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Business situation.

The economic situation in the second quarter of 1985 was not much changed from the first quarter; the pace of production picked up only modestly, and inflation remained moderate. Real GNP increased at an annual rate of 1-1/2 percent, following a 1/2-percent increase in the first quarter (table 1). The GNP fixed-weighted price index increased at an annual rate of 4 percent, following a 4-1/2-percent increase.

The modest pickup in real GNP in the second quarter was more than accounted for by final sales of GNP, which swung to a $20-1/2 billion increase after a small decline. Within final sales, the swing was largely traceable to fixed investment, which increased sharply in the second quarter after no change in the first, and to net exports, which continued to decline in the second quarter, but much less than in the first. The rate of business inventory accumulation was reduced $13-1/2 billion in the second quarter after a small increase in the first (chart 1).

Gross domestic purchases--GNP less exports plus imports--increased 3 percent in the second quarter (table 2). Increases in this measure of U.S. demand have outpaced increases in U.S. production throughout the current recovery and expansion, except in the fourth quarter of 1984. Since the trough in U.S. production in the third quarter of 1982, imports have increased 43 percent, while exports have declined 5 percent. In recent quarters, imports have been strong but erratic; exports have declined steadily (chart 2).

Productivity and costs. --Table 3 shows changes in real gross product, aggregate hours, and compensation in the business economy other than farm and housing. Productivity, as measured by real product per hour, increased 1 percent after declining 3 percent in the first quarter. The turn-about reflected a pickup in real product and a slowdown in hours. Compensation and compensation per hour decelerated in the second quarter; legislated increases in Social Security tax rates and taxable wage bases had boosted the first-quarter increased about 1/2 percentage point. The deceleration in compensation combined with the acceleration in real product led to a sharp deceleration in unit labor cost in the second quarter.

Prices. --GNP prices, as measured by the fixed-weighted price index, increased 4 percent in the second quarter, compared with 4-1/2 percent int he first. Increases have been in the range of 3-1/2-4-1/2 percent in the past several quarters (table 4). A federal pay raise, which in the national income and product accounts (NIPA's) is treated as an increase in the price of employee services purchased by the Federal Government, had added 0.3 percentage point to the first-quarter increase.

The price of gross domestic purchases--which is goods and services bought by U.S. consumers, investors, and government--increased 3-1/2 percent for the third consecutive quarter. The exclusion of exports and inclusion of imports in the price of gross domestic purchases provides a measure of inflation facing U.S. purchasers. Within gross domestic purchases, energy prices increased sharply after a decline; most other prices were up slightly less than in the first quarter. Prices paid by consumers--prices of personal consumption expenditures (PCE)--accelerated 1 percentage point to a 4-percent increase in the second quarter, due to the sharp turnaround in energy prices. Food prices declined slightly after a moderate increase; other PCE prices continued to increase in the range of 4-1/2-5-1/2 percent. Prices paid by investors for non-residential structures and equipment again increased moderately, and prices paid by residential investors again declined. Prices paid by government, which had been boosted by the Federal pay raise in the first quarter, decelerated to a 4-1/2-percent increase in the second.

Employment and hours. --Employment increased in the second quarter, although the household survey showed a much smaller increase than the establishment survey (table 5). In the previous two quarters, both surveys had recorded large gains.

According to the household survey, small increases in adult employment in the second quarter were almost offset by decreased teenage employment. The civilian labor force was virtually unchanged in the second quarter and, as a result, the unemployment rate held steady at 7.3 percent (chart 3). Civilian employment as a percent of the working-age population receded slightly, to 60.0 percent, from its record first-quarter level.

According to the establishment survey, nonfarm employment increased 700,000; the disributive and service industries continued to increase strongly, while employment in goods-producing industries was flat. Average weekly hours in the private nonfarm economy were unchanged in the second quarter; however, in manufacturing, average weekly hours and overtime hours both slipped by 0.1, to 40.3 and 3.2, respectively.

Personal Income

Personal income increased $38 billion in the second quarter, following a $47-1/2 increase in the first. In the two quarters, personal income was signficantly affected by a number of special factors that are shown in table 6. Without these special factors, increases in personal income would have been about the same in both quarters--$35 billion in the second and $34-1/2 billion in the first. These increases were considerably smaller than quarterly increases registered in 1984.

