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The business situation.

the BUSINESS SITUATION

THE pace of U.S. production picked up in the third quarter of 1987. Real GNP increased at an annual rate of 4 percent, following an increase of 2 1/2 percent in the second quarter (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 GNP estimates for the third quarter 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, construction put in place for July and August, and manufacturers' shipments of machinery and equipment for July and August; for residential investment, construction put in place for July and August, and housing starts through September; for change in business inventories, manufacturing and trade inventories for July and August, and unit auto inventories through September; for net exports of goods and services, merchandise exports and merchandise imports for July and August, and fragmentary information on investment income for the quarter; for government purchases of goods and services, Federal unified budget outlays for July and August, and State and local construction put in place for July and August; and for GNP prices, the Consumer Price Index for July and August, the Producer Price Index through September, the unit-value index for petroleum imports for July and August, and unit-value indexes for merchandise exports and nonpetroleum merchandise imports for July. Some of the source data are subject to revision.

U.S. demand also picked up, increasing more than U.S. production for the first time since the third quarter of last year. Real gross domestic purchases increased 4 1/2 percent, following a 2-percent increase in the second quarter.

Inflation, whether measured by the prices of goods and services produced or by the prices of goods and services purchased, slowed in the third quarter. The GNP price index (fixed weights) increased 2 1/2 percent after a 4-percent increase; the price index for gross domestic purchases (fixed weights) increased 3 percent after a 4 1/2-percent increase.

Foreign transactions continued to register substantial changes. To analyze the impact of these changes on U.S. production and demand, exports and imports must be examined separately. Exports--goods and services provided by U.S. residents to foreigners --are added in the calculation of GNP but not in the calculation of gross domestic purchases. Imports-- goods and services provided by foreigners to U.S. residents--are subtracted in the calculation of GNP but not in that of gross domestic purchases. Thus, as shown in table 1, GNP minus exports plus imports is equal to gross domestic purchases.

Real exports increased strongly in both the second and third quarters-- $16 1/2 billion in the second and $16 billion in the third--and continued to be a major contributor to GNP growth. Over the two quarters combined, exports, which make up one-ninth of GNP, accounted for more than one-half of the $59 billion increase in GNP.

Real imports also increased strongly in both quarters--$14 billion in the second and $21 1/2 billion in the third--and continued to meet a sizable portion of the increase in U.S. demand. Almost all of the third-quarter increase was due to a surge in petroleum imports. Over the two quarters combined, imports, which make up one-seventh of gross domestic purchases, accounted for more than one-half of the $61 1/2 billion increase in gross domestic purchases.

Although imports are subtracted in the calculation of GNP, one cannot simply add them back to determine what U.S. production would have been in the absence of imports. Assessing the effect of imports on U.S. production is more complex, involving questions such as the extent to which the imported goods and services could and would have been produced domestically instead and the extent to which U.S. exports would have been affected.

Components of Real GNP

Changes in most of the major components of real GNP were in the same direction in the third quarter as they had been in the second. Personal consumption expenditures and nonresidential fixed investment increased in both quarters, but each was up considerably more in the third. Residential investment was weak in both quarters. The change in business inventories declined in both quarters, but was down considerably more in the thrid. Net exports declined after a small increase: Exports were up strongly in both quarters; imports were up more strongly in the third quarter than in the second. Government purchases increased by about the same amount in both quarters.

Personal consumption expenditures

Real personal consumption expenditures (PCE) increased 5 percent in the third quarter after increasing 2 percent in the second. Durable goods and services each increased more than in the second quarter, and nondurable goods decreased less than in the second quarter (table 2).

Over the three quarters of 1987, increases in PCE have averaged 2 percent, considerably less than in 1986. The smaller increases were consistent with the mixed economic picture for consumers. In 1987, income gains have not kept pace with expenditures: Real PCE has increased twice as much as real disposable personal income. Consumers have stretched spending with the help of stock market gains and added debt. Consumer confidence, as measured by the Index of Consumer Sentiment prepared by the University of Michigan's Survey Research Center, has remained high, reflecting steady job growth, personal tax cuts, and moderate inflation. Although consumers still viewed their financial situations and the economy in a generally positive light, they may have become more cautious about borrowing. Quarterly percent increases in consumer installment credit outstanding in 1987 were well below the double-digit increases in 1986. (Conventional measures of borrowing and debt burden, however, do not capture the increasing use of home equity lines of credit in the past several quarters.)

