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The business situation.

the BUSINESS SITUATION

REVISED (45-day) estimates show that real GNP increased at an annual rate of 1 1/2 percent in the fourth quarter of 1986; preliminary (15-day) estimates had shown about the same rate of increase (table 1).1 Among components of GNP, there were substantial, but largely offsetting, revisions. The largest downward revision was in the change in business inventories ($13 billion). The largest upward revisions were in nonresidential fixed investment ($5 billion) and in net exports ($4 1/2 billion). The increase in the GNP price index (fixed weights) was unrevised at 2 1/2 percent.

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

The revision in inventories largely reflected newly available December book value data for manufacturing and trade. The revision in nonresidential fixed investment was more than accounted for by producers' durable equipment. A modification in the usual quarterly estimating procedure was needed in order to include in fixed investment sizable purchases of "off-the-shelf' equipment that came to light in the December inventory data, especially for wholesale trade. The usual procedure takes into account manufacturers' shipments, exports, imports, and--to some extent-- Government purchases, but assumes negligible changes in wholesale and retail inventories of equipment. The upward revision in net exports reflected incorporation of newly available revised statistical month data on merchandise exports and imports for November. Imports were revised down more than exports. The box on page 2 describes the new schedule for the Census Bureau merchandise trade statistics that will make it possible to incorporate an additional month of trade statistics in the preliminary GNP estimates beginning in April.

Aggregate Price Measures

By either of two BEA aggregate price measures, the GNP price index or the gross domestic purchases price index, inflation was lower in 1986 than in any year since the mid-1960's. For the quarters of 1986, however, the two measures showed different patterns that underscored the importance of international developments in assessing conditions in the U.S. economy. Increases in the GNP price index remained in the range of 1 1/2-2 1/2 percent throughout the year; in contrast, increases in the gross domestic purchases price index dipped to 1/2 percent in the second quarter and accelerated to 3 1/2 percent by the fourth. The following paragraphs discuss conceptual differences between the two measures and analyze price patterns in recent years, featuring a breakdown of the gross domestic purchases index into its food, energy, and other purchases components.

For many applications, the price index for gross domestic purchases may be preferable to the GNP price index as a measure of inflation in the U.S. economy. GNP prices measure prices paid for goods and services produced by the U.S. economy: The GNP price index (fixed weights) is derived from the prices of final purchases-- personal consumption expenditures (PCE), gross private domestic investment, net exports, and government purchases. Gross domestic purchases prices measure prices paid for goods and services purchased in the U.S. economy: The gross domestic purchases index (fixed weights) is derived from the prices of PCE, gross private domestic investment, and government purchases. Thus, the two indexes differ with respect to coverage of the prices of exported and imported goods and services: Price changes in goods and services produced by the U.S. economy and sold abroad are reflected in the GNP price measure but not in the gross domestic purchases price measure; price changes in goods and services produced abroad and sold in the United States are reflected in the gross domestic purchases measure but not the GNP measure.

For example, suppose that, in time period 1, a particular model car is imported into the United States from Japan at a price of $10,000, a margin of $1,000 is added by the importer/ dealer in the United States, and the car is sold to a person for $11,000. In time period 2, the U.S. dollar has depreciated against the Japanese yen, so the same model car is imported at the increased price of $11,500. In order to remain competitive, the importer /dealer decides to absorb some of the increased price in the margin, and the car is sold for $12,000. PCE prices, and, thus, gross domestic purchases prices, will reflect the $1,000 increase ($12,000 minus $11,000) in the sales price. GNP prices, however, will reflect not only the $1,000 increase in PCE prices but also the $1,500 increase ($11,500 minus $10,000) in import prices, which are subracted in deriving GNP prices. Thus, GNP prices, as is appropriate for a measure of U.S. production, will reflect the $500 decrease in the margin on sales.

Over the past two decades, differences between year-over-year percent changes in the GNP price index and in the gross domestic purchases price index have, for the most part, been small. In 1974 and in 1980, however, purchases prices increased about 1 percentage point more than production prices, largely because of sharp runups in the price of imported petroleum. Since 1980, annual increases in purchases prices have averaged several tenths of a percentage point less than those in production prices (table 2). In 1981-85, the differences were due to import prices and mainly reflected widespread declines in the prices of imported goods other than autos. In 1986, purchases prices increased 0.3 percentage point less than production prices; the difference was largely due to a sharp decline in the price of imported petroleum.

Differences between changes in the two price measures were relatively large in the quarters of 1986--ranging from -0.8 to 1.3 percentage points. Moreover, the two measures show somewhat different pictures of the course of inflation: The GNP price index increased at a moderate pace throughout 1986, while the price index for gross domestic purchases accelerated in the second half of the year (table 3). The differences can be traced to prices of imports, specifically merchandise imports. As shown in the addenda to the table, changes in merchandise import prices in 1986 largely mirrored changes in petroleum prices. Following OPEC members' formal abandonment of production quotas in late 1985, petroleum prices plunged in the first three quarters of 1986. In mid-third quarter, OPEC members agreed to reinstate production quotas; petroleum prices rebounded strongly in the fourth quarter. Prices of nonpetroleum imports increased throughout the year: Prices of capital goods, autos, consumer goods, and other goods increased strongly in each quarter; and prices of industrial supplies and materials increased in the second half of the year after declines in the first half. To an extent, the strength in nonpetroleum import prices in 1986 reflected the cumulative effects of dollar depreciation. For example, on a trade-weighted average basis against the currencies of 22 OECD countries, the dollar depreciated 13 1/2 percent from its peak in the second quarter of 1985 to the third quarter of 1986.

