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The business situation.

the BUSINESS SITUATION

REAL GNP, a measure of U.S. production, increased at an annual rate of 2 1/2 percent in the third quarter, the same rate registered in the second (chart 1 and table 1). Although U.S. production increased at the same rate in the third quarter as in the second, two measures of U.S. demand--gross domestic purchases and final sales to domestic purchasers--increased considerably more than in the second quarter, reflecting a sharp drop in net exports. Prices increased less in the third quarter than in the second--3 percent for the GNP price index (following an increase of 5 percent) and 2 1/2 percent for the price index for gross domestic purchases (following an increase of 5 1/2 percent).(1)

The effect of Hurricane Hugo.--Despite the devastation caused by Hurricane Hugo when it battered South Carolina and North Carolina late in September, the storm did not have significant quantifiable effects on the size or composition of third-quarter GNP measured as the sum of expenditures. Personal consumption expenditures, investment, and government purchases may have been affected, but the impacts cannot be quantified from the source data BEA uses to estimate these components. Similarly, in the fourth quarter most of the increased expenditures associated with recovery from the storm will not be quantifiable.

The storm did have significant quantifiable effects on the composition, but not the size, of GNP measured as the sum of incomes. On the income side, GNP is the sum of

* Capital consumption allowances

with capital consumption

adjustment, including accidental

damage to structures and equipment,

* Certain nonfactor charges, such as

indirect business taxes, and

* National income--factor charges

(that is, employee compensation,

profits, proprietors' income, rent,

and interest) net of capital

consumption.

Storm-related accidental damage to structures and equipment increased capital consumption and reduced factor charges. GNP was unaffected because, in the estimates, the increase in capital consumption was offset by the reduction in factor charges.

BEA estimates the storm-related damage to structures and equipment at $13 1/2 billion in constant dollars and $16 billion in current dollars (annual rates). These estimates are based on preliminary information from an insurance industry trade association and from the Federal Emergency Management Administration. The estimates reflect adjustments--based on historical relationships and news reports--to exclude damage to personal property and to include damage not covered by insurance.

These very rough estimates cover only damage to structures and equipment owned by businesses (including damage to owner-occupied residences).(2) Note, in particular, that damage to structures owned by governments (such as roads and bridges) is excluded because those structures are treated as purchases on current account and are, therefore, not capitalized. (Damage to government-owned structures will also be excluded when BEA prepares estimates of the effect of the earthquake that struck northern California in mid-October.)

Net national product (NNP), another measure of production, is GNP less capital consumption. NNP was affected by the hurricane because NNP reflects only the reduction in factor charges. Real NNP increased 1/2 percent in the third quarter but would have increased about 2 percent were it not for the hurricane. Comparison of the $6 1/2 billion increase in real NNP with the $25 1/2 billion increase in real GNP implies that about $19 billion (or 75 percent) of the GNP increase merely offset capital consumption (both accidental damage and the normal using-up of capital in production).

Three types of factor charges were affected: Rental income of persons, proprietors' income, and corporate profits. These incomes are not available in constant dollars in the national income and product accounts; the estimates reported in the following paragraphs are in current dollars and are expressed at annual rates.

The difference between capital consumption attributable to accidental damage, on the one hand, and insurance benefits, on the other, reduced rental income of persons about $3 ` billion, proprietors' income about $1/2 billion, and corporate profits about $1 1/2 billion. In addition, benefits paid by insurance companies reduced their profits by $12 billion for a total effect on corporate profits of $13 1/2 billion.

The reductions in rental income of persons and in proprietors' income, together with about $1/2 billion in wages and salaries lost because of the storm, caused personal income to be roughly $4 billion lower than it would have been if the hurricane had not struck. Estimates of the level of national income that reflect the effects of the hurricane will be released next month when source data for corporate profits become available.

Components of Real GNP

Although real GNP increased at the same rate in the third quarter as in the second, among the major components of GNP, only fixed investment registered roughly similar changes in the two quarters. Personal consumption expenditures and inventory investment, which had added a total of $7 billion to the second-quarter change in GNP, added $48 1/2 billion to the third-quarter change. Net exports and government purchases, which had added a total of $14 1/2 billion in the second quarter, subtracted $27 1/2 billion from the third-quarter change.

Personal consumption expenditures

Real personal consumption expenditures (PCE) increased 6 percent in the third quarter, after increasing 2 percent in the second (table 2). (The third-quarter increase was the largest since the first quarter of 1988, when PCE also increased 6 percent.) All three major components contributed to the acceleration. Durables increased much more sharply than in the second quarter; nondurables increased after a second-quarter decline; and services increased slightly more than in the second quarter.

