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The business situation.

the BUSINESS SITUATION

Preliminary estimates show that real GNP - a measure of U.S. production - decreased at an annual rate of 2.0 percent in the fourth quarter of 1990, 0.1 percentage point less than reported in the advance estimates released a month ago. Real gross domestic purchases - a measure of U.S. demand - decreased 4.5 percent, 0.3 percentage point more than previously reported. The revisions in the two measures differed because of a sizable upward revision in net exports.(1) Among the components that are included in both measures, downward revisions in inventory investment and in Federal Government purchases were partly offset by an upward revision in nonresidential fixed investment (see table 1 on page 23).

The price index for gross domestic purchases (fixed weights), a measure of U.S. inflation, increased 6.4 percent in the fourth quarter; the increase was 0.1 percentage point more than that reported in the advance estimates issued a month ago. The increase in the GNP price index (fixed weights) was revised up 0.6 percentage point, to 4.7 percent. The unusually large upward revision in GNP prices reflected upward revisions in export prices and downward revisions in import prices. These revisions were spread across most major end-use categories of merchandise trade.

Revisions in components of real GNP. - Net exports was revised up $5.1 billion in the fourth quarter; the revision was more than accounted for by a downward revision in imports. Within imports, a $5.8 billion downward revision in merchandise imports was about evenly split between imports of petroleum and products and of nonpetroleum products (mainly in industrial supplies and materials and in autos).

Among the other components of GNP, inventory investment - that is, the change in business inventories - was revised down $5.9 billion; both farm inventories and nonfarm inventories (mainly in durables manufacturing and in retail auto dealers) were revised down. Federal Government purchases was revised down $2.7 billion; the revision was more than accounted for by national defense purchases (mainly in military equipment). Nonresidential fixed investment was revised up $4.4 billion; the revision was more than accounted for by producers' durable equipment (in information processing and related equipment). Within personal consumption expenditures, an upward revision in services (mainly in electricity and gas and in "other" services) was largely offset by a downward revision in durables goods (mainly in furniture and equipment and in "other" durables). (The newly available source data for the preliminary fourth-quarter estimates are listed in the box on page 6.)

Real GNP

The fourth quarter marked what is generally regarded as the beginning of an economic downturn: Real GNP decreased 2.0 percent after increasing 1.4 percent in the third quarter.(2) As described in last month's "Business Situation," the fourth-quarter decrease was concentrated in motor vehicles and construction; the rest of the economy - that is, GNP excluding motor vehicles and construction - continued to record weak growth (table 1). [Tabular Data Omitted]

Before discussing fourth-quarter developments in terms of the conventional GNP components, it is useful to consider recent changes in real GNP expressed on a command basis. Command-basis GNP measures U.S. production in terms of its purchasing power; thus, changes in command-basis GNP reflect changes in the U.S. terms of trade, which BEA measures as the ratio of the implicit price deflator for exports to the implicit price deflator for imports. (Dollar levels for command-basis GNP and the terms-of-trade ratios are shown in table 1.11 of the "Selected NIPA Tables.") Largely in response to surging imported petroleum prices, the U.S. terms of trade worsened considerably in the second half of 1990. As a result, command-basis GNP increased only 0.2 percent in the third quarter (compared with the 1.4-percent increase in real GNP) and dropped 4.5 percent in the fourth (compared with the 2.0-percent decrease in real GNP). (A sharp falloff in imported petroleum prices in the beginning of 1991 points to an improvement in the U.S. terms of trade in the first quarter and a better performance for command-basis GNP relative to real GNP.)

Personal consumption expenditures

Real personal consumption expenditures (PCE) fell 2.9 percent in the fourth quarter, its largest decline since the second quarter of 1980, after increasing 2.7 percent in the third quarter (table 2). For the year 1990, PCE increased only 1.0 percent. [Tabular Data Omitted]

The lackluster performance of PCE was traceable to several interrelated developments: Weakness in disposable personal income, declines in consumer confidence, and an increase in the unemployment rate in the second half of the year. Disposable personal income declined 3.7 percent in the fourth quarter, after a 0.7-percent decline in the third quarter and small increases in the first half of the year. The Index of Consumer Sentiment (prepared by the University of Michigan's Survey Research Center) dropped sharply for the second consecutive quarter - to its lowest level since the second quarter of 1980 - after small declines in the three preceding quarters. The unemployment rate increased for the second consecutive quarter, reaching its highest level since the fourth quarter of 1987.

