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The business situation.

the BUSINESS SITUATION

THE pace of U.S. production and the rate of inflation both picked up somewhat in the third quarter of 1986. Real GNP increased at an annual rate of 2 1/2 percent, following an increase of 1/2 percent in the second quarter. The GNP price index (fixed weights) increased at an annual rate of 2 1/2 percent, following an increase of 1 1/2 percent (chart 1).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 third quarter, prepared in mid-October, are based on the following major source data: For personal consumption expenditures (PCE), retail sales through September, and unit auto and truck sales through September; for nonresidential fixed investment, the same information for autos and trucks as for PCE, July and August construction put in place, and July and August manufacturers' shipments of machinery and equipment; for residential investment, July and August construction put in place, and housing starts through September; for change in business inventories, July and August book values for manufacturing and trade, and unit auto inventories through September; for net exports of goods and services, July revised statistical month merchandise exports and imports, August statistical month merchandise exports, and fragmentary information on investment income for the quarter; for government purchases of goods and services, Federal unified budget outlays for July and August, State and local construction put in place for July and August, and State and local employment through September; and for GNP prices, the Consumer Price Index for July and August, the Producer Price Index for July and August, and unit-value indexes for exports and imports for July and August. Some of the source data are subject to revision.

Over the past several quarters, real GNP has presented a picture of moderate but uneven growth. The other aggregate economic measures, shown in table 1, also shed light on the recent course of U.S. economic activity. Real gross domestic purchases--a measure of U.S. demand for goods and services, whether produced in the United States or abroad--has consistently increased in the range of 3-4 percent for the past several quarters. The growth rates for gross domestic purchases were higher than for GNP over the period, as a substantial portion of the increase in U.S. demand was met by imports. Command-basis GNP--a measure of what the United States could purchase with its current production--has increased more rapidly than real GNP in each of the past three quarters. The higher growth rates for command-basis GNP reflected recent improvements in the U.S. terms of trade--that is, the ratio of the implicit price deflator for exports to the implicit price deflator for imports. The improvements in the terms of trade were primarily due to steep drops in the price of imported petroleum.

In the third quarter, sharp changes in final sales of GNP and in inventory investment were dominated by motor vehicles (table 2). Almost two-thirds of the $41 1/2 billion increase in final sales was due to motor vehicles, primarily reflecting increased consumer purchases of new autos and trucks. The $19 1/2 billion decline in inventory investment was more than accounted for by motor vehicles, primarily reflecting a sharp runoff in new auto inventories. The constant-dollar motor vehicle estimates, which are part of the national income and product account estimates of auto and truck output, are compiled by BEA mainly from unit sales, inventory, and price data from trade sources. A discussion of recent developments in motor vehicles, in terms of units, follows.

Motor vehicles.--The sharp third-quarter increase in motor vehicle sales and reduction in motor vehicle inventories were largely in response to extensive sales-incentive programs that domestic manufacturers offered beginning in late August. The incentive programs were designed primarily to liquidate inventories of 1986 models, which had built to high levels last spring and remained high in early summer. The programs, offered through the manufacturers' finance subsidiaries, featured financing rates below 3 percent--more than 7 percentage points below prevailing market rates--or rebates as high as $1,500.

New car sales increased sharply to a record 13.2 million units (seasonally adjusted annual rate) in the third quarter from 11.2 million in the second (chart 2). The third-quarter increase was largely accounted for by new domestic car sales, which jumped to 9.7 million from 8.1 million. Sales of domestic cars had changed little from April through early August, but then moved up sharply in late August and early September. In late September, sales returned to the previous levels, in part due to shortages of some models covered by the incentive programs. Sales of imported cars increased to a record 3.5 million units in the third quarter from 3.1 million in the second. Although sales of imported cars increased, their share of total car sales declined 1 percentage point to 26 1/2 percent in the third quarter.

Domestic car production fell to 7.3 million units (seasonally adjusted annual rate) in the third quarter from 7.7 million in the second. In the first part of the quarter, production was cut by early closings for model-changeover at a number of plants.

Reflecting the sharp jump in sales and the decline in production, domestic car inventories dropped to 1.12 million units (seasonally adjusted) in the third quarter from 1.73 million in the second. The inventory-sales ratio fell to 1.5 in the third quarter--the lowest ratio since estimates were begun in 1967--from 2.6 in the second.

Unit sales of new trucks increased sharply to a record 5.4 million (seasonally adjusted annual rate) in the third quarter from 4.8 million in the second. Sales of light domestic trucks--which were, for the most part, also covered by the incentive programs--increased to 4.4 million from 3.6 million. Sales of "other' domestic trucks were 0.3 million in both quarters. Imported truck sales dropped sharply to 0.7 million in the third quarter from 0.9 million in the second.