The third-quarter strength in PCE was consistent with most factors usually associated with consumer spending. Real disposable personal income increased 4 percent or more in three of the past four quarters. Consumer confidence (as measured by the Index of Consumer Sentiment prepared by the University of Michigan's SURVEY Research Center) increased in the third quarter after declining in the second. The inflation rate slowed, and the unemployment rate remained very low.

Expenditures for durable goods increased 15 percent in the third quarter after increasing 5 1/2 percent in the second. Most of the third-quarter step-up was in new cars, which increased sharply after a small increase. Consumers' purchases of trucks and recreational vehicles increased sharply in the third quarter after declining in the second. Both car and truck purchases were stimulated by sales incentive programs offered by nearly all domestic (and many foreign) manufacturers. The programs--among the most attractive in 3 years--provided rebates or below-market financing on nearly all 1989 models.

Expenditures for nondurable goods increased 4 percent in the third quarter after declining 2 1/2 percent in the second. Clothing and shoes increased sharply, following a small increase; the third-quarter increase may reflect, in part, consumers' reactions to a downswing in prices. Food rebounded after an abnormally steep decline in the second quarter.

Expenditures for services increased a little more than 4 percent in the third quarter after increasing a little less than 4 percent in the second. Transportation and "other services" increased more in the third quarter than in the second; the third-quarter acceleration in transportation reflected, in part, enhanced discounts on airline tickets. A decline in household operation was more than accounted for by electricity and gas, reflecting the cooler-than-normal summer weather that limited the need for air-conditioning.

Nonresidential fixed investment

Real nonresidential fixed investment increased 5 1/2 percent in the third quarter, following an 8 1/2-percent increase in the second (table 3). Structures and producers' durable equipment (PDE) both contributed to the third-quarter increase. Structures increased 6 percent after declining 9 1/2 percent, and PDE increased 5 percent after increasing 15 percent.

Almost three-fourths of the increase in structures was accounted for by oil well drilling; despite the increase, however, oil well drilling remained very low. Construction of commercial buildings, which had accounted for most of the second-quarter decline in structures, changed little. In PDE, industrial equipment rebounded from a second-quarter decline and accounted for about one-half of the third-quarter increase; information processing equipment and transportation equipment both registered only small increases in the third quarter after substantial increases in the second.

Many factors point to restrained capital spending in the near future: Corporate profits and cash flow were weak in the first half of the year; increases in real final sales (excluding inventory transactions of the Commodity Credit Corporation) have been modest; capacity utilization in manufacturing, although still rather high, edged down in the second and third quarters; and contracts and orders for plant and equipment, as well as manufacturers' new orders for nondefense capital goods, have been flat since late in 1988. Interest rates are one of the few factors pointing in the other direction: The yield on new issues of high-grade corporate bonds dropped almost 1 percentage point from the first to the third quarter.

Residential investment

Real residential investment declined 5 percent in the third quarter, following a 12 1/2-percent decline in the second. Both single-family and multifamily construction declined in the third quarter; the "other" component (which includes additions and alterations, major replacements, mobile home sales, and brokers' commissions on sales of residences) increased.

Single-family construction declined 12 percent in the third quarter, following a much sharper decline in the second. A second-quarter drop of 77,000 (seasonally adjusted annual rate) in starts of single-family units affected single-family construction put in place in both the second and third quarters (chart 2). Multifamily construction declined 8 percent in the third quarter after four consecutive quarters of small increases; the third-quarter slippage occurred despite a declining rental vacancy rate. (The rental vacancy rate was 7.3 percent in the third quarter of 1989, compared with 7.8 percent in the third quarter of 1988.)

The 5 1/2-percent increase in the "other" component was largely accounted for by an increase in brokers' commissions. Sales of new and existing houses increased 160,000 (seasonally adjusted annual rate) in the third quarter as mortgage interest rates declined (chart 3).

Inventory investment

Real inventory investment--that is, the change in business inventories--increased $11 billion in the third quarter, as businesses added $30 billion to their inventories after adding $19 billion in the second quarter (table 4). In contrast, inventory investment had decreased $5 1/2 billion in the second quarter. The upswing in inventory investment was largely in farm inventories.

Farm inventories increased $5 1/2 billion in the third quarter, following a $1/2 billion decrease in the second. These changes--which occurred in the context of rising market sales by farmers and continued weakness in farm output--largely reflected the pattern of transactions with the Commodity Credit Corporation (CCC) under the commodity loan program. In the second quarter, a swing in transactions with the CCC from net withdrawals to net placements and the increase in market sales both led to a downswing in inventories held by farmers. In the third quarter, when net withdrawals of crops from CCC inventories resumed, both market sales and inventories held by farmers increased.

