Why the US economy shrank in the first quarter of 2022

Five charts that explain why inflation is at its highest point in 40 years

Here are some ways to think about the economic growth data, in the context of high inflation, a tight labor market and uncertainty about a possible recession that could be in the future.

What is behind the 1.4% figure?

In short, the US economy contracted sharply at the start of the pandemic and then boomeranged in 2021. Last year, the economy grew by 5.7%, the fastest annual pace since 1984.

Economists did not expect the economy to maintain the same momentum this year as federal stimulus programs faded and the Federal Reserve moved to raise interest rates to curb growth and rein in rising prices. But the negative data on gross domestic product still surprised and masked some signs of strength, such as consumer spending.

The contraction fueled fears that a recession, defined as two consecutive quarters of negative growth, could be on the horizon as the Fed prepares as many as seven rate hikes this year. But economists aren’t drawing a straight line between this GDP report and heightened recession risk. If the economy contracts later this year, it could be for a variety of reasons, such as the Fed raising interest rates too aggressively or people cutting back on spending, economists say.

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“My big question going forward is: ‘When will your pockets start to slow down?’ But it’s not because of this report,” said Beth Ann Bovino, chief US economist at S&P Global Ratings. “Going forward, will there be a point where people run out of reserves, start to feel like they’re spending too much on their savings, or are tired of paying higher prices?”

Withdrawal on inventory purchases

One of the main reasons for the economy’s slump in the first quarter stemmed from what’s known as retail inventory purchases, which are goods that businesses tend to buy before they need them. Retailers often shop well in advance, to prepare for things like the holiday shopping season. And in some cases, companies will stock up on materials if they are concerned about supply chain delays or other issues, such as rising prices. That’s what happened at the end of 2021. Remember all those supply chain blunders? Retailers brought in many products early to ensure there were no shortages during the holidays.

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By early 2022, many of those same companies realized they had leftover sweaters, toys, or gadgets and didn’t need to stock up anymore. Inventory purchases by themselves are responsible for a large part of the drop in GDP, up 0.84 percentage point.

More imports weigh on GDP

The United States did not export as many goods in the first three months of the year. On top of that, the country imported a lot more stuff, in part due to all the different supply chain issues that have been plaguing businesses over the past year, even in the face of high consumer demand. That move widened the trade deficit.

And expanded trade deficits play a big role in how GDP is calculated. The GDP report effectively subtracts all things bought from other countries, which shows up as a huge drag on GDP. In fact, the decrease in exports and the increase in imports, together, were responsible for 3.2 percentage points of the drop.

“Demand for goods is so strong that Americans are turning to the international economy to satiate demand,” said Joe Brusuelas, chief economist at RSM. “There was an increase in demand for goods, and right there, in a nutshell, is the problem.”

International trade figures also tend to undergo serious revisions after initial GDP estimates. More specific data comes out next week. For now, though, “the domestic side of the equation was strong,” Bovino said.

The other major forces in the economy

The GDP report comes as policymakers and economists grapple with two major problems in the economy: skyrocketing inflation and a tight job market.

Inflation has reached the highest levels in 40 years, with prices rising 8.5 percent in March compared to a year earlier. The Federal Reserve is racing to rein in rising prices before they embed themselves further into the economy. Republicans are criticizing the Fed for being too slow to respond and are blaming in large part Democrats’ sprawling stimulus efforts last year.

Meanwhile, the labor market has shown tremendous strength since 20 million jobs were knocked out of the economy two years ago. The unemployment rate remains remarkably low, 3.6 percent, and the job market has been a big talking point for the Biden administration. But economists and policymakers also fear the labor market is unsustainably hot. There are far more job openings than job seekers, and the mismatch has the Fed trying to reduce the demand for workers without people losing their jobs.