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The business situation.

REVISED estimates show that real GNP, a measure of production, increased at an annual rate of 3 1/2 percent in the second quarter of 1988; the advance estimates had shown an increase of 3 percent (see table 1 on page 20). The increase in real gross domestic purchases, a measure of demand, was also revised up, to 1 1/2 percent at an annual rate, from 1 percent. Increases in both the GNP price index (fixed weights) and the gross domestic purchases price index (fixed weights) were unrevised at an annual rate of 4 1/2 percent.

Although the production and demand totals were not revised substantially by the incorporation of newly available source data, several major components showed sizable-largely offsetting-revisions.' Real Federal Government purchases of goods and services was revised up $5.7 billion (due to Federal outlays data for June), personal consumption expenditures for goods was revised up $5.7 billion (largely due to revised retail sales data for May), and producers' durable equipment was revised up $2.4 billion (largely due to aircraft shipments data for June). The largest downward revision was in change in business inventories; $6.1 billion of the $9.0 billion revision was in farm inventories.

About one-half of the revision in farm inventories reflected BEA's revised estimate of crop and livestock losses due to the drought in most of the Midwest and major parts of the East. BEA's estimate is described in the next section. The second section discusses the recent sensitivity of real product and price measures to the weight year used in their calculation. The third and fourth sections discuss corporate profits, for which data become available at the time of the preliminary GNP estimate, and the government sector.

Effects of the Drought on

Farm Output

On the basis of information from the U.S. Department of Agriculture (USDA), BEA now estimates the 1988 loss of constant-dollar farm output due to the drought at $141/2 billion. The estimate was based on the difference between the USDA June forecast of the physical quantity of output, representing conditions before the drought, and the August forecast, which reflects the results of surveys of acreage planted and prospective yields conducted in late July and early August. This difference, after conversion by BEA into constant (1982) dollars, indicates crop losses of $13 billion-about one-half in corn and one-quarter in soybeans and wheat-and livestock losses of $l 1/2 billion. The revised losses are $3 billion higher than last month's estimate, which was based on the USDA July forecast; crop losses account for the entire upward revision. The estimates are subject to further revisions as information from more comprehensive USDA surveys becomes available.

On a quarterly basis, BEA estimates the second-quarter loss at $9 1/2 billion (annual rate), $4 billion higher than last month's estimate, As noted in the July "Business Situation," BEA derived the loss in livestock output for the second quarter using information about earlier-than-usual sales and the loss in crop output using a special procedure that spreads the loss for the year over quarters.

This procedure is used because the procedure normally used for several of the national income and product account (NIPA) components that reflect activity in the farm sector-change in farm inventories and farm income, both corporate and noncorporate- , would not properly record the timing of the effects of the drought. Under the normal procedure, estimates of both current- and constant-dollar change in crop inventories, which also affect the estimates of farm income, are prepared by BEA as the difference between output and sales. BEA estimates quarterly output by interpolating between annual estimates derived from USDA reports, including their forecast for the most recent year, and BEA estimates quarterly sales on the basis of USDA receipts from farm marketings and Commodity Credit Corporation (CCC) loan activity.

Using the normal interpolating procedure, the effects of the drought on farm output (and thus on inventories and income) would have been spread to the quarters of 1987, 1988, and 1989. This procedure was rejected because tbe results would have been inconsistent with the timing of similar losses in nonfarm inventories and with tbe timing of the effects of the farm output losses on other NIPA components. (For the same reasons, the normal procedure has been rejected in similar situations in the past-most recently, for the 1983 drought.) Losses due to the destruction of nonfarm inventories are recorded in the period the loss is recognized. The effects of the losses in farm output on other NIPA componentssuch as nonfarm inventory change, agricultural exports, and CCC inventory change-will be recorded during the harvest period.

To reflect more accurately the timing of the losses in crop output, BEA used a procedure that allocated the losses to the growing season but with the harvest period receiving higher allocations. Specifically, BEA estimated the drought losses by averaging two series. The first allocated the losses equally to the second, third, and fourth quarters of 1988. This allocation acknowledges that farmers recognized their losses during all three of the quarters that span the growing season. The second allocated the losses to the harvest perio d-25 percent in the third quarter and 75 percent in the fourth, reflecting the typical harvest period of the affected crops. This allocation recognizes the timing of the effects of the losses on other NIPA components. Total farm output for the quarters of 1988 was derived by subtracting the estimated losses from pre-drought farm output based on normal interpolation procedures.

Using the annual losses in crop output of $13 billion in constant dollars, $8 1/2 billion (annual rate) was allocated to the second quarter, $15 billion to the third quarter, and $28 billion to the fourth. Including the allocation of losses in livestock output, total losses due to the drought reduced secondquarter real GNP by $9 1/2 billion and will reduce third- and fourth-quarter real GNP by $161/2 and $3l 1/2 billion, respectively. Changes in real GNP will be correspondingly reduced by about 1 percentage point in the second quarter, by 1/2 percentage point in the third quarter, and by 1 1/2 percentage points in the fourth quarter.

