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The business situation, first quarter, 1986.


THE sawtooth pattern of production growth in recent quarters continued into 1986, as real GNP increased 3 percent in the first quarter after a 1/2-percent increase in the fourth quarter of 1985 (chart 1). The increase in GNP prices (fixed weights) decelerated to 2 percent from 4 percent in the preceding quarter; the first-quarter increase was the lowest in 14 years.1

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 annualized. Real, or constant-dollar, estimates are expressed in 1982 dollars.

The preliminary (15-day) GNP estimates for the first quarter, prepared in mid-April, are based on the following major source data: For personal consumption expenditures (PCE), retail sales through March, and unit auto and truck sales through March; for nonresidential fixed investment, the same information for autos and trucks as for PCE, January and February construction put in place, and January and February manufacturers' shipments of machinery and equipment; for residential investment, January and February construction put in place, and housing starts through March; for change in business inventories, January and February book values for manufacturing and trade, and unit auto inventories through March; for net exports of goods and services, January and February statistical month merchandise exports, January revised statistical month merchandise imports, and fragmentary information on investment income for the quarter; for government purchases of goods and services, Federal unified budget outlays for January and February, State and local construction put in place for January and February, and State and local employment through March; and for GNP prices, the Consumer Price Index for January and February, the Producer Price Index for January and February, and unit-value indexes for exports and imports for January and February. Some of the source data are subject to revision.

A number of components of real GNP showed large changes, reversed direction, or both (table 1). Two of these changes--in farm inventory investment and in Federal nondefense purchases--were largely offsets to each other. Farmers placed record amounts of crops under loan with the Commodity Credit Corporation (CCC) in the fourth quarter; in the first quarter, they placed much smaller, albeit still substantial, amounts. Such transactions are treated in the national income and product accounts (NIPA's) as a purchase by the CCC, with an offset in farm inventories. The sharp reduction in farm inventory liquidation in the first quarter added $24 billion to the change in real GNP, while the sharp drop in CCC purchases subtracted $27 billion.

Investment in nonresidential structures includes petroleum exploration, shafts, and wells. The recent sharp drop in petroleum prices led to large cutbacks in petroleum investment that more than offset increased investment in other components of nonresidential structures; as a result, total real investment in nonresidential structures declined 5 percent, ending a 10-quarter uptrend.

Price developments also affected other components of real GNP. Deceleration in prices contributed to a strengthening in real disposable personal income, which helped boost personal consumption expenditures (PCE), and a third consecutive quarter of increase in prices of nonpetroleum imports probably contributed to a downturn in imports.

GNP prices.--With the exception of exports, prices of all major components of GNP decelerated in the first quarter (table 2). A steep drop in petroleum prices was responsible for a 4-percent decline in the prices of the energy components of GNP; in the fourth quarter, energy prices had declined 2 percent. In PCE, a 12-percent decline in energy prices after a 2 1/2-percent decline, along with a sharp deceleration in food prices, produced a slowdown from a 4 1/2-percent to a 1 1/2-percent increase.

A 44-percent drop in prices of imported petroleum and petroleum products was responsible for the swing in import prices from a 5 1/2-percent increase in the fourth quarter to a 4 1/2-percent decline in the first. Prices of nonpetroleum imports increased about 4 1/2 percent in both quarters. The increases in the prices of nonpetroleum imports are noteworthy, and apparently reflect, among other things, the effect of cumulative dollar depreciation.

In view of the 44-percent decline in prices of imported petroleum, it may seem surprising that GNP energy prices declined only 4 percent. A part of the explanation lies in the fact that a drop in import prices affects GNP prices only to the extent that the decline is not passed through on a dollar-for-dollar basis to final purchasers. If the decline is passed through exactly dollar-for-dollar, then GNP prices are unaffected: The decline in prices paid by final purchasers is exactly offset by the decline in import prices, which are entered with a negative weight in calculating GNP prices. If--as appears to have happened with petroleum prices in the first quarter--the passthrough is less than complete, then GNP energy prices would tend to increase or show a smaller decline, a tendency that was reinforced in the first quarter by increases in the prices of some nonpetroleum sources of energy. These upward pressures on GNP energy prices were offset, however, by a decline in the price of domestically produced petroleum. The 4-percent decline in GNP energy prices was the net effect of these forces.