Prices.--The prices of two aggregate economic measures--GNP and gross domestic purchases--accelerated to increases of 2 1/2 percent in the third quarter (table 3). The price index for gross domestic purchases had increased less than the GNP price index in the both the first and second quarters. The 1-1 1/2-percentage point differences between the two price measures in those quarters were largely due to the price of imported petroleum, which plunged 55 percent in the first quarter and 86 percent in the second. Imported petroleum is subtracted out in deriving the production measure but not in deriving the purchases measure.

Most of the pickup in prices in the third quarter was traceable to the prices of personal consumption expenditures (PCE), which increased 3 percent after a small decrease in the second quarter. The turnaround was mainly due to a sharp step-up in prices of food, especially meat, dairy, and poultry products. Largely reflecting gasoline prices, energy prices again declined, but considerably less than in the second quarter. Other PCE prices continued to register increases in the range of 3-3 1/2 percent. Changes in the prices of "other' components were, for the most part, similar in the first and second quarters: Prices of nonresidential structures were down slightly after a modest increase, prices of producers' durable equipment and of residential structures increased slightly less than in the second quarter, and prices paid by government increased slightly more.

Components of Real GNP

Overall changes in the major components of real GNP were in the same direction and, for some, of similar magnitude in the second and third quarters. However, these changes masked divergent movements within the components that signal considerable differences between the two quarters. PCE was up strongly in both quarters, but much of the third-quarter strength was in motor vehicles. Fixed investment increased moderately in both quarters: Nonresidential structures declined much less than in the second quarter, and producers' durable equipment increased much less; residential investment increased in both quarters, but the third-quarter increase was confined to single-family construction. Inventory investment fell sharply in both quarters, but the third-quarter decrease was entirely attributable to motor vehicles. Net exports decreased in both quarters, but less in the third as exports increased after a decline. Government purchases increased in both quarters, but less in the third as national defense purchases flattened.

Personal consumption expenditures

Real PCE again increased strongly --7 percent after a 6-percent increase in the second quarter (table 4). Much of the third-quarter strength reflected the surge in purchases of new cars and trucks. PCE excluding expenditures for motor vehicles and parts increased less in the third quarter than in the second--3 1/2 percent compared with 5 1/2 percent.

Although the unusually large third-quarter increase in expenditures for durable goods was mostly traceable to motor vehicles, the other major categories of durable goods--furniture and household equipment, and other durables--contributed to the overall strength of the component. Furniture and household equipment continued to register strong increases; other durables increased considerably more in the third quarter than in the second.

Expenditures for nondurable goods increased much less than in the second quarter. Most of the major categories contributed to the deceleration: Expenditures for food decreased in the third quarter after increasing in the second; expenditures for clothing and shoes and for energy were up, but less than in the second quarter, when they had registered unusually large increases. In contrast, other nondurables increased moderately in the third quarter after decreasing in the second.

Expenditures for services, which account for almost one-half of PCE, increased somewhat more in the third quarter than in the second. Household operation services and transportation services accelerated, because of larger increases in expenditures for energy and for airline travel, respectively. Housing and medical care services each increased about the same in the third quarter as in the second. Other services, restrained by declines in brokerage services in both quarters, again registered little change.

Nonresidential fixed investment

Real nonresidential fixed investment registered small changes--an increase of 1/2 percent in the third quarter, following a decline of 1 percent in the second (table 5). These changes are broadly consistent with those reported in last month's article on BEA's plant and equipment survey; the survey found that another small increase in expenditures was planned for the fourth quarter. Within nonresidential fixed investment, structures declined, and producers' durable equipment (PDE) increased, in both the second and third quarters.

Structures declined 9 1/2 percent in the third quarter, following a 35-percent decline in the second. Petroleum exploration and drilling declined substantially, although less than in the two preceding quarters; as discussed in more detail in the "Business Situation' in April and July, the declines reflected the effect of the sharp drops in oil prices. Industrial buildings also declined substantially in the third quarter--the third consecutive quarter of decline. Other types of structures contributed a small positive to third-quarter investment in structures; commercial structures, which had dropped sharply in the second quarter, changed little in the third.

PDE increased 4 1/2 percent in the third quarter, following a 19 1/2-percent increase in the second. Changes in PDE in recent quarters have reflected the erratic path of information processing equipment; this category accounts for about one-third of PDE but has accounted for more than two-thirds of the quarter-to-quarter change. In the third quarter, purchases of communications equipment were mainly responsible for a moderate increase in purchases of information processing equipment; purchases of computers changed little after increasing sharply in the second quarter. Increased purchases of cars and trucks both contributed to a second consecutive sharp increase in purchases of transportation equipment. Reduced purchases of tractors and construction machinery accounted for most of a third-quarter decline in other PDE.

