GDP: Modest Second Quarter Gain—Split Level Economy

Second quarter GDP increased at a 2.3 percent pace, with the anticipated split of solid consumer spending and residential investment and softness in business fixed investment. Revisions show a slower expansion to date.

Domestic Strength—Domestic Final Sales

GDP rebounded from a weak start to the year, advancing at a 2.3 percent pace in Q2 (top chart). Consumer spending led the second quarter with a gain of 2.9 percent compared to 1.8 percent last quarter. There were gains in both durable and nondurable goods. These gains were consistent with the improvement in consumer income and with household wealth. This reinforces the view that average hourly wages are not the best indicator of consumer spending.

Residential investment also came in strong. Meanwhile, structures and equipment spending remain a drag—consistent with the orders data we have seen over the past nine months. Government spending was positive, reflecting the gains in state and local spending.

As illustrated in the middle chart, real domestic final sales continued to expand at just above a 2 percent-pace—a downshift from prior economic expansions. This provides a benchmark for decision makers that command a closer watch on operations.

The Swing Factors: Net Exports and Inventories

Net exports were a big swing factor from the first to the second quarter. In the first quarter, net exports subtracted 1.9 percentage points from GDP and then added 0.1 percentage point in the second quarter.

Inventories were a big plus in the first quarter and were a small net drag in the second quarter. This may be a positive if the inventory correction in the second quarter provides a better balance to the final sales/inventory gauge.

Inflation: On the Upswing

The overall GDP deflator came in at a 2.o percent annualized rate in the second quarter, up from the 1.5 percent pace in 2014. Similar to spending, the pickup in inflation has been driven by the consumer sector, with the PCE deflator rising at a 2.2 percent clip versus a second-straight quarter of falling prices for private investment (bottom chart).

Revisions and New Benchmarks: A Slower Recovery to Date

A new seasonal adjustment process was introduced in today’s report, which lifted estimates for first quarter growth in each of the past two years. Instead of contracting as previously reported, the economy is now reported to have expanded at a 0.6 percent annual rate in the first quarter of 2015. Today’s report also included the annual benchmark revisions to GDP. The revisions showed that the current economic expansion has been even slower than previously reported, with real GDP increasing at an average annual rate of 2.0 percent between 2011 and 2014 compared to 2.3 percent in previous estimates. The downward revisions to prior growth suggest productivity has been weaker than previously estimated and may lend further explanation to the weak pace of wage growth in this expansion.