Increases in the price of gross domestic purchases have trended down over the period 1981-86, with some pickup in the second half of 1986 (chart 1). Within purchases, food and energy are shown separately; their prices, which are particularly volatile, are frequently affected by exogenous factors, such as government farm price support programs in the case of food and OPEC price control agreements in the case of energy. Over most of the period, food and energy prices tended to hold down inflation, with energy having a particularly large impact in 1986. Prices of purchases other than food and energy have been relatively stable over the past 4 years--increases have remained in the range of 3 to 4 1/2 percent.

Food, energy, and other products all contributed to the pickup in purchases prices in the second half of 1986. Food prices registered considerably stronger increases in the second half of the year. Meat prices had been low in the first half of the year, perhaps reflecting concerns about increased cattle slaughter under the Dairy Termination Program; prices firmed in the second half, as a step-up in Federal government meat purchases largely offset increased supplies. Energy prices fell in each quarter; the declines lessened in the second half of the year, as the impact of the turnaround in petroleum prices began to work through to final products, such as gasoline and heating oil. Prices of purchases other than food and energy picked up in the fourth quarter. About one-half of the acceleration was due to a one-time employer contribution to a pension fund administered by Los Angeles County; this contribution is treated in the national income and product accounts as a temporary increase in the price of employee services purchased by government.

Personal Income and Outlay Account

At the turn of the year, the major measures in the income and outlay account of the personal sector (seen most often as the table "Personal Income and Its Disposition') registered unusual month-to-month changes and contrasting patterns. Special factors related to Federal programs and tax law changes had a substantial impact on each measure.

In January 1987, personal income increased only $1.2 billion, following a $22.8 billion increase in December 1986 (table 4). Changes in both December and January in farm proprietors' income were dominated by agricultural subsidy payments. In December, subsidies increased $16 1/2 billion (at an annual rate), largely in deficiency payments--payments made when the market price of a crop has been below the target price--on the 1986 wheat crop. In January, in the absence of major deficiency payments, subsidies declined $13 1/2 billion.

Other special factors had smaller effects on personal income. In wage and salary disbursements, the January change included $2.5 billion (at an annual rate) for a 3-percent pay raise for Federal civilian and military personnel. In transfers, the January change included $3.6 billion (at an annual rate) for cost-of-living adjustments to benefits paid under social security and several other Federal retirement and income support programs. In contributions for social insurance (which are deducted when calculating personal income), the January change included $2.0 billion (at an annual rate) for the combination of an increase in the taxable wage base for social security (from $42,000 to $43,800) and an increase in the monthly premium (from $15.50 to $17.90) for supplementary medical insurance, the voluntary program of medicare that helps beneficiaries pay for physician and other outpatient care. Excluding all these special factors, personal income increased $10.5 billion in January and $6.4 billion in December.

Personal tax and nontax payments decreased $21.8 billion in January, following a $9.4 billion increase in December. In both months, payments were dominated by effects--direct and indirect--of the Tax Reform Act of 1986. In January, a large reduction in Federal income taxes withheld was due to provisions of the act. However, the reduction was larger than would have occurred if there had not been a delay in the filing of new W-4 forms. Because new W-4 forms, which would have adjusted the number of allowances so that withholdings approximated liabilities, were not available for calculating withholdings for most employees, the number of allowances associated with the graduated tax tables in use in 1986 were applied to the new graduated tax tables. This reduction in withheld income tax payments was partly offset by a large increase in nonwithheld income tax payments, which was also due to provisions of the Tax Reform Act. Further, as explained in the article "State and Local Government Fiscal Position in 1986,' December payments of State and local taxes included indirect effects of changes made by the Tax Reform Act in the treatment of capital gains and in the value of the deductibility of State and and local income taxes for the calculation of Federal income tax. (The estimates of tax payments for both months are subject to large uncertainties because they are based on fragmentary information. Thus, they may be subject to larger than usual revision as actual payments data become available later in 1987.)

Disposable personal income increased $22.9 billion in January following a $13.4 billion increase in December, reflecting not only the changes in personal income but also the changes in personal tax and nontax payments.

Personal outlays--personal consumption expenditures, interest paid by consumers to business, and personal transfer payments to foreigners (net)--decreased $56.2 billion in January, in contrast to an increase of $62.2 billion in December. Motor vehicle purchases--part of personal consumption expenditures on durable goods-- accounted for much of the swing. A sizable part of the December jump in sales appears to reflect consumers' response to prospective changes in Federal tax law. Effective January 1, the Tax Reform Act eliminated, for taxpayers who itemize Federal tax returns, the deduction of State sales tax and began phasing out the deduction for interest payments on consumer loans. The sales thus "borrowed' from early 1987 were a factor in a January drop in sales. As the difference between disposable personal income and personal outlays, personal saving also registered sharp changes--a $79.1 billion increase in January, following a $48.8 billion decrease in December.

Table: 1.--Revisions in Selected Component Series of the NIPA's, Fourth Quarter of 1986

Table: 2.--Price Indexes (Fixed Weights): Percent Change From Preceding Year

Table: 3.--Price Indexes (Fixed Weights): Change From Preceding Quarter

Table: 4.--Personal Income and Its Disposition

Photo: CHART 1 Gross Domestic Purchases Prices (Fixed Weights): Change From Preceding Quarter
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Title Annotation:4th quarter, 1986
Publication:Survey of Current Business
Date:Feb 1, 1987
Words:2274
Previous Article:Input-output accounts of the U.S. economy, 1981.
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