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The business situation.

U.S. economic activity continued at a moderate pace in the third quarter of 1988: Production slowed somewhat, and demand picked up somewhat. Inflation was about the same in the third quarter as in the second (chart 1).

* Real GNP, a measure of U.S. production, increased at an annual rate of 2 percent, following an increase of 3 percent in the second quarter.

* Real gross domestic purchases, a measure of U.S. demand, increased at an annual rate of 21/2 percent, following a 1-1/2-percent increase.

* The GNP price index (fixed weights) increased at an annual rate of 5 percent, and the price index for gross domestic purchases increased 4-1/2 percent; both indexes had increased 5 percent in the second quarter.'

Differences in movements of real GNP and real gross domestic purchases reflect changes in net exports (table 1). Imports increased strongly in the third quarter after declining in the second; the turnaround was accounted for by nonpetroleum merchandise and by services. Exports increased about the same in both quarters.

Impact of the drought.-On the basis of information available in midOctober, BEA estimates that $13 billion of real farm output was lost as a result of this year's drought. These losses-$12 billion for crops and $1 billion for livestock-were allocated on a quarterly basis as follows: Second quarter, $2.3 billion ($9 billion annual rate); third quarter, $3.7 billion ($15 billion annual rate); and fourth quarter, the remaining $6.9 billion ($28 billion annual rate) (table 2). Losses due to the drought reduced the secondquarter increase in real GNP by 0.9 percentage point and the third-quarter increase by 0.6 percentage point. (In the fourth quarter, the change in real GNP will be reduced by about 1.3 percentage points; in the first quarter of 1989, when farm output returns to a level not affected by the drought, the change in real GNP will be raised by about 2.8 percentage points.)

BEA's estimate of crop losses was based on the difference between tbe U.S. Department of Agriculture (USDA) June forecast of the physical quantity of output, representing conditions before the drought, and the USDA October crop production report. BEA allocated the crop loss for the year over the quarters of the growing season, with the harvest periods receiving higher allocations. (See the August 1988 "Business Situation" for a description of this procedure, as well as for additional information about the effects of the drought on farm output.) BEA estimated the livestock losses using information about earlierthan-usual marketings of livestock and then spread the loss over the three quarters.

The drought also affected farm inventories, farm income, and other estimates that include farm products, but the impact is difficult to quantify. The extent to which the losses affected farm inventories depends on the extent to which they affected sales (or purchases) of farm products. Sales were not greatly affected in the second quarter; sales were affected in subsequent quarters, but to an extent that cannot be quantified from the underlying source data. Although BEA has estimated the impact of the drought on farm output, estimates of its impact on other determinants of farm income-such as crop and livestock prices, farm subsidies, and production expenses-were not made. (A sharp third-quarter drop in agricultural subsidy payments was primarily related to the timing of payments to farmers, not to the effects of the drought.)

Components of Real GNP

The slowdown in real final sales in the third quarter was considerably sharper than that in GNP. Among the final sales components, net exports declined after a strong increase, government purchases declined after a moderate increase, and fixed investment increased much less than in the second quarter; only personal consumption expenditures showed improvement, increasing somewhat more than in the second quarter. Inventory investment declined slightly after a sharp drop.

Personal consumption expenditures

Real personal consumption expenditures (PCE) increased 31/2 percent in the third quarter after a slightly smaller increase in the second (table 3). Although the increases in total PCE were roughly similar in size in the two quarters, the size of increases in each of the three major types of expenditures differed considerably from one quarter to the next. For each, the fluctuation can largely be traced to a single component-used cars within durables, clothing and shoes within nondurables, and energy within services.

Durable goods increased one-half percent after a 10-percent increase. The motor vehicles and the furniture and household equipment categories both contributed to the deceleration. Motor vehicles and parts increased much less than in the second quarter, when they had been boosted by unusually large net purchases of used cars. Purchases of new cars increased in the third quarter after decreasing in the second.