Chart 2 compares quarterly percent changes over the past 3 years in total PCE with those in PCE excluding motor vehicles and parts. Although motor vehicles and parts make up less than one-tenth of PCE, they have dominated the quarterly pattern of the total. In particular, manufacturers' sales-incentive programs in the third quarters of 1985, 1986, and 1987 boosted sales substantially. (A discussion of motor vehicles, in terms of units, appears at the end of the "Business Situation.')

Expenditures for durable goods increased 20 percent in the third quarter, following an increase of 10 1/2 percent in the second. The acceleration was largely attributable to motor vehicles and parts. Expenditures for furniture and household equipment and for other durables accelerated slightly.

Expenditures for nondurable goods decreased slightly in the third quarter, following a 2-percent decrease in the second. In recent quarters, changes in the components of nondurables have been erratic; the large swings have tended to offset one another in the total. Food declined in the third quarter, but less than in the second. Clothing and shoes swung from a sharp decrease to an even sharper increase. Energy decreased sharply after an increase of similar magnitude. Other durables decreased after an increase.

Expenditures for services increased 4 percent in the third quarter, following a 2-percent increase in the second. Household operation services accelerated, largely due to a pickup in expenditures for electricity and gas. Reflecting brokerage services, other services increased moderately after a decline in the second quarter. Housing and medical care registered increases similar to those in the second quarter, and transportation decreased slightly after an increase.

Nonresidential fixed investment

Real nonresidential fixed investment increased 23 1/2 percent in the third quarter, following an 11 1/2-percent increase in the second (table 3). Structures, which had been weak in the first half of the year, increased 16 percent in the third quarter. Producers' durable equipment, which had bounced back in the second quarter after a first-quarter decline, increased 26 1/2 percent.

In structures, petroleum exploration and drilling, which makes up one-fifth of nonresidential structures, accounted for two-thrids of the increase. This component has been buffeted in recent years by sharp changes in crude petroleum prices. Increased exploration and drilling in the past four quarters reflect the better-than-50-percent increase in the Producer Price Index for crude petroleum over the period. Public utilities, which also make up one-fifth of nonresidential structures, more than accounted for the rest of the increase. Office buildings increased slightly, following eight consecutive quarterly declines, but persistently high vacancy rates (in the neighborhood of 20 percent, nationally) cast doubt on the sustainability of the upswing.

In producers' durable equipment, increases were widespread but were especially large in information processing and related equipment. This category, which makes up two-fifths of the total, accounted for two-thirds of the increase. This category's largest component--office, computing, and accounting machinery--increased very sharply, following several quarters of sluggish sales.

Factors usually cited in assessments of investment conditions gave mixed signals for the third quarter. On the one hand, capacity utilization continued to increase, unfilled orders for nondefense capital goods were very high, export demand was strong, corporate cash flow had been quite high relative to investment expenditures in the first half of the year, and capital appropriations had increased sharply in the first half. On the other hand, capacity utilization--although increasing --was still substantially below the peak levels reached in previous expansions, interest rates had increased since the spring, and consumer demand had been sluggish in the first half of the year.

Residential investment

Real residential investment was unchanged in the third quarter, following a 3-percent decline in the second. In the third quarter, an increase in single-family construction was offset by a decline in multifamily construction. In single-family construction, the increase was relatively modest, 6 1/2 percent, but larger than the increases of 3 1/2-4 percent earlier in the year; in multifamily construction, the decline was large, 23 percent, but smaller than the 33-percent drops earlier in the year. The other component of residential investment--which includes major replacements, additions and alterations, mobile home sales, and brokers' commissions on house sales--changed little.

