2

**Profile of the Economy**

(Office of Macroeconomic Analysis)

February 16, 2024

**Introduction**

The U.S. economy ended calendar year 2023 on a strong note as real GDP growth surprised on the upside in the fourth quarter. In labor markets, the pace of job growth was well above the rate needed to accommodate population growth, and importantly, an ample supply of labor has allowed the unemployment rate to hold at low levels without adding to inflation pressures.  Indeed, headline inflation eased further in the fourth quarter, aided by falling prices for energy goods and services as well as core goods.  As of January 2024, the headline inflation rate (as measured by the consumer price index, or CPI) has dropped a full 6 percentage points from its peak in June 2022. Although core inflation remains elevated through early 2023, there have been favorable signs of slowing in the key categories of rent of shelter and core services.  While aggregate data have been relatively consistent with a soft landing for the U.S. economy, further progress is still needed to bring core inflation to a level consistent with the Federal Reserve’s target. 

Economic headwinds have been concentrated in specific sectors.  Housing markets have been mixed: high interest rates have reduced the supply of existing homes for sale, even as new home sales, current supply, and prospective supply have improved.  Meanwhile, surveys of manufacturing business activity have been generally weak—though the January ISM survey signaled increasing customer demand—and businesses and consumers remain pessimistic about the state of the economy.  Overall, however, the U.S. economy proved resilient and strong in 2023, and data from early 2024 suggest the economy remains well-positioned for growth in the new year.

**Economic Growth**

Real GDP growth was unexpectedly strong in the fourth quarter of 2023, rising by 3.3 percent at an annual rate, after exceptionally strong growth in the third quarter of 4.9 percent (see Table 1 – Real Gross Domestic Product). Over the four quarters of 2023, real GDP growth accelerated to 3.1 percent—the second fastest annual pace during this Administration and the third fastest annual pace since before the Global Financial Crisis.

Decomposing GDP into smaller components can be helpful in tracking the economy’s performance.  The four components we consider are: (1) private domestic final purchases (PDFP), the most persistent and stable component of output, consisting of personal consumption, business fixed investment, and residential investment; (2) government consumption and investment; (3) net international purchases (U.S. exports less U.S. imports); and (4) intermediate demand (or the change in private inventories).  Examined separately, each component delivers specific information about activity in various sectors that can be useful in predicting the future path of growth.  

The first component, PDFP, is particularly important to analyze: it measures the private sector’s capacity to drive self-sustaining growth and, therefore, may signal the direction of future economic performance.  In the fourth quarter, real PDFP growth was a strong 2.6 percent at an annual rate, which accounted for 2.2 percentage points of total GDP growth.  Although slowing modestly, personal consumption expenditure (PCE) growth remained close to the third quarter pace and suggested that households’ consumption bundles are slowly rotating from the elevated levels of goods purchases that dominated the pandemic era to services consumption. On net, household spending on services accounted for roughly 55 percent of PCE’s contribution to GDP growth.

Business fixed investment accelerated in the fourth quarter, reflecting growth in all three major components.  Investment in equipment turned positive in the fourth quarter, while spending on intellectual property products grew for the fourteenth consecutive quarter.  However, investment in structures slowed sharply in the fourth quarter, largely driven by less investment in commercial and health care buildings.

Residential investment, the final component of PDFP, posted growth in the fourth quarter, marking this sector’s first back-to-back quarters of expansion in three years.  However, growth slowed as continued weakness in other structures investment (largely reflecting brokers’ commissions from sluggish home sales) partially offset new single-family home construction.  

The other three components of GDP (government spending, net exports, and inventory changes) all made positive contributions to fourth quarter growth.  Total government spending contributed solidly to growth in the fourth quarter, but paces of growth were softer at all levels of government.  International trade was a net positive contributor to real GDP growth as the increase in exports outweighed import growth, resulting in a narrower trade deficit in the fourth quarter.  And the change in private inventories, which can exhibit wide swings from quarter to quarter, added only slightly to growth in fourth quarter after a large contribution in the third quarter.  Notably, the lower contribution from the change in private inventory investment explains most of the deceleration in real GDP growth from the third to the fourth quarters.

