster dose.  The onset of new variants could pose a potential headwind in the near term.

Inflation: Inflation moderated in the second half of 2022, but it remains well-above recent historical experience and the Federal Reserve’s inflation target.  Energy prices have fallen over the course of the year, but further escalation of Russia’s illegal invasion of Ukraine could again raise prices of energy and food.  (Food prices are sensitive to movements in energy prices due to passthrough to agriculture supply chains.)  Excluding food and energy prices, PCE inflation is expected to be around 2.5 percent to 3.5 percent on a four-quarter basis by the end of 2023 according to many forecasters.  The persistence of above-target core inflation reflects in part elevated shelter inflation.  However, with continued signs that rents on new leasing agreements are decreasing and home prices seeing some reductions, inflationary pressures from shelter prices may ease in coming quarters.

Interest rates: Higher interest rates have led to dramatic reductions in structures investment, particularly residential.  Home prices remain well above the pre-pandemic trend and higher mortgage rates have reduced affordability, locked in homeowners, and lowered transaction volumes.  To date, sharply lower volumes have yet to translate into steep reductions in price.  Further declines in home prices may improve affordability, but may bring with them negative wealth effects.  Outside investment in structures, there has been less noticeable impact on the economy to date from increases in interest rates.

Geopolitical Risks: Russia’s war against Ukraine continues to add uncertainty to the medium-run outlook.  Due to the war, Europe has shifted its supply of energy goods from Russia, which may again elevate energy and food prices in coming months.  High cost-of-living, tightening financial conditions, and the energy crisis in Europe caused by Russia’s invasion of Ukraine have all contributed to an erosion of the global economic outlook.  At the same time, central banks around the world are tightening monetary policy to fight high global rates of inflation.  These risks to the global growth outlook may feed back into the U.S. outlook by weakening international demand for U.S. goods and service exports.  In addition, there is potential further risk of global economic shifts from China’s removal of Zero-COVID policies.  Increased supply of goods from China could further ease global supply chain constraints, but increased demand from China, particularly for energy, could put pressure on global prices.

Conclusion

Looking ahead to 2023, the economy will face significant challenges as it transitions from a historically rapid recovery to steady and healthy growth.  But even in the face of these challenges, the economy remains resilient, bolstered by President Biden’s economic plan.  Over the past two years, the Biden Administration has made significant investments to strengthen the foundations of our post-pandemic economy.  The Bipartisan Infrastructure Law is modernizing our nation’s physical and digital infrastructure.  The CHIPS Act is growing semiconductor manufacturing here at home.  And the Inflation Reduction Act is making historic investments in building a clean energy economy.” These investments in infrastructure will boost economic potential as well as help our economy be more resilient to future unexpected shocks—like pandemics or climate disasters.

Table 1 – Real Gross Domestic Product

  Percent Change
(annual rate)
Contribution to GDP Growth
(percentage points)
Percent Change
(Q4 / Q4)
H1 ’22 Q3 Q4 Q4 ’22 2020 2021 2022
Real GDP Growth -1.1 3.2 2.9 -1.5 5.7 1.0
               
  Private Domestic Final Purchases 1.3 1.1 0.2 0.2 -0.9 6.4 1.0
               
    Personal Consumption Expenditures (PCE) 1.7 2.3 2.1 1.4 -1.4 7.2 1.9
      Goods -1.3 -0.4 1.1 0.3 8.6 7.1 -0.5
      Services 3.3 3.7 2.6 1.2 -5.8 7.2 3.2
               
    Business Fixed Investment 3.9 6.2 0.7 0.1 -3.5 5.0 3.7
      Equipment 4.4 10.6 -3.8 -0.2 -2.7 4.7 3.8
      Structures -8.6 -3.6 0.4 0.0 -16.0 -5.1 -5.2
      Intellectual Property Products 9.8 6.8 5.3 0.3 3.8 10.9 7.9
               
    Residential Investment -10.8 -27.1 -26.7 -1.3 16.4 -0.3 -19.2
               
  Total Government Purchases -1.9 3.7 3.7 0.6 1.0 0.5 0.8
    Federal -4.4 3.7 6.2 0.4 5.4 0.4 0.2
    State and Local -0.5 3.7 2.3 0.3 -1.6 0.6 1.3
               
  Net Exports (change, billions of real (2012) dollars) -133 162 36 0.6 -271 -194 65
    Imports (percent change, annual rate) 10.0 -7.3 -4.6 0.1 0 10 2
    Exports (percent change, annual rate) 4.2 14.6 -1.3 0.4 -10 7 5
               
Change in Private Inventories (change, billions (2012) dollars) -87 -72 91 1.5 54 139 -68

 

Source. Bureau of Economic Analysis, Gross Domestic Product (Advance Estimate), Fourth Quarter 2022.