The third-quarter increase in single-family construction largely reflected two offsetting developments in the second quarter. (Almost one-half of the value of construction put in place in a given quarter depends on the value of units started in the immediately preceding quarter.) First, the number of single-family units started dropped 9 percent in the second quarter (chart 3). (Percentages in this paragraph are not at annual rates.) Second, the average value of starts increased sharply in the second quarter. One indication of the increase in average value is shown by the differing behavior of two price measures. The price index for new one-family houses sold--a measure that attempts to remove the effect of changes in size and amentities--increased 1 percent, while the average sales price of new one-family houses actually sold--a measure that reflects changes in size and amenities--increased 5 percent. In the third quarter, the number of starts was flat, while the average value appears to have increased again.

The commitment rate on fixed-rate first mortgages increased 1.18 percentage points in the second quarter and another 0.18 point in the third (chart 4). The effect of these increases on house sales (which determine brokers' commissions and influence future construction plans) was only partly blunted by the availability of adjustable-rate mortgages carrying initial rates 1 to 2 percentage points lower than fixed-rate mortgages. Sales of both new and existing residences in July-August were about 6 percent below first-quarter levels, with the drop in sales of new units occurring in the second quarter and the drop in sales of existing units occurring in July-August. The difference in the timing of the declines in new and existing sales is probably, in part, a statistical mirage; sales of existing units are based on a mixture of sales contracts and closings, and, thus, would tend to trail sales of new units, which are based on sales contracts alone.

The third-quarter decline in multi-family construction reflected--as did declines earlier in the year--changes in tax laws and high vacancy rates resulting from previous overbuilding. At 7 1/2 percent, the national rental vacancy rate was about 2 percentage points above its longrun average, implying, according to one estimate, an excess of approximately 600,000 units.

Inventory investment

Real inventory investment declined $21 billion, as inventory accumulation slowed to $18 billion in the third quarter from $39 billion in the second (table 4). Inventory investment had declined $8 1/2 billion in the second quarter. Both farm and nonfarm inventory investment declined in the third quarter--$7 1/2 billion and $13 1/2 billion, respectively.

Farm inventories accumulated in both the second and third quarters-- $16 1/2 billion and $9 billion, respectively. Not only were open market sales of crops below current production in the two quarters but, also, substantial amounts of crops were redeemed from the Commodity Credit Corporation, especially in the second quarter.

Among nonfarm inventories, inventories of retail auto dealers declined $9 billion after an increase of $3 billion. The decline, which was concentrated in inventories of domestic cars, reflected enhanced sales-incentive programs and cuts in production.

Nonfarm inventories excluding those held by retail auto dealers-- shown as an addendum in table 4--increased $18 1/2 billion, following increases of $19 1/2 billion and $22 1/2 billion in the second and first quarters, respectively. The steady accumulations in this total masked sharp movements in manufacturing and trade inventories. Manufacturing inventories increased $8 1/2 billion after a decline of $4 1/2 billion; the increase was concentrated in transportation equipment other than motor vehicles, petroleum, and nonelectrical machinery. Wholesale trade inventories declined $4 billion after an increase of $5 1/2 billion; the third-quarter decumulation was mostly in durables, especially in metals and minerals and in electrical goods. Among nondurables, strong buildups in petroleum and products and in groceries were largely offset by runoffs in farm products and in apparel and dry goods. Retail trade inventories (excluding autos) increased $7 billion after an increase of $12 1/2 billion. Among durables, the increase was concentrated in furniture and appliances; among nondurables, food and beverages increased moderately, and nondurables other than food increased sharply.

Reflecting the third-quarter increase in inventories and the even stronger increase in final sales, the constant-dollar ratio of total inventories to total final sales declined. At 3.18, down from 3.21 in the first and second quarters, the ratio was near the lower end of the range within which it has moved in recent years.

Net exports

Real net exports declined $5 billion in the third quarter, following increases in the preceding three quarters (table 5). Exports and imports both increased substantially in the third quarter; the larger increase in imports was due to a surge in petroleum imports.