Personal consumption expenditures

Real PCE increased 4 1/2 percent in the first quarter after changing little in the fourth. The first-quarter strength in PCE is consistent with the moderate-to-strong increases in real disposable personal income in recent quarters. As well, the strength may be related to increases in funds available from transactions on existing homes--realized capital gains on sales and refinancing that reduces monthly mortgage payments--and improvement in consumer balance sheets due to the upsurge on the stock market. In addition, and despite a high debt-to-income ratio, consumers continued to add substantially to their debt as a means of financing purchases. Although these factors are consistent with the overall strength in PCE, they contribute little to an explanation of the divergent movements of the durable and nondurable goods components, each of which had unusual features.

Durable goods slipped 1 1/2 percent after a 13 1/2-percent drop in the fourth quarter, the first back-to-back quarterly decreases in 6 years. The first-quarter decline was widespread, whereas motor vehicles and parts more than accounted for the sharp fourth-quarter decline. In motor vehicles and parts, the first-quarter decline occurred despite an increase in purchases of new autos (table 3). The pattern of sales of new autos since the third quarter of 1985 has mirrored the timing of auto manufacturers' sales-incentive programs: A jump in sales in the third quarter was primarily due to programs that ran from mid-August through the end of September and included below-market financing and rebates on a broad range of models; a sharp drop in sales in the fourth quarter reflected in part the discontinuance of the programs; and an increase in sales in the first quarter is consistent with the reinstitution of below-market financing programs. In the third and fourth quarters of 1985, the changes in new autos sales had dominated the changes in motor vehicles and parts (shown in the addendum to table 3). In the first quarter, in contrast, the increase in new autos was more than offset by declines in other subcomponents, mainly in the net purchases of used autos and in new trucks.

Nondurable goods increased 7 1/2 percent after a slight increase in the fourth quarter. The first quarter showed the largest increase in the present 3-year expansion and was the only quarter in that period when food, clothing and shoes, energy, and other nondurables all registered increases that were well above their averages for the period. Further, the 6-percent increase for food followed a decline, and the 12-percent increase for clothing and shoes followed a well-below-average increase. Wide fluctuations are rather typical of these components. In the absence of identifiable factors that might explain the recent fluctuations, these patterns suggest that the large increase in the nondurables total was at least in part coincidental.

Services increased moderately--3 1/2 percent--in the first quarter after a somewhat larger increase in the fourth. Energy services (electricity and gas) dropped sharply after a strong increase in the fourth quarter, when expenditures reflected the unusually cold weather during December in most parts of the country. Housing and medical care services increased about the same as in the fourth quarter. Transportation services and other services each accelerated, attributable to air travel and brokerage fees.

Nonresidential fixed investment

Real nonresidential fixed investment declined 13 1/2 percent in the first quarter, following an 11 1/2-percent increase in the fourth. Both structures and producers' durable equipment (PDE) contributed to the turnaround; structures declined 5 percent, following a 7-percent increase, and PDE declined 18 percent, following 13 1/2-percent increase.

In structures, a large increase in commercial buildings and small increases in most other components were more than offset by a decline in petroleum exploration, shafts, and wells, which plummeted in response to the steep drop in world oil prices. Corroborative evidence of the decline in petroleum investment is readily available: During the quarter, the number of rotary rigs in operation--a good physical measure of drilling activity --fell 45 pecent, the number of seismic crews engaged in exploration fell 25 percent from December to February, and the number of well permit applications dropped 35 percent in the same period. (Percentages not at annual rates.) A significant rebound in petroleum investment would probably require a sustained higher level of petroleum prices. Reflecting the changed price outlook, spending on plant and equipment by companies in mining and in petroleum manufacturing was revised down sharply between the survey conducted by BEA in October-November 1985 and the survey conducted in January-March 1986. (See the article on plant and equipment expenditures later in this issue.)

