According to preliminary (and sure to be revised) estimates from the U.S. Department of Commerce, Gross Domestic Product (GDP) increased at an astounding 5.6% annualized rate in the first quarter of 2002, the strongest gain in seven quarters. Government spending was unusually strong but – with the exception of home building and remodeling – private sector activity wasn't very impressive. So the most recent GDP report was less an indication that "happy days are here again" than simple proof that the recession was mercifully brief and shallow.

The most significant factor in the surge in first quarter GDP, besides government spending on homeland security, was a slowdown in inventory reduction by manufacturers, distributors and retailers. During the second half of 2001, inventories fell by $181.2 billion; during Q1/2002, however, inventories were replenished by $83.1 billion, adding 3.1 percentage points to the first quarter's GDP. Meanwhile, growth in final sales of goods and services fell from 3.8% to 2.6% between Q4/2001 and Q1/2002.

One of the few GDP components that did not record an increase during the first quarter of 2002 was non-residential business investment. This sector includes capital spending for new buildings, building renovation and remodeling, and the purchase or upgrade of equipment and software. Spending for equipment and software declined by the smallest amount (-0.5% on an annualized basis) than in any quarter over the past 18 months, but spending on non-residential structures plunged at a double-digit rate for the third time in the past four quarters.

The nearly 6% gain in first-quarter GDP, largely due to government spending on security, gives a distorted picture of the economic recovery. Government spending may not be productive in terms of its contribution to long-term growth, so the Q1/2002 GDP gain will be unsustainable unless increases in business spending match or exceed consumer and government spending. Still, the Q1/2002 improvement in exports and the strong residential construction market are encouraging signs that GDP will continue to grow at a subdued rate into 2003.