Making Sense of the Mixed-Signal Economy

Recently the Bureau of Labor Statistics released its first estimate for gross domestic product (GDP) growth in the second quarter. The number was -0.9%. That’s the second consecutive quarter of negative GDP growth. That’s a recession.

But with strong job growth and strong spending in luxury consumer spending, is the United States really in a recession?

During every recession, economic output falls. When that happens, businesses lay off some workers. Unemployment rises. As the unemployed see their incomes fall, demand in the economy falls, leading to less output being produced and more layoffs. Unemployment usually rises by 2 to 3 percentage points from pre-recession highs.

This year, total output has declined at about a 2.5% rate since January. With that decrease, unemployment should be well above 4%, which is what economists generally believe is the full employment level.

Yet the unemployment rate has remained at 3.6% — and on Friday, even leading economists were shocked by the robust 528,000 jobs that were added, bringing U.S. unemployment down to 3.5%.

Equally confounding is that the economy has added nearly 3 million jobs since January. How can output decline when the economy keeps adding so many new workers, and consumer spending in some areas, notably luxury goods, trave,l and leisure, is so strong?

‘Full-Employment Recession’

This seeming contradiction can be explained. We are experiencing a new phenomenon known as a “full-employment recession.” That is, we have declining output, meaning we are in recession, and, at the same time, the economy is operating at a full employment level.

The explanation can be found by looking at worker productivity, which usually increases by about 2% per year. We learned from data released Monday that productivity declined at an annual rate of 7.4% in the first quarter, at a 4.6% rate in the second quarter and at a record pace on an annualized basis.

To illustrate this in real-world terms, suppose 100 workers produce 100 units of output per day. A year later, these 100 workers improve their performance and start producing 102 units per day. Productivity increased by 2%, from 100 to 102 units of output.

In the first quarter of this year, instead of 100 workers, the number of workers increased to 101, yet total output fell to 98. That’s a decline in productivity roughly equal to an annualized rate of 7.4%.

Less Productive Workers

The conclusion is that business hired more workers, yet its total workforce produced less output. The reason for this is difficult to determine. It could be due to worker productivity declining because of remote work. It could also be that the newly hired workers, who have been unemployed for perhaps years, having very rusty skills. It may take months for these workers to actually become productive.

The jobs numbers are likely to stay positive well into the current recession. That’s because the country continues to face a severe labor shortage, primarily in services and blue-collar jobs.

Nonetheless, the economy today, even with the output declines seen in the first half of this year, is producing at a higher rate than before the pandemic. Until last month, business was doing this with fewer workers. Today the number of employed Americans is about equal to the number just prior to the pandemic.

The number of job openings in the U.S. is currently 10.9 million, while there are about 5.8 million unemployed. Going forward, we will see a rapid decline in job openings, while the number of new jobs created each month to be in the 200,000 to 300,000 range at least for the next few months.

That’s a full-employment recession; an economy in recession yet with full employment.

Regarding luxury consumer spending being so high during the early days of the recession, this, too, can be explained. Consumer spending is increasing in nominal terms, but adjusting for the 9.1% annual inflation, consumer spending is really falling.

Inflation is strongly felt by lower-income earners and people on fixed incomes, as they spend nearly all of their disposable income on necessities and save little or nothing. So, when prices rise, they have less money to spend on other goods, making the recession worse. They also become very careful when spending for non-necessities.

Why Spending Remains High

With inflation, higher-income earners also pay more for necessities, but they reduce their savings and continue to spend on non-necessities to support their lavish lifestyle. In non-recessionary times, these people usually save a large portion of their income. This allows them to react to inflation by simply saving less and spending whatever they desire to maintain their lifestyle.

Luxury consumer spending changes usually lag economic activity, so that spending won’t fall early into the recession.

This recession is the first time the U.S. has had a full-employment recession. It is also the first time there has been a severe labor shortage in a non-war economy.

Consider the recession of 2022 yet another anomaly, on top of the once-in-a-century pandemic of 2020–2022. One can only wonder what will turn out to be the next lightning bolt from out of the blue.

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