Boom Or Bust? It Depends On Where You Look (September 3, 2023)

GDP’s overlooked twin, GDI, is signaling that a recession has already started. 

By Lisa Beilfuss
September 3, 2023

There is a divergence developing in a pair of economic indicators, and it is sending a message investors should heed. 

For those looking ahead, gross domestic product reports aren’t usually worth much. GDP is especially backward looking given its quarterly frequency, and the staleness is compounded by a series of revisions. By the time a final, twice-revised number is released, it is already the end of the subsequent quarter. 

The latest GDP report is, however, worth considering. Within the revised second-quarter release came gross domestic income, or GDI, GDP’s overlooked twin. Where GDP reflects the value of the final goods and services an economy produces, GDI represents the incomes earned along the way. They are conceptually identical measures of domestic output: The price a consumer pays for a loaf of bread should match the profit plus the salaries, rent, and other inputs paid to make it.

Measurement errors mean the two measures never perfectly match, but the current gap between GDP and GDI is more than a statistical discrepancy and one that investors should observe. That difference has been widening for the past three quarters, and real, or inflation- adjusted, GDP is now outpacing real GDI by the most since at least 1947. 

Quarter-over-quarter, inflation-adjusted GDI was barely positive in the second quarter, following negative prints in both the first quarter of 2023 and the fourth quarter of 2022. Over the past year, real GDI has fallen 0.5% while real GDP is up 2.5%. That is as market focus has been on still-robust GDP despite ongoing monetary-policy tightening, with particular attention on a huge 5.6% third-quarter GDP projection by the Atlanta Fed’s GDPNow model. 

But while investors and economists debate whether such an acceleration is indicative of a soft landing or no landing, GDI suggests that a recession may already be underway. 

“GDI is firmly in contraction and it’s been that way since last year,” says Jeffrey Snider, chief strategist at Atlas Financial and host of the Eurodollar University podcast. The timing, he notes, dovetails with Treasury yield-curve inversions that have largely been dismissed this time. (Please see the July 26, 2023 Praxis article for our interview with Arturo Estrella, the former Fed economist responsible for discovering that the yield-curve slope is a reliable recession predictor). 

Some economists have acknowledged the difference. “One of the most interesting puzzles of the current expansion is why real GDI has been so weak,” says Justin Wolfers, professor of public policy and economics at the University of Michigan. But it probably isn’t as much of a puzzle as it is an inconvenient reality, partly because Wall Street, government, and the media tend to focus on GDP, and partly because GDI is released with an even bigger delay than GDP. 

Some research shows that real GDI leads real GDP into recessions. In a 2010 paper, Jeremy Nalewaik, an economist at the Federal Reserve Board of Governors, found that GDI better reflects business cycle fluctuations because it is more correlated with a wide range of business-cycle indicators, including changes in unemployment, purchasing manager surveys, and changes in stock prices. Nalewaik found that GDP tends to be revised toward GDI; on top of flagging downturns GDP initially misses, GDI better reflects the severity and length of recessions. 

More recently, Francesco Renno, economist at labor-market data provider Chmura, quantified the relationships between both measures of output and the job market. Active job postings are more strongly correlated with GDI, he says, with a correlation coefficient of 82.5 versus 76.8 with GDP.

In recommending that GDI should be emphasized over GDP, Nalewaik is suggesting that income-related statistics are better recession indicators than expenditure-related figures. In that context, it is worth considering household-level personal income and outlays data published in the latest week. 

From a month earlier, personal income rose just 0.2% in July, the slowest pace since December 2022. That is as personal consumption expenditures jumped 0.8%, the fastest since June 2022. Spending growth has outpaced income growth in seven of the past 12 months, subsidized by debt and excess savings accumulated during the pandemic. But that gap seems unsustainable as the cost of credit rises and excess savings, according to the San Francisco Fed, are on track to run out in the third quarter.

“The income numbers look nothing like what most people assume has been a red-hot economy and labor market,” says Snider. Take away government transfer payments, and the situation looks much different. Once the [excess] savings are gone, almost-flat income growth is what is left, he says.  

A precipitous decline in tax receipts underlines the point. Federal government tax receipts fell 8% and 5% year-over-year in the first quarter of 2023 and the fourth quarter of 2022, respectively, the first back-to-back declines since the summer of 2017. “Natural tax receipts are declining as the economy produces less income,” a change that is more consistent with GDI than with GDP, says George Goncalves, head of U.S. macro strategy at MUFG’s institutional client group.

All of this is a red flag for stocks. Piper Sandler chief global economist Nancy Lazar warns that stalling (nominal) or falling (real) GDI is a “very negative” backdrop for corporate revenue. Even when you average GDP and GDI, growth was only 1.2% in the second quarter. Blame higher interest rates and tighter bank lending standards, she says, predicting that economic growth will continue to weaken at least through the second quarter of 2024.  

“​​Looking ahead, it doesn't look too rosy for company earnings,” says Lazar.  “Altogether [it is] a recipe for more layoffs, and a hard landing, most likely starting in 4Q.”

As for the Fed, minutes from the July 5 Federal Open Market Committee meeting showed that “several” participants noted a discrepancy between GDP and GDI. Of them, “most suggested that economic momentum may not be as strong as indicated by the GDP readings,” the minutes said. 

It isn’t clear whether Fed Chairman Jerome Powell is among the “several” concerned with GDI. In his Jackson Hole speech last month, Powell pointed to GDP as indication that the economy isn’t cooling as expected and may require further tightening. 

When it comes to broad output measures, it is possible that the Powell Fed follows GDP over GDI–especially if it wants a reason to remain hawkish in the face of stubborn inflation. But even as inflation remains elevated, recession is probably already unfolding. If GDI is right, it is now a question of how severe the downturn will be.