Expenditures for durables dropped in the fourth quarter, continuing a pattern of alternating decreases and increases that began in the fourth quarter of 1989. Expenditures for motor vehicles and parts - the principal cause of the wide swings in durable goods throughout the year - fell 18.0 percent, to the lowest level since the fourth quarter of 1987. Recent swings in purchases of new cars and trucks have been associated with changes in sales-incentive programs offered by manufacturers: The programs offered in the fourth quarter were modest in comparison with those offered in the third. A sharp increase in the prices of new cars in the fourth quarter may also have contributed to the decline in expenditures. Expenditures for used cars was the only component of durable goods that increased in the fourth quarter. The increase may have been partly attributable to large supplies of attractively priced, late-model used cars on retail dealers' lots; as a result of very aggressive fleet-marketing programs, manufacturers reacquired substantial numbers of fleet cars and sold many of them to dealers. Furniture and household equipment declined 6.5 percent after a slight decline; all components declined, but consumer electronics - the durable goods subcomponent that had increased the most in recent years - declined the most. "Other durables" declined 1.1 percent after increasing 7.1 percent; the largest decline was in jewelry.

Expenditures for nondurables declined 5.9 percent in the fourth quarter - the largest decline since 1974 and the fourth decline in five quarters. Fourth-quarter declines left expenditures for food at their lowest level since the third quarter of 1987 and left expenditures for clothing and shoes and for "other nondurables" at their lowest levels since the second quarter of 1989. Expenditures for energy also declined in the fourth quarter. Fuel oil and coal declined, largely because of warmer-than-normal weather in New England, where use of fuel oil predominates; gasoline and oil was unchanged.

Expenditures for gasoline and oil changed little from the second quarter to the fourth quarter, even though petroleum prices increased 65 percent as a result of the Middle East crisis. In the two earlier periods when petroleum prices increased sharply, expenditures fell: From the fourth quarter of 1973 to the first quarter of 1974, expenditures dropped 34 percent; from the first quarter to the third quarter of 1979, they dropped 21 percent. There are several possible explanations for why gasoline and oil expenditures behaved differently in 1990 than in 1974 and 1979. First, supply shortages were associated with the oil price shocks in 1974 and 1979 but not in 1990. Second, because prices were more volatile in the years prior to 1990 than in the years prior to the earlier oil price shocks, consumers were more accustomed to sharp price changes and thus reacted less to them. Third, gasoline and oil expenditures accounted for a smaller portion of total PCE in 1990 than in the 1970's; this reduction, which was partly the result of higher vehicle fuel efficiency, may have lowered the price elasticity of demand.

Expenditures for services increased 1.8 percent in the fourth quarter after increasing 3.0 percent in the third. The deceleration was accounted for by household operations and medical care. A downswing in household operations reflected declines in natural gas and in telephone and telegraph after increases; the decline in natural gas partly reflected warmer-than-normal weather in much of the United States. Expenditures for housing services and for "other services," mainly recreation, both increased more in the fourth quarter than in the third.

Nonresidential fixed investment

Real nonresidential fixed investment declined 1.3 percent in the fourth quarter after increasing 8.9 percent in the third. A sharp drop in structures more than accounted for the decline (table 3). [Tabular Data Omitted]

Structures dropped 17.9 percent in the fourth quarter. Construction of commercial buildings posted the largest drop, as it fell to its lowest level in 7 years. Construction of industrial buildings declined for the first time since the fourth quarter of 1989.

Producers' durable equipment increased 4.2 percent in the fourth quarter. Information processing equipment increased sharply after two small quarterly declines; the increase was accounted for by office, computing, and accounting machinery. Transportation equipment dropped sharply after a very strong increase. Motor vehicles accounted for most of the drop; some motor vehicle purchases originally scheduled for the fourth quarter may have been shifted into the third quarter in response to the very aggressive fleet-marketing programs by automobile manufacturers.

Although interest rates (as measured by the yield on new issues of high-grade corporate bonds) moved down in the fourth quarter, most of the other factors that are usually considered in assessing the outlook for investment spending are generally discouraging. A Census Bureau survey of business plans for plant and equipment expenditures that was conducted in October and November 1990 found that real spending on plant and equipment is expected to increase only 0.4 percent in 1991. Contract awards for new commercial and industrial buildings fell substantially in each quarter of 1990. The rate of capacity utilization in manufacturing dropped sharply in the fourth quarter. Finally, for more than a year, corporate profits and cash flow have been weak, and real final sales have grown at an annual rate of less than 2 percent.

Residential investment

Real residential investment declined 18.5 percent in the fourth quarter after declining 19.8 percent in the third (table 3). Single-family construction, multifamily construction, and the "other" component (which includes additions and alterations, major replacements, mobile home sales, and brokers' commissions on house sales) each declined in both quarters.