Wage and salary disbursements were up less than in the first quarter, but were about in line with increases in the second half of 1984. A deceleration in wages and salaries in government and government enterprises largely reflected the timing of pay adjustments. Pay raises for employees of the Federal Government and of the Postal Service added $3 billion and $1/2 billion, respectively, in the first quarter; a retroactive wage payment for Postal Service employees added $1 billion in the second. Among the private industries, manufacturing wages and salaries changed little after an increase. In the second quarter, declines in manufacturing employment and average weekly hours were offset by an increase in average hourly earnings. Other commodity-producing industries increased less than in the first quarter, and the distributive and the service industries were up somewhat more than in the first quarter.

Farm proprietors' income again declined; the deterioration was due to continued sharp declines in crop and livestock prices. Agricultural subsidy payments continued to increase, reaching $12 billion in the second quarter and accounting for more than one-half of farm proprietors' income. The increases in subsidies in the last three quarters largely reflected "deficiency payments" under the Agriculture and Food Act of 1981. These payments to farmers who reduced planted acreage are based on the difference between legislated "target prices" and market prices. Nonfarm proprietors' income was again up strongly; the strength was widespread.

Personal interest income registered a small increase after no change in the first quarter. The weakness reflected lower interest rates than had prevailed in mid-1984, when increases in interest income had exceeded $20 billion per quarter.

Transfer payments registered a small increase, following a large--$17-1/2 billion--increase in the first quarter. Most of the difference was accounted for by two special factors that had boosted transfer payments in the first quarter: Cost-of-living increases in several Federal retirement and income-support programs, which had added $8-1/2 billion, and the effect of a change in the date of payment of military retirement pay, which had added $5-1/2 billion.

Personal contributions for social insurance, which are subtracted in deriving the personal income total, increased much less than in the first quarter, when they had been boosted $6-1/2 billion by changes in the Social Security tax rates and taxable earnings bases.

Personal tax and nontax payments fell $42 billion after increasing $37-1/2 billion in the first quarter (table 7). These sharp changes reflected the impact of the timing of refund payments, which are netted against tax payments in calculating personal tax and nontax payments. Because refunds on 1984 Federal personal income taxes were delayed in the first quarter due to processing problems, personal tax payments were unusually large in the first quarter; the catch-up in refund payments in the second quarter led to a large decline in tax payments. The impact on the level of personal tax and nontax payments was plus $27-1/2 billion in the first quarter and minus $27-1/2 billion in the second; therefore, the impact on the change was plus $27-1/2 billion in the first quarter and minus $55 billion in the second. (In the third quarter, the impact on the level will be zero, and the impact on the change will be plus $27-1/2 billion.) In addition, the first-quarter increase in personal taxes had been reduced $7 billion by the effect of indexing of Federal income taxes. Without these factors, personal taxes would have increased $16-1/2 billion in the first quarter and $13 billion in the second.

Largely due to the erratic pattern of personal taxes, disposable personal income jumped $80 billion in the second quarter, following a $10 billion increase in the first. Without the special factors affecting personal income and taxes, the increases in disposable income would have been much closer--$22 billion in the second quarter and $18 billion in the first.

The erratic movements in disposable personal income carried through to real disposable income, which declined 1-1/2 percent in the first quarter and increased 9-1/2 percent in the second. Without the special factors, real income would have been down less than 1/2 percent in the first quarter and up less than 1/2 percent in the second. Quarterly increases in 1984 had ranged from 3-1/2 to 8-1/2 percent.

The movements in disposable personal income resulted in sharp shifts in personal saving, as increases in personal outlays were about the same in both quarters. Personal saving declined $44-1/2 billion in the first quarter and increased $26 billion in the second. The personal saving rate fell sharply from the level of 6.2-6.3 percent that had prevailed in the second half of 1984 to 4.5 percent in the first quarter, before partly recovering to 5.3 percent in the second.

Components of Real GNP

With the exception of net exports, all major components of final sales of GNP increased in the second quarter. Strength was especially evident in PCE and fixed investment. The rate of inventory accumulation declined in the second quarter.

