Consumer, Government Spending Expected to Support GDP in 3rd Quarter

People walk along 5th Avenue in Manhattan, one of the nation's premier shopping streets, in New York City, on Feb. 15, 2023. Spencer Platt/Getty Images

Third-quarter gross domestic product (GDP) numbers that are scheduled for release by the Bureau of Economic Analysis (BEA) on Oct. 26 might signal that the U.S. economy is on the cusp of achieving a soft landing or that the July-to-September period was the last quarter of strong growth.

Early estimates suggest that the U.S. economy expanded more than in the second quarter.

The Federal Reserve Bank of Atlanta’s GDPNow model estimate shows that U.S. output in the recent quarter was 5.4 percent, while the New York Fed Nowcast suggests that the economy grew by 2.55 percent. The St. Louis Fed’s Real GDPNowcast forecasts a print of 2.3 percent.

JPMorgan Chase revised its third-quarter GDP forecast upward to 4.3 percent from 3.5 percent.

KPMG Chief Economist Diane Swonk is projecting a 5.5 percent reading.

Economists argue that the third-quarter GDP growth rate has implications, particularly for monetary policy.

Fed Chair Jerome Powell has repeatedly noted that the rate-setting Federal Open Market Committee needs to see below-trend economic growth before it can be convinced that inflation is sustainably returning to its 2 percent target rate.

Monetary authorities are aiming to slow demand to help ease inflationary pressures. Since consumer spending accounts for two-thirds of economic output, higher interest rates are the way to achieve this objective. However, despite rising rates and elevated inflation, consumption has been healthy.

Retail sales rose by 0.6 percent in July, 0.8 percent in August, and 0.7 percent in September. Personal spending jumped by 0.9 percent in July and 0.4 percent in August.

It has also helped that the U.S. labor market finished the third quarter strong, with 336,000 new jobs in September and an unemployment rate below 4 percent.

Is a soft landing—a Goldilocks porridge of an economy that averts a recession, maintains labor stability, and vanquishes inflation—a guarantee at this point?

Not so fast, says Gregory Daco, chief economist at EY-Parthenon.

“The U.S. economy continued to show remarkable resilience over the summer, with surprisingly robust job growth and an unexpected consumer spending spree that likely propelled real GDP growth above 5% annualized in Q3,” he wrote in a note. “While these signs of economic strength will likely fuel speculations that the economy is reaccelerating, we do not expect such strong momentum will be sustained.”

Indeed, the U.S. economy is grappling with a wide array of economic challenges: tightening lending standards, surging Treasury yields, eroding pandemic-era savings, resuming student loan repayments, rising corporate bankruptcies, soaring home prices, higher energy prices, and above-trend inflation.

Two foreign wars could also weigh on the economic landscape, be it threats to oil and gas prices or geopolitical tensions affecting trade.

At the same time, government spending could further prop up the gross domestic product.

Government Spending and GDP

Spending by federal and state governments has risen so much that it’s supporting the GDP.

Last year, federal net outlays as a percentage of GDP were 25 percent. While this was down from the COVID-19 pandemic peak of 31 percent, the last time it was this high was during World War II.

In the second quarter, according to the BEA, government consumption rose at an annualized pace of 3.3 percent. Federal spending swelled by 1.1 percent, national defense climbed by 2.3 percent, and state and local government outlays surged by close to 5 percent.

It has been more than a year since the Inflation Reduction Act and the U.S. CHIPS and Science Act were enacted, and the effects of these legislative initiatives are beginning to show up in the data. This year, U.S. and foreign companies have taken advantage of federal and state subsidies—from tax credits to grants—to construct factories, produce goods, and hire workers.

That’s part of the White House’s 2022 ambitions of having the government invest in the private sector.

“When the public sector stepped back, economic growth diminished and became less evenly shared. The private sector did not lose a rival; it lost a partner,” the administration wrote in a 2022 report, titled “The Public Sector’s Role in Economic Growth.”

“A core aim of the Biden–Harris Administration’s economic policy agenda is to restore the public sector as a partner in long-run growth, with a particular focus on the economy’s supply side—from physical infrastructure to the vitality of our workforce.”

But government payrolls have also grown, representing more than a fifth of all job creation in 2023.

President Joe Biden’s spending mirrors what economist John Maynard Keynes recommended for economic policy: borrow money to spend on public works projects, and the deficit-financed spending will produce jobs, trim inflation, and enhance purchasing power.

In fiscal year 2023, the U.S. government posted a budget deficit of $1.7 trillion, while the national debt is currently north of $33.6 trillion. While Washington has had little difficulty in spending on public works endeavors, the Treasury is finding it difficult to attract buyers for its debt.

Recent Treasury auctions have seen weakened demand for three-, 10-, and 30-year bonds, leading some analysts to suspect that there’s concern about the country’s fiscal path. In other words, they want a yield higher than 5 percent.

The current administration might be hoping that its investment efforts will eventually produce higher tax revenue to help fund the government’s ballooning deficits.

Federal revenues, derived from taxes and other sources to fund government expenditures, tumbled by 9 percent in fiscal 2023.