**Growth of Real GDP**

(Quarterly percent change at annual rate)

**Labor Markets and Wages**

Despite mounting signs of easing in some indicators, labor markets remain relatively tight and job creation is consistent with a stable unemployment rate.  The pace of job creation averaged 289,000 per month in the first half of 2023, then slowed to an average 220,000 per month in the latter half of the year.  Over the turn of the year, however, job creation surged, averaging 343,000 per month in December and January.  The unemployment rate dropped to a 54-year low of 3.4 percent in January 2023 (and again in April) but by the end of the year, had risen to 3,7 percent, where it stood in January 2024, reflecting solid labor supply.  The broadest unemployment rate—which includes those working part-time for economic reasons and those marginally-attached to the labor force—stood at 6.7 percent at the start of 2023, close to the record low of 6.5 percent in December 2022 (series dates from 1994), but has trended higher since, reaching 7.2 percent as of January 2024. 

The rebalancing of labor supply and demand in the economy continues, but at a slow pace.    Throughout 2023 and in January 2024, the labor force participation rate (LFPR) for all workers has held within a range of 62.4 percent and 62.8 percent.  In more recent months the rate has drifted down and stood at 62.5 percent in January 2024, or 0.8 percentage points below the level in February 2020.  However, among prime-age workers, the LFPR has surpassed the pre-pandemic high of 83.1 percent since March 2023, peaking 0.4 percentage points higher in three of those months, and stood at 83.3 percent as of January 2024.  In addition to increased labor supply, demand for labor is slowly normalizing.  The number of job openings and the vacancies rate have each trended down since March 2022; as of December 2023 (latest available data), there were 1.4 job openings per unemployed worker, the lowest ratio since September 2021.  This lower ratio (fewer jobs per unemployed worker) signals improving balance in labor markets.

Measures of****wage growth in the private sector showed a gradual slowing last year but have stabilized, on balance, in more recent months.  In each of the final three months of 2023, 12-month growth of average hourly earnings was 4.3 percent, then stepped up to 4.5 percent in January 2024.  These rates are considerably below the 5.9 percent peak in March 2022, but higher than the 3.3 percent yearly-rate average in 2019.  Despite relatively stable wage growth recently, progress in reducing inflation has helped improve purchasing power: real average hourly earnings were up 1.4 percent over the year through January 2024 – the fastest pace since last July and contrasting with the 1.7 percent decline in real wages over the year-earlier period.  An alternative measure of wage growth, the Employment Cost Index (ECI), also suggests that wage pressures moderated in the fourth quarter.  (The ECI controls for employment shares among industries and occupations, making it a better reference for wage growth.)  Over the four quarters through December 2023, the ECI for private sector wages and salaries grew 4.3 percent, slowing from the 4.5 percent pace over the year through September 2023, and well down from the 5.1 percent pace over the four quarters through December 2022.      

**Payroll Employment**

(Monthly average for year shown and monthly amounts, in thousands)

**Unemployment Rate**

(Percent)

**Nonfarm Productivity of Labor**

In 2023, productivity picked up with solid economic growth. Over the latter three quarters of 2023, nonfarm productivity growth was 3.9 percent at an annual rate, above the 3.5 percent over the four quarters of 2019.  Indeed, nonfarm productivity grew by 3.2 percent annualized in the fourth quarter, more than double the rate a year earlier.  The most recent increase reflected a 3.7 percent jump in real output which offset a 0.4 percent increase in worker hours.  Over the four quarters of 2023, productivity was up 2.7 percent.

