A Strong 1H21, Moderation Seen in 2H21

Chief Economist Scott Brown discusses current economic conditions.

The economy strengthened considerably in the first half of this year, much more than the headline GDP figure would suggest. The key components, consumer spending and business fixed investment, each rose at double-digit percentage rates. Higher inflation is widely expected to be transitory, but there are concerns that it could last longer and lead to a higher trend. The delta variant is a wildcard.

Real GDP rose at a 6.5% annual rate in the advance estimate for 2Q21, following +6.3% in 1Q21 (averaging 6.4% in 1H21). Inventories fell in the first quarter and even more sharply in the second, lopping nearly 2 percentage points from headline GDP growth in the first half. The trade deficit rose, subtracting a full percentage point. Consumer spending rose at an 11.8% annual rate in 2Q21 (following +11.4% in 1Q12), while business fixed investment rose at an 8.0% pace (following 12.9%). This is extremely strong.

The monthly data showed a mix in consumer spending. Spending on services picked up, while spending on consumer durables decreased. One of the surprises in the pandemic has been the strength in consumer durables (a 31.2% increase from February 2020 to June 2021, up 22.7% adjusting for inflation). Spending on services is now up 0.5% relative to the pre-pandemic level (although still down 3.1% adjusting for inflation). The areas hit hardest by the pandemic (transportation, restaurants, live entertainment, etc.) improved significantly in the first half of the year and there is potential for further strengthening in the second half. We can expect a further moderation in spending on consumer durables as services rebound.

Inflation is elevated. The PCE Price Index, the Fed’s key inflation gauge, rose 4.0% in the 12 months ending in June (in comparison, the Consumer Price Index rose 5.0%). Some of this reflects base effects (a rebound from the low levels of a year ago -- the PCE Price Index was up just 0.5% in the 12 months ending June 2020). Some of the increase reflects restart pressures. Production bottlenecks and materials shortages occur in every recession. They are more intense this time because of the speed of the recovery.

Scott Brown
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Will the surge in cases of the delta variant have an economic impact? Most likely. It’s difficult to model. The delta variant is more contagious, even passed along by people who have already been vaccinated. The experiences in the U.K. and India suggest that, while not good, the rise in the delta variant may be soon contained (relatively speaking), but it’s hard to say. Many people are expected to cram in a vacation (or two) before the school year begins, spreading the delta variant more widely, and the kids may spread it around further once in school. Much depends on efforts to contain the virus. Even a partial lockdown seems unlikely at this point, but we will likely see an increase in voluntary social distancing, which means a slower recovery in consumer services.