Personal consumption expenditures

Real PCE increased 5 percent in the second quarter, the same as in the first. The largest monthly increase in PCE occurred in April, in part, a recovery from a dip in March. In creases during the remainder of the quarter were much smaller. It is tempting to try to explain the monthly changes in PCE in terms of the timing of the delay and catchup in Federal income tax refunds, but no clear relationship is evident.

Durables increased strongly in both quarters--8 percent in the second quarter and 9 percent in the first. Motor vehicles again were up substantially. In the second quarter, the increase was largely in new cars, particularly imports. Sales of Japanese cars were spurred by the raising of the voluntary restraint on shipments to the United States for the year beginning April 1, 1985 to 2.3 million cars from 1.85 million the preceding year. In the first quarter, the increase in motor vehicles had been concentrated in new trucks. Purchases of furniture and household equipment and of other durable goods also increased strongly in both quarters.

Nondurables increased 6 percent, following a 3-1/2-percent increase in the first quarter. The acceleration was primarily due to strong increases in purchases of food and of clothing and shoes. Energy components--largely gasoline and fuel oil--declined, after large increases in the first quarter. Other nondurables increased slightly less than in the first quarter.

Services were up 3-1/2 percent, following a 5-percent increase in the first quarter. Much of the deceleration was attributable to a declinein purchases of electricity and gas after an increase. In the first quarter, these purchases had been unusually high due to severe cold weather. Most other components registered increases either smaller than, or about the same as, in the first quarter.

Nonresidential fixed investment

Real nonresidential fixed investment increased 13-1/2 percent in the second quarter after slipping 1-1/2 percent in the first. Producers' durable equipment (PDE) increased 11-1/2 percent in the second quarter, following a 5-1/2 percent decline in the first, and structures increased 19 percent, following a 9-1/2-percent increase.

The turnaround in PDE can be traced in terms of the four broad product categories shown in table 8. High-technology PDE--the largest of the four, accounting for almost one-half of the total--is approximated by aggregating office, computing, and accounting machinery; communications equipment; scientific and engineering instruments; and photographic equipment. This category more than accounted for the first-quarter decline in PDE and accounted for about 80 percent of the second-quarter increase. Changes in high-technology PDE in the two quarters were dominated by computers.

Transportation equipment--largely passenger cars, trucks, and aircraft--limited the second-quarter increase in PDE; in the first, it had limited the decline. Both cars and trucks declined in the second quarter; in the first, an increase in cars had more than offset a decline in trucks.

The heavy industrial equipment and "other" categories both increased in the second quarter after small declines in the first. In the former, general and special industrial machinery accounted for the bulk of the increase. In the latter, the largest increase was in agricultural machinery.

In structures, commercial and industrial buildings each accounted for about one-third of the second-quarter increase; the increase in industrial buildings was the largest since the first quarter of 1984. All of the other categories of structures increased in the second quarter, with the exception of public utilities, which slipped slightly; the increases in religious and farm drilling for oil and natural gas were relatively large. The breadth of the second quarter's strength in structures contrasts sharply with the first quarter's, when commercial structures accounted for the entire increase.

Residential investment

Real residential investment increased 14-1/2 percent in the second quarter, following a 5-1/2-percent increase in the first. Single-family construction increased at about the same rate as in the first quarter, and multi-family construction stabilized after a sharp drop. The "Other" component increased more rapidly than in the first quarter, mainly reflecting increased mobile home sales and brokers' commissions on the sale of new and existing residences.

Resiential construction lags housing starts, with a shorter lag in single-family than in multifamily units. Single-fmaily starts had increased at roughly the same rate in the first quarter as in the fourth (chart 4). Multifamily starts had dropped substantially in the last half of 1984. In the second quarter, single-family housing starts slipped 4 percent, while multifamily starts increased 3 percent (not annual rates).

Lower mortgage rates, in conjunction with stable house prices and rising incomes, stimulated construction activity and house sales in recent quarters. The mortgage commitment rate has declined 245 basis points since last July (chart 5). This decline translates into a 15-percent drop in monthly principal and interest payments and in the income level often used as a guideline in qualifying for a mortgage. Median sales prices of both new and existing residences have fluctuated since last July, but were not much different in May than they had been 10 months earlier. Incomes increased over the period--median family income, by 5.2 percent, and personal income by 4.7 percent (not annual rates). Largely in response to these factors, sales of both new and existing houses have increased, albeit somewhat erratically. Sales of new one-family houses increased from a low of 557,000 (seasonally adjusted annual rate) in August to 676,000 in May. Sales of existing single-family homes increased from a low of 2.73 million (seasonally adjusted annual rate) in September to 3.01 million in May.