Single-family construction declined 25.6 percent in the fourth quarter, the third consecutive quarter in which the decline exceeded 20 percent. These declines mirror a sharp falloff in single-family starts (chart 2). In the fourth quarter, single-family starts were 786,000 units (seasonally adjusted annual rate), 202,000 units below their year-earlier level.

The 4-year downward trend in multifamily construction continued in the fourth quarter. Multifamily construction declined 10.0 percent after declining 25.9 percent. Vacancy rates above 7 percent continue to plague the multifamily housing sector.

The "other" component declined 11.5 percent in the fourth quarter after declining 9.2 percent in the third. Both declines were largely accounted for by additions and alterations and by major replacements, two components that measure improvements to existing houses. Brokers' commissions on house sales also declined in both quarters, as sales of both new and existing homes continued to drop. Sales of new houses declined 46,000 units, to 478,000 units (seasonally adjusted annual rate), in the fourth quarter, the fifth consecutive decline; sales of existing homes declined 90,000 units, to 3,164,000 units (seasonally adjusted annual rate). These declines are consistent with a falloff in consumer confidence: The percentage of respondents to the University of Michigan's survey of consumer sentiment who indicated that "now is a good time to buy a house" fell to 53 percent in the fourth quarter from 65 percent earlier in the year. The weakness in the housing market continued despite recent declines in interest rates (chart 3). The commitment rate on fixed-rate mortgages declined 16 basis points, to 9.95 percent, in the fourth quarter after falling 33 basis points in the third.

Inventory investment

Real inventory investment - that is, the change in business inventories - fell $26.9 billion in the fourth quarter, as businesses reduced their inventories $22.2 billion after adding $4.7 billion in the third quarter (table 4). Nonfarm inventories, particularly manufacturing inventories and retail auto dealers' inventories, more than accounted for the downswing. [Tabular Data Omitted]

Manufacturing inventories declined $16.1 billion in the fourth quarter after increasing $3.7 billion in the third. Inventories of durables registered a substantial decumulation, resuming a runoff that had been interrupted by a modest accumulation in the third quarter. The decumulation was primarily in electrical machinery, in nonelectrical machinery, and in transportation equipment other than motor vehicles. Inventories of nondurables declined after small increases in the second and third quarters; the decline was concentrated in petroleum and coal products and in apparel.

Retail auto dealers' inventories were drawn down $10.3 billion in the fourth quarter after increases in the two preceding quarters. The liquidation reflected the extremely low level of motor vehicle production. Other retail trade inventories increased after a decline; the upswing was in nondurables.

Wholesale trade inventories increased $1.4 billion in the fourth quarter, continuing a series of moderate increases. Inventories of merchant wholesalers were up considerably more than in the third quarter; the larger increase was accounted for by inventories of grocery and farm product wholesalers. Inventories of nonmerchant wholesalers declined after a small increase; the downswing was largely in inventories held in petroleum bulk stations and terminals.

Farm inventories increased $1.9 billion in the fourth quarter after no change in the third. Inventories of crops increased after two quarters of decline; these changes largely reflected net placements of crops with the Commodity Credit Corporation. Inventories of livestock increased less than in the third quarter.

Although the fourth quarter marked what is generally regarded as the beginning of an economic downturn, all three of the aggregate constant-dollar inventory-sales ratios shown in table 5 moved lower. For example, the ratio of nonfarm inventories to final sales dropped from 2.82 in the third quarter to 2.79 in the fourth. All three ratios were considerably below their year-earlier levels. [Tabular Data Omitted]

An alternative set of constant-dollar inventory-sales ratios that provides more detailed information about inventory developments shows a somewhat different picture. This set is limited to the manufacturing and trade industries: The inventories account for approximately 85 percent of total nonfarm business inventories, and the sales include intermediate sales - that is, sales from one industry to another - as well as sales to final purchasers. The inventory-sales ratio for manufacturing and trade increased from 1.43 to 1.46 in the fourth quarter, bringing it back up to the year-earlier level. The ratio for manufacturing turned up in the fourth quarter; among manufacturing industries, the ratios for primary metals and for motor vehicles were considerably higher than a year earlier. The ratio for merchant wholesalers jumped in the fourth quarter; the ratios for motor vehicles and for other durables were considerably higher than a year earlier. The ratio for retail trade edged up in the fourth quarter; ratios for durables other than auto dealers and for food stores were higher than a year earlier.