Nonfarm inventories increased $24 1/2 billion in the third quarter, following a $19 1/2 billion increase in the second. The step-up was accounted for by manufacturing and wholesale trade inventories; a downswing in retail trade inventories was more than accounted for by auto dealers. Nonfarm inventories excluding those held by auto dealers were up $36 billion in the third quarter, considerably more than in the second.

The accumulation in manufacturing inventories jumped to $18 1/2 billion in the third quarter from $8 1/2 billion in the second. Inventories of durable goods accounted for two-thirds of the third-quarter accumulation; the largest accumulation was in transportation equipment, although inventories of fabricated metals and electrical machinery also registered sizable increases. Inventories of nondurable goods increased substantially for the second quarter in a row. The two-quarter accumulations were widespread; the largest were in chemicals and allied products, petroleum and coal products, and "other" nondurable goods.

Wholesale trade inventories increased more in the third quarter than in the second. Inventories of merchant wholesalers of durable goods--primarily of machinery, equipment, and supplies--were up strongly in both quarters. Inventories of merchant wholesalers of nondurable goods changed little after a decline.

Retail trade inventories decreased in the third quarter after increasing in the second. Auto dealers' inventories fell $11 1/2 billion after decreasing $3 billion; the third-quarter liquidation came about as a result of the more attractive sales incentive programs discussed earlier. Other retail inventories were up about the same amount in the third quarter as in the second.

Reflecting the third-quarter changes in inventories and in final sales by business, the constant-dollar ratio of total inventories to total final sales edged up to 3.05. The ratio has been in the range of 3.04 to 3.07 since the first quarter of 1988; these ratios are below those registered at any time in the past 20 years.

Net exports

Real net exports declined $23 billion in the third quarter, following a $4 billion increase in the second (table 5). Merchandise imports increased sharply and, together with a small rise in imports of services, fully accounted for the third-quarter movement; a modest increase in merchandise exports was offset by a decline in exports of services.

Merchandise exports increased $4 billion (or 4 1/2 percent) in the third quarter after increasing $14 1/2 billion (or 16 1/2 percent) in the second. Agricultural exports declined; nonagricultural exports increased, but only about one-half as much as in the second quarter, and at the lowest rate since the second quarter of 1988. Weakness was evident in all major end-use categories other than capital goods (except autos), which increased $7 1/2 billion.

Merchandise imports increased $22 billion (or 19 1/2 percent) in the third quarter after increasing $10 billion (or 8 1/2 percent) in the second. Both petroleum and nonpetroleum imports contributed to the third-quarter increase. Within nonpetroleum imports, capital goods (except autos) registered the largest increase; all other end-use categories registered modest increases except for autos and "other," both of which declined slightly.

Exports of services declined $4 billion after a $3 1/2 billion increase, and imports of services increased $1 billion after a $4 billion increase. In both cases, the movements were dominated by downswings in investment incomes that reflected declining interest rates.

Government purchases

Real government purchases decreased $4 1/2 billion (or 2 1/2 percent) in the third quarter, following an increase of $10 1/2 billion (or 5 1/2 percent) in the second (table 6). The turnabout reflected the pattern of change in inventories of farm products held by the CCC. Both Federal defense purchases and State and local government purchases increased slightly more in the third quarter than in the second.

The level of inventories held by the CCC decreased $7 billion in the third quarter, largely reflecting net withdrawal of crops--mainly cotton and wheat--under the commodity loan program.

Federal defense purchases increased $2 1/2 billion in the third quarter, somewhat more than in the second. The third-quarter increase was spread across all types of defense purchases other than nondurables. Nondefense purchases excluding CCC inventory transactions changed little after increasing slightly.

Within State and local government purchases, structures changed little in the third quarter, following a decline in the second. Purchases other than structures increased at the same rate as in the second quarter.

Prices

Inflation slowed in the third quarter, following several quarters in which price increases had been in the range of 4 1/2 to 5 1/2 percent. GNP prices were up 3 percent after a 5-percent increase in the second quarter, and gross domestic purchases prices were up 2 1/2 percent after a 5 1/2-percent increase (table 7). The slowdown was most evident in PCE prices, especially in food and energy prices.

PCE prices increased 2 1/2 percent in the third quarter, following a 6 1/2-percent increase in the second. Food prices slowed sharply, to a 2 1/2-percent increase. The slowdown was largely in meat prices, where increases moderated after substantial gains in the two preceding quarters; also, prices of fresh fruits and vegetables increased moderately after a sizable increase. Energy prices declined 9 percent after surging 31 1/2 percent. The sharp movements were largely traceable to prices of gasoline and oil; prices of electricity and gas registered a small decline in the third quarter after little change in the second. The increase in "other" PCE prices slowed for the third consecutive quarter; the third-quarter slowdown was largely due to a sharp downswing in prices of clothing and shoes. Prices of nonenergy services, which account for nearly one-half of PCE, increased 4 1/2 percent in the third quarter after increasing 4 percent in the second.