In PDE, information processing and related equipment accounted for three-fourths of the first-quarter decline, after having accounted for one-half of the fourth-quarter increase (table 4). Transportation equipment also declined in the first quarter, following a somewhat smaller decline in the fourth, and industrial equipment declined after increasing substantially. In transportation equipment, an increase in autos was more than offset by a decline in trucks; in the previous quarter, an increase in trucks had been more than offset by a decline in autos. In industrial equipment, declines were widespread, with the largest drop occurring in electrical transmission and distribution equipment.

Residential investment

Real residential investment increased 9 1/2 percent in the first quarter, following a 5 1/2-percent increase in the fourth. Single-family construction increased 21 percent, following a 4-percent increase; multifamily construction increased 7 1/2 percent, following a 1 1/2-percent decline; and the other component--which includes additions and alterations, major replacements, brokers' commissions on sales, and mobile home sales--changed little.

The large increase in single-family construction reflected a surge in housing starts that, in turn, reflected continued declines in interest rates. Starts of single-family units increased 26,000 (seasonally adjusted annual rate) in the fourth quarter and 176,000 in the first (chart 2). Mortgage interest rates dropped more than 1 percentage point during the first quarter, following a similar drop in the fourth; in March, the commitment rate on conventional fixed-rate mortgages stood at 10.08 percent (chart 3).

Sales of new and existing residences, although relatively high--4 million units--in January-February, have not increased in response to the recent drop in interest rates, despite the fact that the drop had a significant effect on the affordability of housing. Monthly principal and interest payments on a 30-year fixed-rate mortgage negotiated in March were 15 percent lower than for the same mortgage 6 months earlier, while house prices increased only 2-3 percent (not annual rate). Despite this decline, house sales were 2 percent lower (not annual rate) in January-February than in the third quarter of 1985. Although some potential buyers may be postponing their purchases in the hope that rates will fall still lower, it seems unlikely that such behavior completely explains the failure of sales to increase.

Change in business inventories

Real inventory investment increased $32 1/2 billion in the first quarter,

following a $4 1/2 billion decline in the fourth (table 5). Three-fourths of the increase in inventory investment in the first quarter was attributable to farm inventories. Farm inventory investment increased $24 billion, as inventory liquidation slowed to $1/2 billion in the first quarter from $24 1/2 billion in the fourth. The slowing largely reflected farmers' crop placements with the CCC under the commodity loan program, as described in the section on government purchases.

Nonfarm inventory investment increased $8 1/2 billion, as inventories increased $26 1/2 billion in the first quarter after an $18 billion increase in the fourth. Within nonfarm inventories, manufacturing inventories declined in both quarters; the combined liquidation of $22 1/2 billion was concentrated in durables, where inventories were liquidated in all of the major industry groups--metals, machinery, transportation, and other durables. Other inventories, particularly retail, increased sharply in both quarters. About three-fourths of the combined accumulation of $42 1/2 billion in retail inventories was in inventories held by auto dealers. In the first quarter, auto dealers' inventories reached their highest level in more than 6 years.

Net exports

Real net exports of goods and services increased $15 billion in the first quarter, following a decline of $21 billion in the fourth. Reflecting this swing, gross domestic purchases--a measure of U.S. demand--increased 1 1/2 percent, while GNP--a measure of U.S. production--increased twice as fast; in the last 3 years, U.S. demand had typically outpaced U.S. production. The first-quarter swing in net exports is consistent with the effect of the year-long decline in the exchange value of the dollar and slightly improved economic conditions in a number of the United States major trading partners.

Merchandise more than accounted for the increase in total net exports; merchandise exports increased $9 1/2 billion, following a $5 billion increase, while merchandise imports declined $7 billion, following a $27 1/2 billion increase. The two-quarter increase in exports was the largest in several years, and the fourth-quarter drop in imports was the first in a year. Net exports of services declined $1 1/2 billion in the first quarter after increasing by a similar amount in the fourth.