The estimates of the losses in farm output enter the calculation of change in farm inventories and of farm income. The extent to which the losses affect the estimates of the change in farm inventories depends on the extent to which they affect sales. In the second quarter, sales do not appear to have been affected, so that tbe entire $9 1/2 billion loss reduced inventory change. In the third and fourth quarters, sales probably will be affected, but by amounts that cannot be estimated because the droughes effects cannot be identified in the underlying source data. Consequently, it will not be possible to estimate the effects on the change in farm inventories in these quarters. For farm income, no attempt has been made to estimate the drought's total effects. Although the extent to which the quantity of farm output is reduced because of tbe drought is known, farm income is also affected by drougbt-induced changes in crop prices, farm subsidies, and production expenses. Finally, the drought's effects on NIPA components that reflect purchases of farm products also cannot be estimated because the effects cannot be identified in the underlying source data.

GNP Growth and Price Change with Recent Weights

For some recent quarters, the published growth rate of real GNP, which is expressed in 1982 prices, has been larger than the growth rate of real GNP expressed in prices of a more recent period. Growth from the second quarter of 1987 to the second quarter of 1988 is 4.3 percent based on 1982 dollars, but only 3.7 percent based on a chain measure (described below) that changes weighting period from quarter to quarter. Rates of price increase have also been larger with 1982 weights than with more recent weights, but by a smaller margin than real growth rates.

Weighting period sensitivity is not a new phenomenon. It tends to increase with the length of time since the weight year. The rapid fall in computer prices, coupled with rapid growth in computer output, is an important contributor to the current sensitivity. From 1982 to 1987, real purchases of office, computing, and accounting machinery-the category of producers' durable equipment that includes computers-increased by 296 percent (in 1982 prices), while the fixed-weighted price index for the same category of equipment fell by 45 percent. The increase in real purchases of computers contributes far more to the growth of real GNP when computers are valued at 1982 prices than when they are valued at their much lower recent prices. The fall in price, in contrast, contributes far less to the change in a GNP price index when its weight is calculated using 1982 purchases than when its weight is calculated using recent purchases.

In general, measures of growth and price change are lower with more recent weighting periods whenever (1) goods and services whose prices have decreased relative to the overall price level have tended to grow rapidly, and (2) goods and services whose prices have increased relative to the overall price level have tended to grow slowly.

At present, BEA publishes only one measure of real GNP growth, expressed in 1982 prices. It is possible, however, to derive an alternative measure of real GNP growth that uses changing weights from two estimates that BEA publishes in NIPA table 8.1: The percent change in current-dollar GNP, and the percent change in tbe chain price index for GNP. The alternative measure is equivalent to one that measures growth between each pair of quarters using the prices of the later quarter.

The alternative measure is approximately equal to the current-dollar growth rate minus the growth rate of the chain price index. The exact formula is:

g(t) = 100 x [(100 + g$(t))/

(100 + pch(t))] - 100

in which g(t) is the growth rate of real GNP using current-period prices from quarter "t-l" to quarter "t"; g$(t) is the growth rate of current-dollar GNP from quarter t-1 to quarter t; and pch(t) is the percent change in the chain price index for GNP from quarter t-1 to quarter t.

Table 1 shows quarterly GNP growth based on 1982 dollars and based on changing weights, beginning in the first quarter of 1987. Differences between the 19 82-based estimate and the changing-weight estimate (both seasonally adjusted annual rates) range from -0.4 to +1.1 percentage points.

The largest positive differences are for the fourth quarter of 1987 and tbe first quarter of 1988. The shift to a negative difference in the second quarter of 1988 is due to movements in inventories of farm and and petroleum products.

Table 1 also shows the two measures of price cbange that BEA publishes for each quarter, tbe fixed-weighted index based on 1982 weights and the chain price index. The 1982-based measure increases more than the changingweight measure for all six quarters, by margins that range from 0.1 to 0.5 percentage point. The average difference between the two price change measures is about two-thirds as large as the average difference between the two growth rate measures.

Corporate Profits

Profits from current production increased $16 billion in the second quarter after little change in the first. Domestic profits and profits from tbe rest of the world contributed equal amounts to the second-quarter increase; in the first quarter, an $11 1/2 billion increase in domestic profits bad been offset by a decline in profits from the rest of the world. (Although the changes in rest-of-world profits were the same as the changes in domestic profits in both quarters, the level of rest-of-world profits was only about one-eighth that of domestic profits.)

Rest-of-world profits equals the difference between (a) profits of U.S.owned corporations abroad and (b) profits of foreign-owned corporations in the United States. In the first quarter, an increase in the profits of foreignowned corporations accounted for most of the decline in rest-of-world profits; in the second, a decline in profits of foreign-owned corporations accounted for about one-half of the increase in rest-of-world profits. These movements in profits of foreign-owned corporations reflect first-quarter accounting adjustments that some of these corporations made in accordance with a new financial accounting standard (see the May "Business Situation" for a discussion). If these accounting adjustments had not been made, profits from the rest of the world would have declined about $7 1/2 billion in the first quarter and increased about $4 billion in the second. Profits of foreign-owned corporations would still have accounted for most of the firstquarter change in rest-of-world profits, but would have had little effect on the second-quarter change.