Nondurable goods increased 3-1/2 percent after a slight increase in the second quarter. The acceleration was largely attributable to clothing and shoes, which increased sharply after several quarters of decline. "Other" nondurables, which increased somewhat more than in the second quarter, also contributed to the acceleration.

Services increased 4-1/2 percent after a smaller increase; most major categories of services contributed to the acceleration. The largest step-up was in energy services, reflecting increased expenditures for air conditioning due to unusually hot weather in tbe first part of the quarter. Nonresidential fixed investment

Real nonresidential fixed investment increased 4-1/2 percent in the third quarter, following a 15-percent increase in tbe second. Most of the deceleration was accounted for by producers' durable equipment (PDE), although structures also slowed (table 4).

In structures, a decline in construction of nonresidential buildings was offset by an increase in construction by public utilities; in the second quarter both categories had increased. Oil well drilling and "other" construction increased slightly after two consecutive quarters of decline.

Information processing equipment and transportation equipment were the main contributors to the deceleration in PDE. A slowdown in information processing equipment can be attributed to a single component-office, computing, and accounting machinery. A downswing in transportation equipment was largely accounted for by a single component-aircraft.

Residential fixed investment

Real residential fixed investment increased 11/2 percent in the third quarter, following little change in the second. In the third quarter, a decline in single-family construction was more than offset by increases in multifamily construction and in the "other" component-which includes mobile homes, additions and alterations, major replacements, and brokers' commissions on house sales (table 4).

The decline in single-family construction mainly reflected the lagged effect of a drop of 40,000 (seasonally adjusted annual rate) in the number of single-family units started in the second quarter; starts were unchanged in the third quarter (chart 2). Tbe increase in multifamily construction interrupted a 2-year downtrend that reflected high rental vacancy rates and the curtailment of tax incentives for investment in multifamily structures. Despite the increase, multifamily construction in tbe third quarter was about 40 percent below its high in the second quarter of 1986.

The increase in "other" residential investment was partly traceable to brokers' commissions. Tbe increase in brokers' commissions resulted from an increase in the average value of houses sold; the number of units sold changed little. Mortgage rates changed little despite increases in short-term interest rates (chart 3).

Inventory investment

Real inventory investment decreased $1-1/2 billion in the third quarter, as inventory accumulation was down slightly to $34 billion from $35-1/2 billion in the second quarter (table 5). Inventories had accumulated at much higher rates-$66-$67 billion-in tbe two preceding quarters.

Nonfarm inventories increased $34 billion, a little more than in the second quarter but considerably less than in the first. Accumulation in manufacturing inventories stepped up in the third quarter. Within manufacturing, inventories of durable goods continued a pattern of steady accumulation; much of the increase in tbe second and third quarters was concentrated in nonelectrical machinery. Wholesale trade inventories accumulated after a small decumulation. The turnabout was in inventories of merchant wholesalers of durable goods; in particular, inventories of motor vehicle wholesalers increased after a substantial decline. A sharp dropoff in the rate of accumulation of retail inventories was accounted for by retail auto dealers. Their inventories changed little after a sharp buildup in the second quarter.

Farm inventories declined $1/2 billion, following moderate accumulation in the second quarter and substantial accumulation in the first. The pattern of inventory changein the second and third quarters reflected the impact of the drought. To quantify this impact, it is necessary to have information about the impact of the drought on sales. (Change in farm inventories is estimated as the difference between farm output and the sum of open market sales and of net transactions of farmers with the Commodity Credit Corporation.) Assuming, as seems reasonable, that sales were not affected in the second quarter, the entire $9 billion second-quarter loss in farm output reduced farm inventory change. In the third quarter, sales may have been affected some by the drought, but by amounts that cannot be estimated from the underlying source data; thus, tbe effect on farm inventories cannot be quantified.

Reflecting the steady pace of inventory investment and the slowdown in final sales, tbe constant-dollar ratio of total business inventories to total business final sales moved up to 3.20 from 3.18. The ratio has remained within the 3.12-to-3.22 range for the past 3 years.

Net exports

Real net exports declined $21/2billion in the third quarter after an increase of $161/2 billion in the second (table 6). The downswing was attributable to imports, which increased after a decline. Exports increased roughly the same in both quarters.