* Percentage point contribution to GDP growth.

Table 2- Labor Market Indicators

  Average Monthly Change
(thousands)
Annual Change
(December/December)
Establishment Survey Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
Payroll Employment 444 366 247 -9292 6743 4503
             
  Private Sector 438 312 214 -8252 6293 4203
    Manufacturing 40 30 17 -605 365 379
    Construction 20 18 19 -172 189 231
             
    Service Providing 371 262 175 -7336 5703 3539
      Education and Health Services 70 95 82 -1087 589 950
      Leisure and Hospitality 90 71 65 -4022 2356 946
      Temporary Help Services 11 -3 -29 -201 303 -32
             
  Government 6 54 34 -1040 450 300
    State and Local Education 5 28 14 -811 495 158
  Monthly Average Annual Change
(December/December)
Household Survey Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
  Household Employment (% Total Population) 59.9 60.0 60.0 -3.6 2.1 0.6
    Prime-Age (% of Population Ages 25 to 54) 79.8 80.1 79.9 -4.1 2.8 1.0
    55+ (% of Population Ages 55+) 37.8 37.7 37.8 -3.0 1.1 0.4
             
  Unemployment Rate, U-3 (% of Total Labor Force) 3.7 3.6 3.6 3.1 -2.8 -0.4
    Underemployment Rate, U-6* 7.0 6.8 6.6 4.9 -4.4 -0.8
    Long-Term (27+ weeks) 0.9 0.7 0.7 1.8 -1.3 -0.6
             
  Labor Force Participation Rate (% Total Population) 62.3 62.2 62.2 -1.8 0.5 0.3
    Prime-Age (% of Population Ages 25 to 54) 82.4 82.6 82.4 -1.9 0.9 0.5
    55+ (% of Population Ages 55+) 38.9 38.7 38.8 -1.7 -0.1 0.3
  Monthly Average Annual Change (December/December)
Job Openings and Labor Turnover Survey Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Nov ’222
2020 2021 20222
   Job Openings (thousands) 11418 10712 10485 197 4510 -990
             
    Private Sector 10377 9644 9515 257 4094 -842
      Professional Business Services 2151 1914 1920 274 498 5
      Education and Health Services 2200 2203 2125 25 914 -97
      Leisure and Hospitality 1602 1497 1578 -148 1197 -471
             
  Separations Rate (% of Payroll Employment) 4.0 3.8 3.8 0.2 0.1 -0.3
    Quits Rate 2.9 2.7 2.7 0.1 0.6 -0.3
    Layoffs and Discharges Rate 0.9 0.9 0.9 0.1 -0.6 0.1
             
  Job Openings per Unemployed Person 1.9 1.8 1.7 -0.5 1.2 0.1

Sources. Bureau of Labor Statistics, The Employment Situation – December 2022; Job Openings and Labor Turnover – November 2022.

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.                        

2 Through November 2022

Table 3 – Inflation and Wage Growth Indicators

  Average Monthly Percent Change Percent Change
(December / December)1
Inflation Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
  Consumer Price Index (CPI) 0.9 0.2 0.2 1.4 7.0 6.5
    Foods 1.0 0.9 0.5 3.9 6.3 10.4
    Energy 3.9 -3.9 -1.5 -7.0 29.3 7.3
             
  Core (ex. Food and Energy) CPI 0.6 0.5 0.3 1.6 5.5 5.7
    Core Goods 0.4 0.2 -0.4 1.7 10.7 2.1
    Core Services ex. Rent of Shelter1 0.7 0.4 0.2 0.8 4.1 5.3
    Rent of Shelter 0.5 0.7 0.7 2.3 3.3 8.3
             
  PCE Price Index 0.6 0.2 0.2 1.3 6.0 5.0
    Core PCE Price Index 0.4 0.4 0.2 1.5 5.0 4.4
  Percent Change
(annual rate)
Percent Change
(December / December)
Wages and Earnings Dec ’21 to Jun ’22 Jun ’22 to Sept ’22 Sept ’22 to Dec ’22 2020 2021 2022
  Average Hourly Earnings (AHE), Total Private 4.7 4.8 4.1 5.5 4.9 4.6
    Good Producing 4.3 4.3 4.9 2.8 4.7 4.4
    Services Providing 4.8 4.8 4.1 6.2 4.9 4.6
             