Alongside strong productivity gains, workers have seen higher compensation.  Nominal hourly compensation costs in the nonfarm business sector rose 3.7 percent at an annual rate in the fourth quarter and were up 5.0 percent over the four quarters of 2023, more than doubling from the 2.3 percent, year-earlier pace.  Combined with slowing inflation, such strong compensation growth has led to real gains.  Real compensation per hour was up 0.9 percent at an annual rate in the fourth quarter and 1.8 percent over 2023.  

Productivity gains have also led to relatively slow cost growth for businesses. Unit labor costs, defined as the average cost of labor per unit of output, increased just 0.5 percent at an annual rate in the fourth quarter. Although this partly retraced a 1.1 percent decline in the previous quarter, growth of these costs on a four-quarter basis was 2.3 percent in 2023, roughly one-half of the pace in 2022 and the slowest pace of labor cost growth since before the pandemic.  

**Industrial Production, Manufacturing, and Services**

Industrial production—that is, the output of manufacturing businesses, mining, and utilities—has been relatively lackluster since the spring of 2022.  Throughout 2023, total output was volatile, and over the year through January 2024, output at factories, mines, and utilities was essentially flat.  

Manufacturing production, which accounts for about 75 percent of all industrial output, has also trended lower since spring of 2022.  In the fourth quarter of 2023, manufacturing production declined 1.9 percent at an annual rate.  In January, output growth decreased another 0.5 percent and was down 0.9 percent over the year.  The downtrend in manufacturing output has been broadly based, save for three specific industries: high-tech manufacturing, automotive factory output, and manufacturing of aerospace equipment. Excluding these sectors, most manufacturing industries’ output has trended down.

Unlike the manufacturing sector, mining output (14 percent of industrial production) has trended higher, largely driven by oil and natural gas well drilling—though the latest year-over year reading through January was still down 1.2 percent due to inclement weather.  Since crude oil prices have held above most breakeven points for new wells, U.S. oil and gas producers have gradually increased output.  The final component of industrial output is utilities production, which tends to fluctuate month to month due to weather; unseasonable weather in months often causes sharp swings in output from one month to the next.  For example, utilities output declined 1.7 percent in December 2023, then surged 6.0 percent in January 2024. 

According to survey measures of manufacturing and service-sector businesses, business growth remains negative in the manufacturing sector and has slowed significantly in the services sector.  According to the Institute for Supply Management (ISM), its manufacturing index has remained below the growth threshold of 50 for the past fifteen months.  In January 2024, however, the index posted its largest monthly gain in about three years, rising to 49.1.  For the services sector, the ISM’s index has held above 50 for thirteen consecutive months.  In January 2024, the index rose 2.9 points to 53.4. 

**Housing Markets**

Housing markets have been relatively weak, constrained by low total housing inventories and sales, related to elevated mortgage rates and high home prices.  Existing home sales—which account for a supermajority of all home sales—have declined on a twelve-month basis every month since August 2021, while monthly rates have fluctuated.  In December, existing home sales fell 1.0 percent and, over the year through December, were down 6.2 percent.  Even so, the year-over-year decline was much less steep than the 34.0 percent plunge over the year through December 2022.  By contrast, new single-family home sales have trended higher since July 2022 and were up 8.0 percent in December.  After several months of double-digit 12-month gains, new single-family home sales grew 4.4 percent over the year through December 2023.

Inventories of existing homes available for sale have risen from all-time lows in 2022 (1.6 months in January 2022) but remain constrained as many existing homeowners are still reluctant to sell homes with lower mortgage rates in exchange for new mortgages at much higher rates.  Even so, the months’ supply of existing homes for sale has remained at or above the three-month mark for the past eight months and stood at 3.2 percent in December 2023 – double the record low but still much lower than the average 3.9 months of supply in 2019.  Inventories of new homes on the market remain elevated but after trending lower in mid-2023, have resumed a rising trend, and stood at 8.2 months’ supply in December 2023.  

