Ukraine-Russia a Big Downside Risk for 2022
- GDP growth in the fourth quarter was revised modestly higher in the second estimate to 7.0%, from 6.9% in the advance estimate.
- Revisions were mixed for the outlook.
- The U.S. economy should continue to expand throughout 2022. However, the Ukraine-Russia war is a downside risk for the U.S. economy, largely because of its potential impact on global energy markets and U.S. inflation.
There was a small upward revision to real GDP in the second estimate for the fourth quarter of 2021, to 7.0% at an annualized rate, from 6.9% in the advance estimate. In the second estimate, there were upward revisions to business fixed investment, state and local government spending, and investment in housing, offset by downward revisions to consumer spending and exports.
Growth accelerated in the fourth quarter from 2.3% at an annualized rate in the third quarter. However, most of the improvement in growth came from investment in inventories. Inventories added 4.9 percentage points to growth in the fourth quarter as businesses restocked. Final sales of domestic product-GDP minus the change in inventories, and is domestic and foreign demand for goods and services produced in the U.S.-increased a solid, but unspectacular, 2.0% annualized in the fourth quarter.
On a year-ago basis, real GDP was up 5.6% in the four quarter, compared to 4.9% growth in the third quarter.
There were two notable revisions in the release. First, the personal consumption expenditures price index, the Federal Reserve’s preferred inflationary measure, was revised lower in the fourth quarter. Overall inflation was 6.3% at an annualized rate in the fourth quarter with the second estimate, compared to 6.5% in the advance estimate. However, core PCE inflation, excluding volatile food and energy prices, was revised somewhat higher in the second estimate, to 5.0% from 4.9%. Inflation is still much higher than the Federal Open Market Committee would like, and the FOMC will raise the fed funds rate at its meeting in mid-March in an attempt to cool off growth and slow inflation.
The second was an upward revision to wages and salary in the third quarter. As a result, gross domestic income-income going to households and businesses from economic activity, and an alternative measure of the size of the economy-rose 6.4% annualized in the third quarter, up from 5.8%. Thus the economy had some extra momentum heading into late 2021 and early 2022.
Normally the second estimate for GDP reports corporate profits for the quarter, but for the fourth quarter corporate profits come out with the third estimate.
The revisions in the second estimate for fourth-quarter GDP were modest, and don’t change the storyline. Growth is strong, but inflation is high. Much of the acceleration in growth in the fourth quarter came from inventories. Underlying demand was decent but unspectacular.
The U.S. economy will continue to expand throughout 2022, although at a slower pace than in 2021. Consumers have lots of cash saved up and will spend, especially on services as the omicron wave fades. Business fixed investment, inventories, housing, and exports will add to growth this year. But growth will slow over the course of 2022 due to drags from high inflation, and higher interest rates as the Fed combats that inflation. But inflation should slow over the course of this year as the impact of supply-chain disruptions fades and growth slows.
The biggest risk to the outlook is the Ukraine-Russia conflict. An extended war in Eastern Europe could lead to higher global energy prices and higher U.S. inflation, forcing the Federal Reserve to tighten monetary policy aggressively, and higher interest rates could become a larger headwind for the U.S. economy. The war could also weigh on growth in Western Europe, which is a very important U.S. export market, through reduced Russian energy imports and higher energy prices. Thus, the Fed could be raising interest rates more aggressively at the same time that global growth is slowing, increasing the likelihood of a central bank policy misstep. The direct impact of U.S. sanctions on the Russian economy would be small.
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