Within merchandise exports, both agricultural and nonagricultural exports registered a second consecutive increase. The increases in nonagricultural exports were spread across almost all major end-use categories. Within merchandise imports, both petroleum and nonpetroleum imports declined. The small decline in petroleum imports was from a fourth-quarter level that was the highest in more than 2 years. The decline in nonpetroleum imports was widespread and appears to reflect, at least in part, increased prices.

Among services, an increase in receipts of investment income by the United States was more than offset by higher payments to foreigners, which reflected a strong increase in U.S. assets, especially bonds, held by foreigners.

Government purchases

Real government purchases were down 15 percent in the first quarter, following a 9-percent increase in the fourth. Federal government purchases more than accounted for the decline; State and local government purchases increased moderately.

Federal national defense purchases declined 7 percent, following a smaller decline in the fourth quarter. It is likely that the first-quarter decline reflected to some extent the reductions made to comply with the Balanced Budget and Emergency Deficit Control Act of 1985, better known as the Gramm-Rudman-Hollings Act. Under this act, effective March 1, Federal agencies are required to cut outlays for the current fiscal year a uniform 4.3 percent for all programs not explicitly exempted. (See "'Reducing the Federal Government Deficit: An Update' in the February 1986 SURVEY OF CURRENT BUSINESS.) For defense spending, the act provided the President the option, which he took, of making the cut in defense programs in categories other than compensation. The pattern of defense spending in the first quarter is consistent with many defense agencies beginning to move toward the lower level of spending before March 1. However, the large quarter-to-quarter fluctuations typical of defense spending --of which the large fourth-quarter increase in services other than compensation is an example--make it difficult to identify how much of the decline can be attributed to the act. (Detail on national defense purchases, in current and constant dollars, is now presented regularly in the National Income and Product Accounts Tables, in tables 3.9 and 3.10.)

In Federal nondefense purchases, almost all of a large decline in the first quarter and of a large increase in the fourth were accounted for by the transactions of the CCC. In the fourth quarter, farmers placed record amounts of crops with the CCC under the commodity loan program; in the first quarter, they placed a much smaller, albeit still substantial amount. These large placements reflect the fact that prices for major crops continued to be low enough relative to the CCC "'loan rate' to give farmers an incentive to place crops under loan--in effect, to sell them to the CCC. (See "'Federal Farm Programs, 1986-90' later in this issue for a discussion of CCC programs and how they are treated in the NIPA's.) Largely as a result of these transactions, additions to CCC inventories amounted to $33 1/2 billion in the fourth quarter and $6 1/2 billion in the first.

Other nondefense purchases, in total, were down 5 percent, only slightly more than in the fourth quarter. Thus, an effect of the Gramm-Rudman-Hollings Act is not readily apparent in the total. However, quarter-to-quarter fluctuations typical of these purchases could mask an effect. Further, the first-quarter decline is more than accounted for by services other than compensation, and a decline in this category is consistent with the kind of actions that agencies are likely to have taken to begin to comply with the act.

In State and local purchases, purchases other than structures continued to increase at the modest rates registered over the past year. Purchases of structures, which for several quarters have shown relatively large fluctuations, increased after a sharp drop in the fourth quarter.

Personal Income

Personal income increased $43 1/2 billion in the first quarter, compared with $56 billion in the fourth (table 6). The pattern reflected a deceleration in incomes from production that was only partly offset by an acceleration in transfer payments. Both wage and salary disbursements and proprietors' income increased less in the first quarter than in the fourth.

Wage and salary disbursements were up $29 billion in the first quarter, $6 1/2 billion less than in the fourth. The deceleration was largely in manufacturing and was attributable to a swing in average hours worked--from a substantial increase in the fourth quarter to a decline in the first--and to a smaller increase in average hourly earnings in the first quarter than in the fourth. Wage and salary disbursements in government and government enterprises also increased less than in the fourth quarter, which had included a military pay raise and one-time retroactive payments to Postal Service employees.

