State of the State Mid-2022: Growth slowing, but state GDP to be positive at year end

Pinning down a clear consensus on the U.S. economy is, as the old saying goes, like trying to nail Jello to a wall. A recession is obvious unless it’s not. Inflation is likely permanent until fuel prices begin to decline. And then the July jobs report blew past estimates.

The usual metrics and historic trends economists and other market watchers have depended on for decades are not as reliable, thanks to the past two-plus years of a seeming landslide of global disruptions. The COVID-19 pandemic singlehandedly changed every element of the modern global economy. Billions of people changed spending patterns. Hundreds of thousands of factories altered production. Inventory management, in many cases, became an oxymoron. Millions of tons of cargo wasn’t sure if it was coming or going – or sitting still.

Add to that reality accommodative monetary policies from many governments around the world, inflation fueled in part by the aforementioned global economic disruption, a declining labor force, and the Russian invasion of Ukraine, and it becomes a period in modern history at least as tumultuous as the second World War.

John Shelnutt, administrator of economic and tax research for the Arkansas Department of Finance and Administration, notes the “contradictory patterns.”

“Meanwhile, the job market remains robust, and consumer sentiment hit new lows because of inflation’s impact on fuels, food, and housing. The net effect of these contradictory patterns in indicators and fundamentals will probably result in low growth in the second half of 2022 and first half of 2023,” he said in a note for Talk Business & Politics.

Indeed, the July jobs report from the U.S. Bureau of Labor Statistics showed a gain of 528,000 jobs, more than double what was expected by most economists.

Shelnutt noted the economy will slow, with U.S. Gross Domestic Product (GDP) now projected at 1.4% from a previous high of 4.1% estimated in January.

“That downgraded outlook reflects war in Ukraine, more inflation than expected, and the stepped-up effort by the Federal Reserve to accelerate interest rate increases compared to a more gradual pace with ‘transitory’ inflation expectations. Growth in 2023 looks similar at 1.3%, before resuming trend average growth and inflation in 2024,” Shelnutt wrote.

Michael Pakko, chief economist and state economic forecaster at the Institute for Economic Advancement at the University of Arkansas at Little Rock, stressed that the economy is not in a recession and that the conventional thinking that two consecutive quarters of negative GDP marks a recession is not correct.

“The official Business Cycle Dating Committee of the NBER (National Bureau of Economic Research) looks at a wide range of indicators to declare the starting and ending points of recessions. At this point, many of those indicators, particularly employment growth, remain strong. The likelihood of a recession is increasing as the Fed raises rates, but it is not inevitable,” Pakko noted.

Likewise, Greg Kaza, an economist and executive director of the Arkansas Policy Foundation, said the July jobs report shows that the “U.S. economy is in the third year of an economic expansion, not a recession.” He also said inflation “remains a serious monetary problem.”

Following are other responses from Pakko and Shelnutt to questions from Talk Business & Politics about the state and national economies.

• Pakko
“The sluggish growth of payroll employment in Arkansas over the first six months of the year indicates that the second quarter is likely to follow the national pattern (negative growth) as well. Modest growth in GDP is likely to resume in the second half of the year, but by the fourth quarter, we’ll be down slightly in year-over-year terms. Looking at annual averages, on the other hand, Arkansas GDP growth in 2022 is likely to be slightly positive (one percent or less).”

“Inflation should begin to moderate over the second half of the year. We have already seen some respite from high gasoline prices, and world commodity prices more generally are coming down from recent highs. Most of the recent price increases at the retail level will persist, so I would not expect any widespread deflation (beyond the basic commodities sectors), but a slowing of the rate of price increases over the next several months.”

“By the end of the year, the benchmark federal funds rate is likely to exceed 3% – probably closer to 3-1/2%. If inflation does not moderate by the end of the year, the Fed is likely to keep inching rates higher in early 2023 (albeit at a slower pace).”

“I don’t expect (Arkansas) consumer spending to collapse (or even contract), but it is unlikely to continue the kind of year-over-year growth that we have been seeing over the past two years.”

• Shelnutt
“The state-level GDP equivalent adjusted for inflation is expected to settle at 0.9% growth in 2022, after a robust 5% gain in 2021. Part of this deceleration stems from the wind-down of stimulus programs and completion of a rebound in sectors most impacted by pandemic effects earlier. Higher inflation amid rising borrowing costs also limits current real growth.”

“State GDP growth unadjusted for inflation is expected to reach 8.6% in 2022 and 4.5% in 2023. Total inflation-adjusted wage income will expand by 2.0% in 2022 and 1.7% in 2023. Unadjusted for inflation, this equates to an 8.4% gain in 2022 and 4.9% gain in 2023. Average annual wages adjusted for inflation will contract by -0.4% in 2022 and then expand 1.2% in 2023 as inflation eases.”

“In monthly terms, energy prices are already moving down from a peak in June CPI inflation reports. Noticeable slowing in top-line and core inflation measures will be evident by the 4th quarter of this year. That break in overall inflation is accompanied by interest rate increases and slower economic growth in the process–It will not be achieved by swings in energy markets alone.”

“The Federal Reserve has signaled to markets that a mild recession is acceptable in the fight to tame core inflation and tight labor markets. Newfound conviction to fight inflation in 2022 in the U.S. (and Europe) will change the rate outlook to a temporarily restrictive range of 3.25% to 3.5% by yearend before achieving a preferred policy rate range of 2.5% to 3% longer term.”