Merchandise exports increased $5 billion (or 6-1/2 percent), following an increase of twice that amount. Nonagricultural exports were up somewhat less than in the second quarter. The deceleration was centered in the industrial supplies and materials and the "other" end-use categories; in contrast, capital goods (except autos) were up more than in the second quarter. Agricultural exports declined after a slight increase.

Merchandise imports increased $6-1/2 billion (or 6 percent), following a decline of $4 billion (or 3 V2 percent). Nonpetroleum imports accounted for most of the upswing. With the exception of capital goods (except autos), all of the major end-use categories contributed to the swing; capital goods (except autos) increased less than in the second quarter. Petroleum imports increased for the third consecutive quarter, almost regaining the high reached in the third quarter of 1987.

Exports of services increased $5 billion after a $1/2 billion increase, and imports of services increased $6 billion after a $1-1/2 billion decline. For both exports and imports, the changes largely reflected swings in investment income from modest declines in the second quarter to sizable increases in the third. The third-quarter increases mainly reflected higher interest rates.

Government purchases

Real government purchases decreased $2-1/2 billion (or 1-1/2 percent) in tbe third arter, following an increase of $7-1/2 billion (or 4 percent) in the second (table 7). Federal defense purchases decreased more than in the second quarter; Federal nondefense purchases and State and local purchases increased less than in the second quarter.

Federal defense purchases decreased for the fourth consecutive quarter, but the decrease-$7 billion (or 10 percent)-was considerably larger than in tbe preceding quarters. Although the third-quarter decrease was spread across all types of purchases other than employee compensation, more than one-half of it was accounted for by military equipment, particularly aircraft and missiles.

Within Federal nondefense purchases, substantial decumulation of Commodity Credit Corporation (CCC) inventories continued for the third consecutive quarter, (Net withdrawals have been successively smaller each quarter, leading to the pattern of change shown in table 7.) The inventory decumulations reflected net sales of crops by the CCC to the nonfarm sector and net withdrawals of crops under the CCC commodity loan program. Among the other nondefense components, purchases of durables, nondurables (excluding CCC inventory transactions), and services other than employee compensation all decreased after increasing in the second quarter.

The slowdown in State and local purchases was traceable to structures, which decreased slightly after a small increase. The downswing was accounted for by sewer and water supply construction.

Prices

In the third quarter, GNP prices increased 5 percent and gross domestic purchases prices increased 4-1/2 percent; in tbe second quarter, both price measures had increased 5 percent (table 8). The third-quarter difference in the increases in the two price measures was largely traceable to a sharp deceleration in prices of imports. Prices of imported petroleum declined considerably more than in the second quarter, and prices of other imported merchandise increased less.

PCE prices increased 5 percent, somewhat less than in the second quarter. Both PCE energy and "other" PCE prices were up less than in the second quarter. The deceleration in energy prices was traceable to prices of fuel oil and coal and of electricity and gas. Among other PCE prices, prices of clothing and shoes fell 8 percent after a 15-1/2-percent jump, continuing the recent pattern of sharp changes. Prices of transportation services increased considerably less than in the second quarter.

At least partly reflecting the impact of the drought, PCE food prices stepped up to a 9 V2-percent increase from a 6percent increase in the second quarter. The acceleration was widespread, but was particularly sharp for fresh fruits and vegetables and for cereals and bakery products; in contrast, meat prices were up less than in the second quarter.

Among other components of final sales, fixed investment prices registered another modest-1-1/2 percent-increase. Prices of nonresidential structures were up somewhat more than in the second quarter, and PDE prices were up somewhat less; residential investment prices registered small increases in both quarters. Prices paid by government increased 4'/2 percent in both quarters.

Personal Income

Personal income increased $63-1/2 billion in the third quarter, following a $71 billion increase in the second (chart 4 and table 9). The deceleration was accounted for by the sharp downswing in subsidy payments to farmers. Reflecting a swing from a large increase to a large decline in personal tax and nontax payments, disposable personal income (DPI) increased more in the third quarter than in the second.