Residential investment

Real residential investment increased 7 percent in the third quarter, following a 14 1/2-percent increase in the second. Single-family construction increased 23 1/2 percent after a 12 1/2-percent increase: multifamily construction declined 7 percent after a 22-percent increase; and the other component--which includes additions and alterations, major replacements, brokers' commissions on sales, and mobile home sales--declined 5 1/2 percent after a 13 1/2-percent increase.

The strong third-quarter increase in single-family construction occurred despite recent declines--15,000 units (seasonally adjusted annual rate) in the second quarter and 87,000 units in the third--in single-family starts (chart 3). Two factors help explain the apparent anomaly. First, although the number of starts declined in the second and third quarters, the constant-dollar value of starts--(number of starts) (average value of units started) | (price index of new one-family houses)--increased in the second quarter, indicating that although fewer units were being started, they were bigger or had more amenities than units started in the first quarter. In the third quarter, the constant-dollar value of starts slipped, but by much less than the number of starts. Second, reflecting the pattern with which value is added over the several months that it takes to construct a house, units started in a particular quarter have a bigger impact on construction in the following quarter.

The drop in multifamily construction reflected a sharp falloff in multifamily starts that began in May. Multifamily starts in the second and third quarters averaged 640,000, down 83,000 from the preceding 6 months.

A decline in brokers' commissions on the sale of new single-family houses contributed to the drop in the "other' component. These sales plummeted 155,000 units (seasonally adjusted annual rate) in July-August; the August level of 594,000 was the lowest in 2 years, despite continuing favorable mortgage interest rates (chart 4).

Inventory investment

Real inventory investment decreased $19 1/2 billion in the third quarter, as inventories decreased $4 1/2 billion after an increase of $15 billion in the second (table 6). Most of the decrease in investment was accounted for by nonfarm inventories, mainly inventories of retail auto dealers. Retail auto dealers liquidated $16 1/2 billion of inventories in the third quarter, following modest decumulation in the second.2

2. In general, the estimates for inventories of retail auto dealers, which are derived from Census Bureau book value inventory data, cover most auto inventories --including inventories of new and used autos, domestic and foreign--but do not include those held by manufacturers and wholesalers. The data for retail auto dealers cover, in addition to autos, some trucks and other motorized vehicles, and also parts. The change in business inventory estimates for retail auto dealers differ in terms of sources and coverage from the change in inventories of autos and trucks that are part of the motor vehicle output estimates.

Farm inventories were up only slightly in the third quarter, following moderate accumulations in the two preceding quarters. The slowdown may be related, in part, to a positive swing in agricultural exports in the third quarter (see next section on net exports).

Nonfarm inventories other than those held by retail auto dealers accumulated only slightly less than in the second quarter--$11 1/2 billion compared with $13 billion. Manufacturing inventories were down after a small increase, but wholesale inventories were up much more than in the second quarter. In manufacturing, durables inventories again registered substantial decumulation; in particular, inventories of primary metals and nonelectrical machinery have declined sharply over the past several quarters. Nondurable manufacturing inventories again accumulated, but much less than in the second quarter; the slowdown was largely in chemicals and petroleum. In wholesale trade, inventories held by petroleum wholesalers, which include both crude and refined oil, accumulated after substantial decumulation in the second quarter.

Reflecting changes in inventories and final sales, the constant-dollar ratio of total inventories to total final sales dropped from 3.23 to 3.19--the lowest level recorded during the current recovery and expansion. The third-quarter drop in the ratio largely reflected the impact of the developments in motor vehicles, which affected both inventories and sales.

Net exports

Real net exports of goods and services decreased $10 1/2 billion in the third quarter, after decreasing $28 billion in the second. The decrease was substantially less in the third quarter because of a sharp swing in exports to an increase of 15 1/2 percent from a decrease of 10 percent; imports increased 20 percent, following an increase of 16 percent (table 7).

The third-quarter increases in both exports and imports were accounted for by merchandise trade. Within merchandise exports, both agricultural and nonagricultural exports turned up sharply. The upturn in agricultural exports may reflect the increased competitiveness of U.S. farm products in world markets, aided by the Food Security Act of 1985, which reduced support prices on several major exported crops. Among nonagricultural exports, much of the increase was in capital goods, except autos, especially civilian aircraft and business machines. Within merchandise imports, petroleum was again up strongly, as declining world oil prices continued to stimulate U.S. demand. The increase in nonpetroleum imports was widespread.

Government purchases

Real government purchases increased 3 1/2 percent in the third quarter, following a 9 1/2-percent increase in the second (table 8). The slowdown was largely accounted for by Federal national defense purchases, which changed little after a substantial increase. The second-quarter increase had reflected large deliveries of military equipment. Defense purchases, which have trended up about 3 percent over the past year, often fluctuate sharply from quarter to quarter.