Proprietors' income increased only $1 1/2 billion in the first quarter, $12 billion less than in the fourth. The smaller increase reflected a large drop--$7 1/2 billion--in farm proprietors' income, following a large increase --$11 billion. A major part of the swing was due to Federal subsidy payments; subsidies had increased $5 1/2 billion in the fourth quarter, mainly reflecting "deficiency' payments on the 1985 wheat crop, but they declined $1 billion in the first. Another part of the swing was due to prices received by farmers; a fourth-quarter increase had interrupted a long slide, but prices were down once more in the first. Nonfarm proprietors' income increased more in the first quarter than in the fourth, following the pattern of residential construction activity and retail sales.

Transfer payments increased $11 billion in the first quarter, following a $3 billion increase in the fourth. The larger increase reflected cost-of-living adjustments, effective January 1, to benefits under Social Security and several other Federal retirement and income-support programs.

Of the other incomes, three--other labor income, rental income of persons, and personal dividend income-- increased by the relatively small amounts typical of the last several quarters. Personal interest income again changed very little, as the effect of declining interest rates offset increases in assets held by persons. Contributions for social insurance, which are subtracted in deriving the personal income total, increased $5 1/2 billion --about $3 billion more than in the fourth quarter. The larger increase reflected legislated increases in social security tax rates and in the taxable wage base that became effective January 1.

Personal tax and nontax payments decreased about $4 1/2 billion in the first quarter, following an increase of $10 1/2 billion in the fourth. The first-quarter decrease was due to the indexing provision of the Economic Recovery Tax Act of 1981, which reduced withheld and nonwithheld Federal income taxes a total of $7 1/2 billion, and to tax cuts in several States, which reduced State income taxes a total of $1 1/2 billion.

As a result of the decrease in personal tax an nontax payments, disposable personal income (DPI) increased $48 billion, or 7 percent, in the first quarter, a little more than in the fourth. Reflecting the deceleration of prices, real DPI increased 5 1/2 percent in the first quarter, compared with 2 1/2 percent both in the fourth quarter and over the year from the fourth quarter of 1984 to the fourth quarter of 1985. The four-quarter change provides useful perspective because the auarterly changes in DPI earlier in 1985 were affected by the delay and catchup of Federal income tax refunds in the first half of 1985.

Personal outlays increased $39 billion in the first quarter, $6 billion more than in the fourth. As in the fourth quarter, the increase in outlays was less than the increase in DPI, so that saving increased. The first-quarter saving rate was 4.3 percent, up from 4.0 percent in the fourth quarter and 3.7 percent--the lowest level in 35 years--in the third. Even after the increases, the rate is well below those registered inearlier quarters of the present expansion.

Corporate Profits in 1985

Profits from current production-- profits before tax plus inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $22 billion in 1985, the third year of economic recovery and expansion, following increases of $59 1/2 in 1984 and $64 billion in 1983 (chart 4).2

2. The 1985 estimates are based on revised estimates for the fourth quarter, which are $6 billion lower than the preliminary estimates released in March; domestic profits of nonfinancial corporations accounted for the revision.

Domestic profits of financial corporations increased $4 1/2 billion, mainly reflecting interest rate movements. Domestic profits of nonfinancial corporations increased $18 billion, reflecting a small increase in product combined with a moderate increase in unit profits; in 1984, increases in both had been large. In both years, the increase in unit profits reflected a larger increase in unit prices than in unit costs. Profits from the rest of the world declined $1/2 billion.

Profits before tax.--Profits before tax (PBT) declined $12 1/2 billion in 1985, to $225 1/2 billion. The contrast between the increase in profits from current production and the decline in PBT reflects changes in the IVA, which increased $5 billion, to negative $1/2 billion, and in the CCAdj, which increased $30 billion, to $71 billion; both of these adjustments are reflected in the current production measure but not in PBT.3

3. Definitions of the IVA and CCAdj are available in U.S. Department of Commerce, Bureau of Economic Analysis, Corporate Profits: Profits Before Tax, Profits Tax Liability, and Dividends, Methodology Paper Series MP-2, (Washington, DC: GPO, May 1985), pp. 2,5.