Wages and salary disbursements increased $50 billion, about the same as in the second quarter. Increases in each of the major private industry components were similar to those in the second quarter. Average hourly earnings were up somewhat more than in the second quarter; employment was up slightly less, and average weekly hours declined slightly after small increase. Government wages and salaries increased about the same in both quarters.

Farm proprietors' income declined $14-1/2 billion, following a decline of $1-1/2 billion in the second quarter. The dropoff was accounted for by Federal agricultural subsidies, which fell from $14 billion in the second quarter to $1 billion in the third. The pattern in subsidies reflected the completion in the second quarter of deficiency and diversion payments made to farmers under the 1988 Acreage Reduction Program. Farm income excluding subsidies declined in both quarters-$1-1/2 billion in the third and $3-1/2 billion in the second. These declines were attributable to the falloff in production; price increases for farm products, particularly crops, offset most of the effect of this falloff in both quarters. The effect of the drought on farm income is difficult to determine; the drougbt reduced output but, presumably, was at least partly responsible for the increases in prices.

Personal interest income was up $15-1/2 billion, the third consecutive quarter of progressively larger increases. The third-quarter increase reflected increases in both interest rates and asset holdings by persons.

Increases in other labor income, nonfarm proprietors' income, transfer payments, and personal dividend income were roughly similar to those in the second quarter. Rental income increased after a decline. Personal contributions for social insurance, which aresubtracted in deriving the personal income total, increased about the same in both quarters.

Personal tax and nontax payments decreased $14 billion, following a $25 billion increase in the second quarter. The sharp downswing reflected the effects of the Tax Reform Act of 1986. Largely through lower withholdings for Federal income taxes, the act led to reduced taxes in 1988, but by varying amounts in each quarter ($33 billion in the first, $20-1/2 billion in the second, and $46 billion in the third). The quarterly fluctuations reflected the act's effect on Federal nonwithheld taxes (mainly declarations and net settlements). Net settlements dropped sharply after a large increase in the second quarter; the second-quarter increase had resulted from payments on income tbat had been shifted from 1986 to 1987 to take advantage of lower tax rates.

Reflecting the downswing in personal tax and nontax payments, DPI increased $77-1/2 billion, or 9-1/2 percent, in the third quarter, compared with $46 billion, or 5-1/2 percent, in the second. Real DPI increased 41/2 percent after no change, as the acceleration in DPI was augmented by the slowdown in PCE prices.

Personal outlays increased about the same in both quarters, so the acceleration in current-dollar DPI carried tbrough to personal saving. Personal saving increased $12-1/2 billion after a $22 billion decline; the personal saving rate increased 0.3 percentage point to 4.0 percent.

Looking Ahead. . .

* NIPA Methodology. The fifth in BEA's series of methodology papers has been completed and will be available soon. The paper, Government Transactions, describes the source data and estimating methods for the Federal and the State and local government estimates. Order information will appear in an upcoming issue of the SURVEY.

* Pollution Abatement Expenditures. Plant and equipment expenditures for pollution abatement for 1987 will appear in the November SURVEY.

* Local Area Estimates. Estimates of total wage and salary disbursements and total wage and salary employment for 1987 for counties and metropolitan areas will be available in December.

* Input-Output Accounts. The 1983 annual input-output tables will be presented in a forthcoming issue of the SURVEY. The annual accounts are prepared using basically the same procedures as used in the 1977 benchmark tables, but with less comprehensive and less reliable source data.

NoTE.-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 advance 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; for government purchases of goods and services, Federal 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 through September, the Producer Price Index through September, the unit-value index for petroleum imports for July and August, and unit-value indexes for exports and nonpetroleum imports for July. Some of the source data are subject to revision.
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Title Annotation:third quarter of 1988
Publication:Survey of Current Business
Date:Oct 1, 1988
Words:3246
Previous Article:Constant-dollar inventories, sales, and inventory-sales ratios for manufacturing and trade: revised estimates, 1985:I=1988:II.
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