Since early 2023, monthly growth rates of house prices have been picking up, and yearly rates have turned higher since mid-2023.  The Case-Shiller 20-city house price index—which measures sales prices of existing homes—has risen since March 2023, though in recent months, the pace of growth has begun to slow.  Over the year ending November 2023 (latest data available) the 20-city index was up 5.4 percent, a bit slower than the 6.9 percent, year-earlier advance.  Meanwhile, the FHFA purchase-only house price index has shown positive growth to varying degrees. Over the year through November 2023, the FHFA measure was up 6.6 percent, slower than the 8.2 percent, year-earlier rate but roughly double the paces seen in mid-2023.

Signals from new construction starts and permits (a signal for future starts) were mixed throughout 2023 and remained so at the beginning of this year.  Since the latter half of 2023, single-family housing starts have fluctuated on a monthly basis and fell 4.7 percent in January 2024.  But 12-month rates have been trending higher since July 2023 and were up 22.0 percent over the year through January 2024.  Single-family permits have been growing since February 2023 and rose 1.6 percent in January 2024.  Yearly rates for these permits turned positive in July 2023 and were up 35.7 percent over the twelve months through January 2024.  

In contrast to the single-family sector, multi-family starts have declined noticeably during the past several months and dropped 35.6 percent in January 2024.  Multi-family starts were down 36.8 percent over the year through January 2024.  Meanwhile, multi-family permits have declined in seven of the past twelve months, including a 7.9 percent decline in January 2024 to the lowest level since April 2020.  Multi-family permits are down 24.9 percent over the year through January 2024, suggesting that the weakening trend in this segment of the market continues.

Despite mixed trends between single-family and multi-family construction, activity in the housing sector remains relatively elevated, as builders continue to work through construction backlogs.  The number of total homes under construction—both single-family and multi-family—stood at 1.676 million as of January 2024, modestly below the record high of 1.710 million reached in October 2022 (data series begins in 1970).  Notably, home builders have grown more optimistic in recent months, due to a moderation in mortgage rates and the persistent shortage of existing homes inventory.  The National Association of Home Builders’ housing market index rose for the third consecutive month in February, reaching 48, the highest level since August 2023.

**Prices**

Inflation has slowed substantially since 2022. In the fourth quarter, headline inflation (as measured by the CPI) averaged 0.2 percent per month, driven by an average 1.3 percent decline in energy prices from October to December.  Although energy prices fell further in January 2024, monthly headline inflation ticked up to 0.3 percent as food price inflation accelerated and core inflation picked up.

Core CPI inflation (which strips out the volatile energy and food components) was elevated for much of 2022 but began to slow during the final three months of the year. By the latter half of 2023, core inflation held within a range of 0.2 percent to 0.3 percent.  In January 2024, however, monthly core CPI accelerated to 0.4 percent.  Core goods prices have fallen in seven of the past eight months, helping to constrain core readings.  Inflation for core services has the driving force behind core CPI inflation.  Rent of housing inflation—that is rent of primary residence and owners’ equivalent rents—has set a high floor for core services inflation, despite some recent slowing. Monthly readings for rent of housing inflation have fluctuated between 0.4 percent and 0.5 percent since May 2023, accounting for roughly 0.2 percentage points of monthly headline inflation.  Even so, rent of housing price growth has moderated from the 0.7 percent to 0.8 percent monthly rates seen in the latter half of 2022. 

On a twelve-month basis, inflation has also slowed considerably from peak readings.  Though still elevated relative to pre-pandemic paces, it is moving closer to the Federal Reserve’s target rate.  Over the year ending January 2024, CPI inflation was 3.1 percent—roughly one-third of the peak, 9.1 percent pace recorded over the year through June 2022.  Core inflation has also slowed on a yearly basis, but to a lesser extent than headline: over the year ending in January 2024, core inflation was 3.9 percent, or 2.7 percentage points below the peak rate of 6.6 percent reached over the year through September 2022 and the slowest yearly pace since May 2021.  As with monthly inflation, price growth of core services—driven by strong shelter inflation—has been the primary contributor to relatively rapid core inflation.  