  Employment Cost Index, Wages & Salaries, Total Private 5.8 4.8 2.8 4.9
    Good-Producing Industries 5.2 5.1 2.5 4.0
    Service-Providing Industries 5.9 4.7 2.9 5.1
             
  Real AHE, Private -5.8 3.0 2.2 4.2 -2.1 -1.7
    Good Producing -6.1 2.2 2.9 1.5 -2.2 -1.9
    Services Providing -5.8 3.0 2.2 4.9 -2.0 -1.7

Sources. Bureau of Labor Statistics, Consumer Price Index – December 2022; The Employment Situation – December 2022; Employment Cost Index – September 2022. Bureau of Economic Analysis, Personal Income and Outlays, December 2022.

1 For CPI, 12-month growth is not seasonally adjusted.

2 Imputed from CPI Data.

Table 4 – Housing Market Indicators

  Thousands Average Monthly Percent Change Percent Change
(December / December)
New Residential Construction Dec ’22 Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
  Building Permits, Total 1337 -1.8 -2.7 -5.1 20.2 9.6 -29.5
    Single-Family 731 -2.3 -3.6 -5.6 31.7 -7.8 -34.6
               
  Units Authorized but Not Started, Total1 285 1.4 1.5 -1.6 3.3 40.6 8.4
    Single-Family1 137 0.4 0.5 -1.9 18.2 34.6 -2.1
               
  Housing Starts, Total 1382 -1.9 -2.4 -1.9 7.3 7.1 -21.8
    Single-Family 909 -2.9 -4.1 0.6 29.9 -7.3 -25.0
               
  Units Under Construction, Total1 1712 1.7 0.3 0.2 7.0 20.9 12.3
    Single-Family1 769 1.2 -1.4 -1.0 16.5 27.1 -0.1
               
  Housing Completions, Total 1411 0.8 1.0 -0.5 5.8 -3.7 6.4
    Single-Family 1005 -0.1 1.3 -1.3 4.9 7.2 -0.9
  Thousands Average Monthly Percent Change Percent Change
(December / December)
Home Sales Dec ’22 Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
  Existing Homes, Total 4020 -2.9 -2.7 -5.1 19.8 -6.7 -34.0
    Single-Family 3600 -2.8 -2.5 -5.2 19.8 -6.7 -33.5
               
  New Homes, Single-Family 616 -6.2 -1.2 3.8 26.6 -3.7 -26.6
  Thousands Average Months’ Supply
(inventory / sales)
Change in Month’s Supply
(December / December)
Inventories of Home for Sale Dec ’22 Dec ’21 to Jun ’22 Jun ’22 to Sept ’22 Sept ’22 to Dec ’22 2020 2021 2022
  Existing Homes, Total 970 2.2 3.2 3.2 -1.1 -0.2 1.2
    Single-Family 860 2.1 3.2 3.1 -1.2 -0.1 1.2
               
  New Homes, Single-Family 461 7.4 9.6 9.2 -1.5 1.4 3.4

Sources. Census Bureau, Monthly New Residential Construction, December 2022; Monthly New Residential Sales, December 2022. 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

  Percent Change
(annual rate)
Percent Change
(October / October)
Home Price Indices (HPI Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Oct ’22
2020 2021 2022
  S&P Core Logic Case-Shile National HPI* 18.8 -8.1 -3.1 8.4 19.1 8.7
    Composite 20-City HPI* 20.8 -12.5 -6.1 8.1 18.5 8.6
             
  FHFA Purchase-Only HPI 16.5 -4.2 0.1 10.6 17.6 9.8
             
  Zillow Total Home Value Index (HVI) 19.4 4.4 1.7 6.5 19.2 13.5
    Bottom-Tier Homes HVI 18.7 6.6 4.0 6.6 18.4 13.9
  Percent Change
(annual rate)
Percent Change
(December / December)
Rent Indices Dec ’21 to
Jun ’22
Jun ’22 to
Sept ’22
Sept ’22 to
Dec ’22
2020 2021 2022
  CPI Rent of Primary Residence 7.2 9.5 9.4 2.3 3.3 8.3
             
  Zillow Observed Rent Index 10.6 8.1 2.0 1.1 16.0 7.8

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 – December 2022.

* 12-month percent change not seasonally adjusted.

Official news published at https://home.treasury.gov/news/press-releases/jy1230

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