Change in business inventories

Real business inventories increased only $6 billion in the second quarter, following an increase of $19 billion (table 9). The slowdown in inventory accumulation--which contributed negatively to the change in GNP--was accounted for by retail trade and manufacturing durables. Within retail trade, a swing from an increase to a sharp decline in inventory investment was largely in auto dealers' inventories. These inventories were down $2-1/2 billion, following substantial increases in the previous two quarters, when auto dealers were still rebuilding inventories from a low level at the beginning of the 1985 model year. Manufacturing durables also declined after an increase; the turnabout was widespread. Farm inventories increased $2 billion, following an increase of $3-1/2 billion in the first quarter.

As inventory accumulation slowed and final sales swung to a substantial increase, the constant-dollar ratio of total inventories to total final sales declined to 3.06, the middle of the 3.01-0.09 range within which it has fluctuated over the last 2 years.

Net exports

Real net exports registered a $5-1/2 billion decline, following a decline of $15 billion in the first quarter. Unlike the first quarter, the negative contribution of net exports to the change in GNP came primarily from exports: exports declined $4-1/2 billion, following a decline of $3-1/2 billion, and imports increased only $1/2 billion, following an increase of $1-1/2 billion. More than one-half of the second-quarter decline in exports was in agricultural products; a decline in non-agricltural merchandise exports was spread across many commodity categories. The declines largely reflected the cumulative effect of dollar appreciation and, in the case of agricultural exports, ample worldwide supplies. Within imports, increases in petroleum imports and in services more than offset a decline in nonpetroleum merchandise.

Government purchases

Real government purchases increased 4 percent, following little change in the first quarter. Federal defense purchases were up after no change; these purchases often fluctuate sharply from quarter to quarter, partly because of the erratic timing of deliveries of items such as aircraft and missiles. Federal nondefense purchases declined after an increase; these changes largely reflected operations of the Commodity Credit Corporation. State and local government purchases were up after no change; the pickup was accounted for by highway construction.

The federal sector.--Changes in current-dollar Federal receipts and expenditures on a NIPA basis are shown in table 10. Among expenditures, purchases again were up moderately, as the step-up in defense purchases was largely offset by the swing in nondefense purchases. Transfer payments declined after a large increase in the first quarter, which mainly had been due to the cost-of-living increases and the change in the timing of military retirement pay. Grants-in-aid to State and local governments increased after a decline; the rebound was mainly due to increased highway grants. The increase in interest paid was again moderate, reflecting the continued effects of the earlier decline in interest rates. Subsidies less the current surplus of government enterprises continued to increase, reflecting, in part, the increases in agricultural subsidy payments. Wage accruals less disbursements--which are subtracted from expenditures--declined more in the second quarter than in the first, largely due to the retroactive payment to Postal Service employees. Change in these components sum to an increase of $10 billion in total expenditures, the smallest increase in nearly 2 years.

Among receipts, the sharp changes in the last two quarters in personal tax and nontaxes were mainly due to the delay and catchup in income tax refund payments. Contributions for social insurance returned to a moderate increase after a first-quarter bulge, which had reflected the changes in the Social Security tax rates and taxable earnings bases. Indirect business taxes were up more than in the first quarter; the larger increase reflected a one-time fee levied on the nuclear power industry for existing stocks of nuclear waste. Estimates of corporate profits, and, thus, of corporate profits tax accruals, are not yet available for the second quarter. Corporate profirs tax accruals can be approximated by using a residual calculation of corporate profits that assumes that the statistical discrepancy in the NIPA's is the same as in the preceding quarter. On the basis of this calculation, total receipts declined nearly $45 billion in the second quarter.

The Federal deficit on a NIPA basis had declined $32-1/2 billion to $165 billion in the first quarter and is likely to increase almost $55 billion in the second. These changes largely reflect the delay and catchup in tax refunds.
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Title Annotation:second quarter 1985
Publication:Survey of Current Business
Date:Jul 1, 1985
Previous Article:U.S. international transactions, first quarter 1985.
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