Federal nondefense purchases were unchanged, following a modest decline in the second quarter. Changes in these purchases have often fluctuated sharply due to operations of the Commodity Credit Corporation (CCC), but, in the first three quarters of 1986, net purchases of farm products by the CCC stabilized in the range of $4 1/2-$6 1/2 billion. Nondefense purchases other than by the CCC have remained flat for the past several quarters.

State and local government purchases increased somewhat less than in the second quarter. The pattern largely reflected that of structures, mainly highway construction. Other State and local purchases have continued to increase in the range of 2 1/2-3 percent.

Personal Income

Personal income increased $18 1/2 billion in the third quarter, substantially less than the increases in the past several quarters (table 9). The slowdown was almost entirely attributable to farm proprietors' income, which declined $18 billion after increasing $15 billion.

Wage and salary disbursements increased $23 billion in the third quarter, $8 billion more than in the second. The step-up was primarily due to wages and salaries in the manufacturing and distributive industries, which increased after declines in the second quarter. In manufacturing, the turnaround was concentrated in durables. Average weekly hours in manufacturing increased after a decline; employment continued to decline, and average hourly earnings continued to increase, at about the same pace as in the second quarter. In the distributive industries, the turnaround largely reflected the impact of a strike in the communications industry, which had reduced wages and salaries in the second quarter.

The sharp--$33 billion--swing in farm proprietors' income largely reflected the pattern of Federal agricultural subsidy payments. Subsidy payments had jumped $15 1/2 billion to a record $19 billion in the second quarter, when they had included advance deficiency payments on 1986 crops as well as final deficiency payments on the 1985 corn crop. Payments fell $13 1/2 billion in the third quarter. Farm income excluding subsidies declined for the third consecutive quarter. Nonfarm proprietors' income increased about the same amount in both quarters.

Transfer payments increased $8 billion in the third quarter, somewhat more than in the second. The larger increase was mainly accounted for by retroactive social security payments, which amounted to $2 1/2 billion in the third quarter. These payments result from the recalculation of the earnings base underlying benefits for retirees.

Among the remaining components of personal income, personal interest income declined substantially more than in the second quarter; the declines reflected lower interest rates. Rental income of persons was unchanged after an increase, and dividends were up less than in the second quarter. Other labor income continued to increase at about the same pace as in the preceding several quarters. Personal contributions for social insurance, which are subtracted in deriving the total, registered small increases in both quarters.

Personal tax and nontax payments were up almost twice as much as in the second quarter, reflecting, in part, the improvement in wages and salaries. The deceleration in personal income, in combination with the acceleration in personal taxes, led to a sharp slowdown in disposable personal income (DPI). DPI increased $4 1/2 billion, or 1/2 percent, in the third quarter, following an increase of $43 1/2 billion, or 6 percent, in the second. Reflecting this slowdown and the turnaround in PCE prices, real DPI declined 2 percent in the third quarter after a 7-percent increase.

Personal outlays--largely PCE-- were up substantially more than in the second quarter. This pickup, along with the slowdown in current-dollar DPI, led to a sharp swing in personal saving--from a $7 1/2 billion increase to a $65 1/2 billion decline. The personal saving rate dropped 2.2 percentage points to 2.9 percent, the lowest rate in 35 years.

Such a sharp drop in the saving rate is not unprecedented; in the third quarter of last year, the saving rate dropped 2.3 percentage points. In both cases, the drops were associated with sharp declines in farm proprietors' income and sharp increases in motor vehicle purchases. Changes in farm proprietors' income have, historically, had relatively little impact on personal outlays. If it is assumed that the third-quarter decline in farm income had no effect on personal outlays, that income change by itself would have lowered the saving rate by about 0.5 percentage point. Historically, large changes in consumer purchases of motor vehicles have coincided with changes in the opposite direction in the saving rate. These purchases may, to some extent, represent an alternative kind of saving--an accumulation of physical capital as opposed to financial capital.

Table: 1.--Selected Aggregate Economic Measures

Table: 2.--Recent GNP Patterns

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

Table: 4.--Real Personal Consumption Expenditures: Change From Preceding Quarter

Table: 5.--Real Gross Private Domestic Fixed Investment: Change From Preceding Quarter

Table: 6.--Change in Real Business Inventories

Table: 7.--Real Net Exports of Goods and Services: Change From Preceding Quarter

Table: 8.--Real Government Purchases of Goods and Services: Change From Preceding Quarter

Table: 9.--Personal Income and Its Disposition: Change From Preceding Quarter

Photo: CHART 1 Selected Measures: Change From Preceding Quarter

Photo: CHART 2 Retail Sales of New Cars

Photo: CHART 3 Housing Starts

Photo: CHART 4 Selected Interest Rates
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Title Annotation:3rd quarter, 1986
Publication:Survey of Current Business
Date:Oct 1, 1986
Words:3830
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