The Federal Reserves’ preferred measure of inflation is the PCE price index.  The PCE price index assigns different weights for different components than does the CPI and uses a different methodology in its calculation—though the drivers of both measures remain similar.  Inflation as measured by the PCE price index typically runs at a slower pace than CPI inflation due to these methodological and weighting differences.  As of December 2023, PCE inflation was 2.6 percent on a year-over-year basis, 0.8 percentage points slower than CPI inflation for the comparable timeframe.  Core PCE inflation was 2.9 percent over the year ending December 2023, a full percentage point below the 3.9 percent core CPI rate measured over the same time frame.

**Consumer Prices**

(Percent change from a year earlier)

****

**Consumer and Business Sentiment**

Despite solid economic growth, strong job creation, and slowing inflation, consumers’ and businesses’ sentiment remained relatively low through much of 2023.  However, starting in December, the mood among consumers began to brighten.  After falling to a record low of 50.0 in June 2022, the Reuters/Michigan consumer sentiment index fluctuated above that level through November 2023.  Yet the index began to rise consistently starting in December 2023, increasing to 79.6 in the preliminary reading for February 2024—the highest level since July 2021.  Meanwhile, consumer confidence in The Conference Board’s alternative household survey has improved since October. By January 2024, the consumer confidence index was 114.8, the highest reading since December 2021.  Even so, households’ assessments of the economy remain low by historical norms.

The mood among small businesses remains pessimistic as well.  The National Federation of Independent Business’s (NFIB) small business optimism index has trended lower since mid-2021.  In January 2024, the small business optimism index stood at 89.9, or 2 points below the early pandemic low.  This marked the twenty-fifth consecutive month that the index was below the pre-pandemic long-term average of 98.0.

**Federal Budget Deficit and Debt**

The federal government’s deficit and debt rose sharply following the multiple fiscal responses to mitigate the pandemic’s impact on the economy.  In FY 2020, the federal deficit peaked at 14.7 percent of GDP.  However, federal finances have improved significantly since FY 2020 with the deficit in FY 2023 equal to 6.3 percent of nominal GDP.

Even so, the level of the deficit was higher over the fiscal year by $320 billion, reaching $1.70 trillion as lower receipts outweighed decreased spending.  Receipts shrank by $457 billion from FY 2022 to FY 2023, partly an artifact of abnormally high capital gains taxes in 2022.  Meanwhile, outlays decreased by $137 billion in FY 2023, partly reflecting lower outlays for student loan relief programs by the Department of Education. By contrast, outlays increased for national defense, Social Security, Medicare, and net interest.  Over the twelve months through January 2024, the federal government’s deficit had risen to $1.77 trillion. 

At the end of FY 2023, gross federal debt stood at $33.2 trillion (122.9 percent of GDP), up from $30.9 trillion (122.2 percent of GDP) at the end of fiscal year 2022.  Since September 2023, gross federal debt has risen to $34.2 trillion as of January 2024.  Debt held by the public was $26.3 trillion (97.6 percent of GDP) at the end of FY 2023, up from $24.3 trillion by the end of fiscal year 2022 (96.0 percent of GDP).  Since the end of FY 2023, debt held by the public has risen to $27.1 trillion.  In June 2023, the Treasury’s borrowing limit was suspended until 2025.

**Monetary Policy**

The FOMC began raising its policy rate at its meeting in March 2022 to address inflation. In the first half of 2023, the FOMC increased the Federal funds target rate of interest by 100 basis points—versus a 425-basis point increase in 2022—but did not raise the target range at any of its meetings since July 2023.  During the post-FOMC meeting press conference on January 31, Chair Powell noted that “[w]e believe that our policy rate is likely at its peak for this tightening cycle, and that if the economy evolves broadly as expected it will likely be appropriate to begin dialing back policy restraint at some point this year.”