The IVA is an estimate of inventory profits with sign reversed. Inventory profits in 1985 were lower than at any time since 1964, primarily reflecting the stability of materials prices and the cost of goods puchased for resale. The Producer Price Index (all commodities), a major source for estimating the IVA, was the same at the end of 1985 as it had been at the end of 1984.

The CCAdj is the difference between depreciation based largely on tax accounting, on the one hand, and economic depreciation as defined by BEA, on the other. In recent years, the former has been larger than the latter, and the CCAdj, therefore, has been an estimate of the overdepreciation of capital. Its increase in 1985 was largely due to sharp increases in nonresidential fixed investment in 1984 and 1985 and to the effect of the Economic Recovery Tax Act of 1981, which allowed the use of shorter service lives in tax accounting. In each year since the act's passage, the CCAdj increased by an increasing amount.

Profits with IVA but without CCAdj.--The measure of profits available by industry declined $7 1/2 billion in 1985, to $224 1/2 billion. Domestic profits of nonfinancial corporations more than accounted for the decline; profits of financial corporations increased $3 1/2 billion, and profits from the rest of the world slipped $1/2 billion.

An $11 billion drop in the profits of nonfinancial corporations was concentrated in manufacturing; profits in trade, transportation, communication, and utilities were flat or declined slightly, while profits in other nonmanufacturing industries increased. In manufacturing, large declines were recorded for producers of chemicals ($3 billion), and motor vehicles ($2 1/2 billion).

The drop in chemical profits, from $8 billion to $5 billion, reflected weak demand and increasing costs. Production of inorganic fertilizers and of plastics and resin materials registered sizable drops, and production of many other products was flat. The weakness in sales reflected, in part, strong foreign competition, evidenced by a drop in import prices that was associated with increased imports and reduced exports. While weak demand limited receipts, costs increased; for example, average hourly earnings of production and nonsupervisory personnel in the industry increased about 4 percent. (Asset write-offs and other revaluations were especially large in the chemical industry in 1985. As explained in the March "Business Situation,' such special charges do not affect NIPA measures of profit.)

The drop in motor vehicles profits, from $10 billion to $7 1/2 billion, largely reflected the costs of sales-incentive programs in the second half. (Auto sales and the incentive programs are discussed earlier in the "Business Situation.') The costs were largely of two types. Those associated with rebates on new auto and truck purchasers directly reduced profits of motor vehicles producers; those associated with below-market financing reduced profits in their financing subsidiaries. (The same sales-incentive programs that reduced manufacturers' profits helped boost retailers' profits; profits of auto dealers increased $1/2 billion, to $3 billion.)

The $3 1/2 billion increase in the domestic profits of financial corporations was concentrated in savings and loan associations (S&L's) and other depository institutions; profits of the Federal Reserve System were unchanged. The profits increase largely reflected a wider spread between interest rates paid and earned. At S&L's, rates paid on deposits and borrowings declined, reflecting the general drop in short-term rates, while rates earned on mortgage portfolios were flat. At federally insured S&L's, for example, the spread between the yield on mortgage portfolios and the cost of fund increased from 152 basis points at the end of 1984 to 252 basis points at the end of 1985.

Table: 1.--Real GNP: Change From Preceding Quarter

Table: 2.--GNP Price Indexes (Fixed Weights): Change From Preceding Quarter

Table: 3.--Real Motor Vehicle Output

Table: 4.--Real Nonresidential Producers' Durable Equipment

Table: 5.--Change in Real Business Inventories

Table: 6.--Personal Income and Its Disposition

Photo: CHART 1 Selected Measures: Change From Preceding Quarter

Photo: CHART 2 Housing Starts

Photo: CHART 3 Selected Interest Rates

Photo: CHART 4 Profits From Current Production
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Publication:Survey of Current Business
Date:Apr 1, 1986
Previous Article:National income and products accounts tables.
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