Profits before and after tax. In the second quarter, profits before tax (PBT) and profits after tax (PAT) registered their largest increases in several years. PBT increased $24 1/2 billion in the second quarter to $31O 1/2 billion, following an increase of $4 1/2 billion in the first; PAT increased $17 billion to $166 1/2 billion, following an increase of $3 1/2 billion. Unlike profits from current production, PBT and PAT include "inventory profits" and "depreciation profits." Inventory profits (or losses) are generated by changes in prices of inventoried goods; depreciation profits (or losses) are generated by differences between the procedures for determining depreciation under tax accounting, on the one hand, and the procedures BEA employs to estimate depreciation, on the other. Inventory profits increased $7 1/2 billion in the second quarter, largely reflecting increased prices of grain, hogs, and petroleum; the second-quarter increase raised inventory profits to $27 billion, the highest level since 1981. Depreciation losses-i.e., negative depreciation profits, which have been in evidence since 1983-declined $1 billion, reflecting the provisions of the Tax Reform Act of 1986; this act mandated an increase in service lives, narrowing the difference between the lives used in tax accounting and those BEA uses to estimate depreciation.

Government Sector The fiscal position of the govemment sector improved in the second quarter of 1988, as the combined deficit of the Federal Government and of State and local governments decreased $24 1/2 billion. The deficit of the Federal Government declined $24 billion, and the surplus of State and local govemments increased $V2 billion.

The Federal sector.-The Federal Government deficit declined to $131 billion, as receipts increased more than expenditures.

Receipts increased $32v2 billion, compared with $6 1/2 billion in the first quarter. Personal tax and nontax receipts increased $20 1/2 billion, compared with a $17 1/2 billion decline in the first quarter. These large changes in personal taxes were due to provisions of the Tax Reform Act of 1986: in the first quarter, the second round of rate reductions lowered taxes; in the second quarter, higher final settlements resulting from income shifting raised taxes. Corporate profits tax aecruals increased $5 billion, compared with a small decline in the first quarter. Indirect business tax and nontax accruals were unchanged in the second quarter, and contributions for social insurance increased $7 billion.

Expenditures increased $8 1/2 billion, compared with $1 billion in the first quarter. Purchases of goods and services increased $4 billion, compared with a $13 V2 billion decline in the first quarter. This shift was largely due to nondefense purchases, which increased $4 billion in the second quarter after a $13 billion decline in the first. The shift in nondefense purchases was due to purchases of agricultural commodities by the Commodity Credit Corporation (CCC).

Transfer payments to persons increased $3 1/2 billion, compared with $17 billion in the first quarter, when various transfer payments-such as social security-were boosted by costof-living adjustments. Net interest paid increased $2 billion, and subsidies less the current surplus of government enterprises was unchanged. In the latter category, a $4 billion decrease in the Postal Service deficit-due to a full-quarter effect of the April postal rate increase-was offset by a $2 1/2 billion increase in subsidies to farmers and a $2 billion increase in the CCC deficit. Grants-in-aid to State and local govemments declined $1/2 billion, compared with a $9 1/2 billion increase in the first quarter. All major categories of grants had increased in the first quarter; they either declined or increased less in the second.

Cyclically adjusted surplus or deficit. When measured using cyclical adjustments based on middleexpansion trend GNP, the Federal deficit on the national income and product accounts basis declined from $193 billion in the first quarter to $173 1/2 billion in the second (see table on page 21)." The cyclically adjusted deficit as a percentage of middleexpansion trend GNP declined from 4.2 percent in tbe first quarter to 3.7 percent in the second.

The State and local sector.-The State and local government surplus increased to $56 billion, as receipts increased more than expenditures.

Receipts increased $13 billion, compared with $18 1/2 billion in the first quarter. The deceleration was more than accounted for by the shift in Federal grants-in-aid. Indirect business tax and nontax accruals increased $6 1/2 billion, compared with $4 1/2 billion in the first quarter; the acceleration was in sales taxes. Personal tax and nontax receipts increased $4 1/2 billion, compared with $2'/2 billion in the first quarter; the acceleration was due to higher net final settlements as a result of indirect effects of the Tax Reform Act of 1986. Corporate profits tax accruals increased $2 billion, and contributions for social insurance increased $1 billion.

Expenditures increased $12 1/2 billion, the same as in the first quarter. Purchases of goods and services increased $12 billion; employee compensation and structures recorded smaller gains than in the first quarter, and all other purchases accelerated. All other categories of expenditures combined increased about $1 billion in both quarters.
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Title Annotation:the second quarter of 1988
Publication:Survey of Current Business
Date:Aug 1, 1988
Words:2987
Previous Article:A user's guide to BEA information; publications, computer tapes, diskettes, and other information services.
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