Imports increased $21 1/2 billion, following a somewhat smaller increase in the second quarter. In the third quarter, as in two of the three preceding quarters, the change in merchandise imports was dominated by petroleum. Petroleum imports were up $19 1/2 billion in the third quarter, the largest increase on record. The third-quarter surge followed an increase of $2 1/2 billion in the second quarter and substantial declines in each of the two preceding quarters. The unusually large increase, in the face of rising crude oil prices, may have reflected some precautionary building of stocks due to increased uncertainty about oil supplies from the Middle East. Further, domestic crude oil production continued to decline and growth in U.S. economic activity continued to boost oil demand.

Nonpetroleum merchandise imports increased $1 1/2 billion, following a $5 billion increase. The increases were more than accounted for by sharp gains in imports of capital goods, except autos. The other major end-use categories remained weak--below or no higher than year-ago levels. The weakness reflected, to some extent, substantial increases in prices (see the section on prices later in the "Business Situation'), which were largely due to depreciation of the dollar.

Imports of services increased $1/2 billion, following a $6 1/2 billion increase. The slowdown was in factor income and mirrored movements in interest rates on portfolio investment.

Exports increased $16 billion, following a similar increase in the second quarter. Merchandise exports, both agricultural and nonagricultural, increased strongly in both quarters. The third-quarter increase in agricultural exports, mainly in soybean exports, reflected the growing competitiveness of U.S. agricultural products in the world market due to lower prices and reduced competitor supplies.

Increases in nonagricultural exports in the second and third quarters averaged $10 1/2 billion, twice the averaged increase in the preceding four quarters. The second- and third-quarter increases were spread across most of the major end-use categories, but were especially sharp in exports of capital goods, except autos. The strength in nonagricultural exports reflected, to some extent, the cumulative effects of dollar depreciation.

Exports of services declined $1 1/2 billion, following a $5 billion increase in the second quarter. Factor income increased less than in the second quarter, mirroring movements in interest rates on portfolio investment; other services declined after an increase.

Government purchases

Real government purchases increased $9 billion, or 4 1/2 percent, in the third quarter, following an increase of $7 billion, or 4 percent, in the second (table 6). Federal Government purchases increased by about the same amount in the third quarter as in the second; State and local government purchases increased more than in the second quarter.

Within Federal Government purchases, national defense purchases increased much less than in the second quarter; the slowdown was concentrated in services other than employee compensation and in military hardware. Nondefense purchases increased after a small decline; the swing reflected the pattern of changes in inventories held by the Commodity Credit Corporation (CCC). The level of CCC inventories declined in each of the past three quarters, but the decline was considerably larger in the second quarter than in the first or third quarters. Withdrawals from CCC inventories, particularly in the second quarter, included not only redemptions by farmers of crops they had previously placed under loan but also redemptions using certificates initially issued to farmers by the CCC in lieu of cash subsidy payments. Other nondefense purchases resumed a slight downtrend that had been interrupted in the second quarter by a bulge in services other than employee compensation.

Within State and local government purchases, structures changed little after a decline in the second quarter. The pattern largely reflected changes in two components: Buildings changed little after a $1 billion decline, and highways increased $1/2 billion after a $1/2 billion decline.

Prices

GNP prices and gross domestic purchases prices both decelerated 1 1/2 percentage points in the third quarter --to increases of 2 1/2 percent and 3 percent, respectively (table 7). The continued higher increases in the purchases price measure largely reflected substantial increases in the prices of merchandise imports. As shown in the addenda to the table, prices of merchandise imports have increased at double-digit rates in recent quarters. The sharp, although decelerating, increases in petroleum prices during the period are most notable, but prices of other imported goods have registered strong increases as well. Over the past three quarters, increases in prices of industrial supplies and materials, excluding petroleum, averaged 11 1/2 percent; increases in prices of capital goods, except autos, averaged 6 1/2 percent; and increases in prices of consumer goods averaged 9 percent.

The third-quarter slowdown in inflation was widespread. Prices of PCE, fixed investment, and government purchases all increased less than in the second quarter.

