Eyes on the Economy: Economic Outlook, Manufacturing Contraction, Inflation

Economic Outlook Still Gloomy But Improved

The Investor’s Business Daily/Technometrica Institute of Public Policy Economic Optimism Index increased to 46.9 in March from 45.1 in February, marking the highest reading since December 2021. Nonetheless, a reading below 50 indicates pessimism. The index is a composite of Americans’ six-month outlooks on the economy, personal finances and confidence in federal economic policies.

Interestingly, the majority (53%) of those polled think the economy is in a recession despite the fact it’s officially not. The figure—although above 50%—has been declining in recent months. The six-month outlook increased to 41.6 and confidence in federal economic policies rose to 44.2—both well into the pessimism territory. The outlook for personal finances increased to 55, the only subindex to signal optimism. Recall our previous Financial Feature on borrowing and optimism. Americans indeed remain optimistic about their personal finances despite mounting debt. 

Manufacturing Contracts Four Consecutive Months

The Institute for Supply Management Manufacturing Purchasing Managers Index ticked up to 47.7 in February from January’s 47.4, which was the lowest reading since May 2020. The marginal increase fell below the forecast figure of 48. A reading below 50 indicates a contraction. This marks the fourth consecutive month of contraction for manufacturing. 

February’s reading reflects improvement but still contraction from the previous month in new orders (47 vs. 42.5) and backlog orders (45.1 vs. 43). Meanwhile, production fell (47.3 vs. 48) and employment moved to the contraction territory at 49.1, down from January’s 50.6. Despite this, manufacturing companies indicated they have no plans to substantially reduce headcounts. 

In Real Terms, Inflation Created Worker Pay Cuts in 2022

Quarterly nonfarm business productivity growth in the fourth quarter of 2022 was revised down to 1.7% from the preliminary estimate of 3%. Accounting for the full year of 2022, the annual average nonfarm productivity declined 1.7%, the largest annual decrease since 1974. 

Last year was bad news for productivity as decades-high inflation added to unit labor cost—the ratio of hourly compensation to labor productivity—while real hourly compensation—compensation after accounting for inflation—declined. That means inflation effectively led to pay cuts for workers in real terms while also pushing up labor costs for employers, resulting in lower productivity. Both sides of the economy lost because of skyrocketing prices. 

The fourth quarter data, however, provided a glimpse of hope as productivity picked up—although much less than anticipated. Unit labor cost decelerated from the previous quarter but remained high compared with a year ago. Many blame monetary tightening for economic declines in 2022. But remember: Monetary policy operates on a lag as its impact manifests many months later. It is this year and next when we will see the full impact of monetary tightening, so buckle up. 

Average Annual Changes in Labor Productivity
(2018–2022)

_{Source: U.S. Bureau of Labor Statistics}