Net exports

Real net exports jumped $28.0 billion in the fourth quarter after declining $1.9 billion in the third (table 6). Exports were up $10.9 billion, slightly more than in the third quarter; imports were down $17.1 billion after increasing $12.3 billion. In both exports and imports, merchandise trade more than accounted for the fourth-quarter movements; several major end-use categories posted exceptionally large changes. [Tabular Data Omitted]

Merchandise exports increased $13.2 billion (or 13.1 percent) in the fourth quarter after a small increase in the third. Nonagricultural exports, which increased $13.4 billion after increasing $3.9 billion, accounted for most of the pickup. Within nonagricultural exports, industrial supplies and materials, which increased a record $6.8 billion, accounted for most of the fourth-quarter increase; capital goods (except autos) accounted for most of the rest of the increase. Agricultural exports changed little after a $1.3 billion decline.

Merchandise imports declined $17.8 billion (or 12.9 percent) in the fourth quarter after a substantial increase in the third. Petroleum imports, which dropped a record $18.0 billion, accounted for the decline. The drop in petroleum imports reflected a reaction to higher prices and the falloff in economic activity. Nonpetroleum imports changed little; a substantial increase in capital goods (except autos) was nearly offset by the largest decline in auto imports in 8 years.

Government purchases

Real government purchases increased $8.6 billion (or 4.2 percent) in the fourth quarter after increasing $2.5 billion (or 1.2 percent) in the third (table 7). Both Federal defense purchases and State and local government purchases increased more than in the third quarter; Federal nondefense purchases declined more than in the third quarter. [Tabular Data Omitted]

Federal defense purchases increased $5.2 billion in the fourth quarter after increasing $1.7 billion in the third; the step-up was at least partly attributable to spending for Operation Desert Shield. Purchases of nondurables increased considerably after a decline; purchases of petroleum products were up $3.7 billion, and purchases of ammunition were up $1.2 billion. Compensation of military personnel increased $0.7 billion after little change. Among services other than compensation, spending on transportation of material, on travel of persons, and on personnel support picked up; together, these services increased $2.4 billion in the fourth quarter. Purchases of military equipment declined $1.2 billion after increasing $4.4 billion.

Federal nondefense purchases declined $2.9 billion in the fourth quarter after declining $1.6 billion in the third. The larger decline was traceable to changes in inventories of farm products held by the Commodity Credit Corporation (CCC); these changes largely reflected transactions under the commodity loan program. The level of CCC inventories declined $1.6 billion in the fourth quarter after two quarters of modest accumulations. Federal nondefense purchases excluding CCC inventory change was unchanged after a decline.

State and local government purchases increased $6.2 billion in the fourth quarter after increasing $2.4 billion in the third. The pickup was traceable to structures, largely reflecting a rebound in highway construction.

NOTE. - Quarterly estimates in the national income and product accounts are expressed at seasonally adjusted annual rates, and quarterly changes are differences between these rates. Quarter-to-quarter percent changes are annualized. Real, or constant dollar, estimates are expressed in 1982 dollars and are based on 1982 weights.

The preliminary GNP estimate for the fourth quarter incorporates the following revised or additional source data that were not available when the advance estimate was prepared a month ago.

Personal consumption expenditures: Retail sales for November (revised) and December

(revised).

Nonresidential fixed investment: Construction put in place for November (revised) and December,

manufacturers' shipments of equipment for November (revised) and December,

and partial information on plant and equipment expenditures for the quarter.

Residential investment: Construction put in place for November (revised) and December.

Change in business inventories: Manufacturing and trade inventories for November

(revised) and December.

Net exports of goods and services: Merchandise exports and imports for November (revised)

and December.

Government purchases of goods and services: Federal outlays for December, and State and

local construction put in place for November (revised) and December.

GNP prices: Detailed merchandise export and import price indexes for October through

December, values and quantities of petroleum imports for December, and residential

housing prices for the quarter.

1. Revisions in net exports - that is, exports minus imports - lead to revisions in GNP but not in gross domestic purchases. Gross domestic purchases is calculated as the sum of personal consumption expenditures (PCE), gross private domestic investment (GPDI), and government purchases. GNP is calculated as the sum of these three components plus exports minus imports (thereby including U.S. production of goods and services marketed outside the United States and excluding goods and services in PCE, GPDI, and government purchases that are not U.S. produced).

2. The regularly featured estimate of real GNP is based on 1982 weights. An alternative estimate of real GNP growth based on 1987 weights decreased 3.5 percent in the fourth quarter after increasing 1.7 percent in the third (see tables 3 and 4 on page 24).

PHOTO : CHART 1 Selected Measures: Change From Preceding Quarter

PHOTO : CHART 2 Housing Starts

PHOTO : CHART 3 Selected Interest Rates
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Title Annotation:fourth quarter of 1990
Publication:Survey of Current Business
Date:Feb 1, 1991
Words:3493
Previous Article:Personal income continued to grow slowly in third quarter 1990.
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