PCE prices increased 3 1/2 percent, following a 5-percent increase in the second quarter. Food prices were up moderately after a strong second-quarter increase, when prices of meat and of fruits and vegetables had been up sharply. Increases in meat prices slowed in the third quarter; in particular, retail prices of beef leveled off, after a 5-year high in June. Prices of fruits and vegetables fell in the third quarter. Energy prices, largely reflecting gasoline prices, increased a little less in the third quarter than in the second. Other PCE prices were up less than in the second quarter. The slowdown was largely accounted for by prices of clothing and shoes; these prices, which often fluctuate sharply from quarter to quarter, declined in the third quarter after a double-digit increase in the second.

Among the investment components, increases in the prices of structures-- both nonresidential and residential-- decelerated sharply in the third quarter. PDE prices have changed little in the past three quarters.

Prices paid by government increased 4 percent, slightly less than in the second quarter. Prices of Federal defense purchases--primarily reflecting missiles, aircraft, and employee compensation--increased considerably less than in the second quarter. Prices of nondefense purchases were up somewhat less than in the second quarter, and prices of State and local government purchases were up somewhat more.

Personal Income

Personal income increased $51 billion in the third quarter, following a $46 1/2 billion increase in the second (table 8). The acceleration was largely accounted for by stronger increases in wage and salary disbursements and in personal interest income. Disposable personal income jumped in the third quarter, as personal tax and nontax payments fell after a sharp increase in the second.

Wage and salary disbursements increased $35 1/2 billion in the third quarter, following a $28 billion increase in the second. The step-up was concentrated in wages and salaries in the manufacturing and services industries, although the other major private industries also contributed. Employment, average weekly hours, and average hourly earnings in the private industries all increased more than in the second quarter. Government wages and salaries increased by about the same amount as in the second quarter. (Treatment in the national income and product accounts of a shift in pay days for military personnel is described in the accompanying explanatory note.)

Farm proprietors' income decreased $8 billion in the third quarter, following a decrease of $4 billion in the second. Federal agricultural subsidy payments to farmers declined in both quarters--$5 billion in the third and $9 1/2 billion in the second; farm income excluding subsidies declined $3 billion in the third quarter after a $5 1/2 billion increase in the second. The swing in farm income excluding subsidies was largely attributable to changes in prices received by farmers; crop prices were down in the third quarter after a strong increase in the second, and livestock prices increased much less in the third than in the second. Nonfarm proprietors' income was up somewhat more in the third quarter than in the second; the pickup reflected increases in the services and real estate industries after declines in the second quarter.

Personal interest income was up $11 1/2 billion in the third quarter, following a $6 1/2 billion increase in the second. The step-up reflected continued increases in interest rates.

Transfer payments were up less in the third quarter than in the second. In the second quarter, retroactive social security payments amounting to $2 billion were made to recent retirees. These retroactive payments are one-time payments; thus, the change in transfer payments was raised $2 billion in the second quarter and reduced $2 billion in the third.

Third-quarter changes in the remaining components of personal income were small and were similar to those in the second quarter. Other labor income and personal dividend income increased, and rental income declined. Personal contributions for social insurance, which are subtracted in deriving the personal income total, registered a small increase.

Personal tax and nontax payments decreased $12 billion in the third quarter, following a $42 billion surge in the second. The swing reflected the direct and indirect effects of the Tax Reform Act of 1986 on Federal and on State and local tax payments. These effects subtracted $25 1/2 billion from the change in tax payments in the third quarter after adding $25 1/2 billion to the second-quarter change. Most of the third-quarter swing in Federal tax payments resulted from a sharp dropoff in declarations (estimated tax payments) and net settlements (final tax payments less refunds on the preceding year's taxes). These payments had been large in the first half of the year, reflecting the acceleration of capital gains realizations into 1986. The third-quarter swing in State and local tax payments reflected the indirect effects of the tax act, which had raised second-quarter payments to the extent that taxpayers shifted realizations of capital gains into 1986. (For more information, see the discussion in the July 1987 "Business Situation.')

Largely reflecting the sharp swing in personal tax and nontax payments, disposable personal income (DPI) jumped $63 billion in the third quarter, following a $4 1/2 billion increase in the second. Real DPI increased 4 1/2 percent in the third quarter, following a 4 1/2-percent decline in the second; the swing reflected both the sharp acceleration in DPI and the declaration in PCE prices.

Personal outlays--largely PCE-- were up about the same as DPI in the third quarter; they had been up much more than DPI in the second. As a result, personal saving swung sharply from a $45 billion decrease to a $1 1/2 billion increase. The personal saving rate, after dropping 1.4 percentage points to 3.0 percent in the second quarter, was unchanged in the third.

Motor Vehicles

Sales of new cars, boosted by manufacturers' sales-incentive programs, jumped 1.5 billion units to 11.5 million (seasonally adjusted annual rate) in the third quarter (chart 5). The third-quarter increase was the largest since the 1.9-million jump in the third quarter of 1986, which had also been spurred by incentive programs.

Two-thirds of the third-quarter increase was in sales of domestic cars, which were up to 8.0 million from 7.0 million in the second quarter. The sharp increase reflected the introduction of sales-incentive programs offering interest rates as low as 1.9 percent. However, third-quarter sales were well below the record of 9.5 million in the third quarter of 1986; the lower level of sales in the third quarter of this year reflected the weakness in domestic car sales in 1987 and the fact that the recent sales-incentive programs were less attractive than those offered in the third quarter of 1986.

Domestic car sales averaged 6.9 million in the first half of 1987, compared with 7.8 million in the first half of 1986. The weakness in 1987 sales was due to several factors, including a saturation in the new car market, a slight decline in consumer confidence, and a substitution by consumers of purchases of light trucks (pickups, recreational vehicles, and vans) for cars. Further, incentive programs in the third quarter of 1987 may have had a different effect on quarterly sales patterns than programs in the third quarters of 1985 and 1986. Programs in 1985 and 1986, which were not expected by consumers, shifted sales only from future quarters. In the first and second quarters of 1987, consumers, anticipating enhanced incentive programs at the end of the model year, may have postponed purchases.

The third-quarter 1987 incentive programs were similar to, but less attractive than, programs offered in the third quarter of last year. The recent programs were not as dramatically different from programs in preceding quarters, and, because the interest rates offered were not as far below prevailing market rates, the incentives amounted to a smaller portion of a consumer's total outlay for a new car.

In addition to offering enhanced incentive programs in the third quarter of 1987, domestic automakers cut production to reduce inventories. Domestic car production declined to 6.3 million units from 7.1 million in the second quarter. Domestic car inventories declined sharply to 1.36 million units from 1.80 million in the second quarter. Reflecting higher sales and reduced inventories, the inventory-sales ratio fell sharply to 2.1 in the third quarter, the lowest level since 1.7 in the third quarter of 1986. The ratio had been 3.1 in the second quarter.

Sales of imported cars increased to a record 3.6 million in the third quarter from 3.0 million in the second. The increase reflected, in part, incentive programs offered by foreign automakers in an attempt to compete with the domestic programs.

Unit sales of new trucks increased to 5.3 million in the third quarter from 5.0 million in the second. Sales of domestic trucks increased to 4.4 million from 4.1 million; sales of imported trucks were 0.9 million in each quarter.

Table: CHART 1 Selected Measures: Change From Preceding Quarter

Table: 1.--U.S. Production and U.S. Demand

Table: 2.--Real Personal Consumption Expenditures

Table: 3.--Real Gross Private Domestic Fixed Investment

Table: CHART 2 Real Personal Consumption Expenditures: Change From Preceding Quarter

Table: 4.--Change in Real Business Inventories

Table: CHART 3 Housing Starts

Table: 5.--Real Net Exports of Goods and Services

Table: CHART 4 Selected Interest Rates

Table: 6.--Real Government Purchases of Goods and Services

Table: 7.--Price Indexes (Fixed Weights): Change From Preceding Quarter

Table: 8.--Personal Income and Its Disposition

Table: CHART 5 Retail Sales of New Cars
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Title Annotation:third quarter, 1987
Publication:Survey of Current Business
Date:Oct 1, 1987
Words:4911
Previous Article:Constant-dollar inventories, sales, and inventory-sales ratios for manufacturing and trade: revised estimates.
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