Among other components of final sales, prices of nonresidential fixed investment again increased 3 percent, as prices of both structures and PDE increased at about the same rate in the third quarter as in the second. Prices of residential structures were up somewhat less than in the second quarter, and prices of government purchases increased at the same rate in both quarters.

Prices of exports and imports both declined after increases in the second quarter. A sharp downswing in prices of merchandise imports, following two quarters of substantial increases, was traceable to petroleum. Petroleum prices, which had jumped 114 percent in the first quarter and 99 1/2 percent in the second, dropped 29 percent in the third. Prices of "other" merchandise imports declined 3 percent in the third quarter, following a similar decline in the second. The two-quarter dropoff in these prices included all of the major end-use categories of imports except for consumer goods.

Personal Income

Personal income increased $56 billion in the third quarter, following an $82 1/2 billion increase in the second (chart 4 and table 8). Personal interest income and farm proprietors' income were responsible for much of the deceleration, but nearly all of the major components contributed. Reflecting a swing from a large increase to a small decrease in personal tax and nontax payments, disposable personal income increased more in the third quarter than in the second.

Wage and salary disbursements were up $44 1/2 billion in the third quarter, $3 1/2 billion less than in the second. Among the major private industry components, wages and salaries in the distributive industries were up $3 billion less than in the second quarter; about one-half of this deceleration was accounted for by strikes in the telecommunications industry.

Farm proprietors' income decreased $14 billion in the third quarter, following a decrease of $7 1/2 billion in the second. Federal agricultural subsidies declined in both quarters--$8 billion in the third, $4 1/2 billion in the second. Farm income excluding subsidies also declined in both quarters--$6 billion in the third, $3 billion in the second. The third-quarter decline in farm income excluding subsidies was largely due to lower crop prices; the second-quarter drop had reflected lower farm production.

Personal interest income increased $14 billion in the third quarter, substantially less than in the past several quarters. The slowdown reflected declines in interest rates.

Rental income of persons declined $5 billion, the fourth consecutive quarterly drop. As noted earlier, rental income was reduced about $3 billion by Hurricane Hugo. Among the remaining components of personal income, increases in other labor income, personal dividend income, and nonfarm proprietors' income were similar to those in the second quarter. Transfer payments increased $8 1/2 billion in the third quarter, somewhat less than in the second. Personal contributions for social insurance, which are subtracted in deriving the personal income total, increased about the same in both quarters.

Personal tax and nontax payments decreased $6 billion in the third quarter, following a $24 1/2 billion increase in the second. The downswing mainly reflected the effects of the Tax Reform Act of 1986: Net settlements dropped sharply in the third quarter after a substantial second-quarter increase that was related to payments on income that had been deferred from earlier periods.

Disposable personal income (DPI) increased $62 billion (or 7 percent) in the third quarter, compared with a $58 billion (or 6 1/2-percent) increase in the second. Real DPI increased 5 percent, following an increase of 1 percent, as the modest acceleration in current-dollar DPI was augmented by the sharp slowdown in PCE prices.

Personal outlays--largely PCE--increased almost $67 billion in the third quarter, $3 1/2 billion more than in the second. The larger increase in outlays than in current-dollar DPI led to a $4 1/2 billion decrease in personal saving. The personal saving rate declined 0.3 percentage point to 5.1 percent in the third quarter. [Chart 1 to 4 Omitted] [Tabular Data 1 to 8 Omitted]

(1)The regularly featured estimates of real GNP and GNP prices are based on 1982 weights. An alternative measure of price change that uses more current weights--the chain price index--is published in table 8.1 of the "Selected NIPA Tables." The GNP chain price index, which increased 3 percent in the third quarter after a 5-percent increase in the second, can be used to calculate an alternative measure of real GNP growth based on more current weights; this measure increased at annual rates of 3 percent in the third quarter and 2 percent in the second. Growth of real GNP in 1987 dollars, another measure based on more current weights, will be published in the "Reconciliation and Other Special Tables" in the November SURVEY OF CURRENT BUSINESS. (2)Damage to personal property is reflected in reduced personal consumption expenditures to the extent that insurance benefits cover the damage. Specifically, personal consumption expenditures for casualty insurance are estimated on a net basis--premiums minus benefits--so increased benefits reduce personal consumption expenditures. In the context of current-dollar personal consumption expenditures in the neighborhood of $3 1/2 trillion, this effect was negligible in the case of Hurricane Hugo. Note that to the extent that damaged personal property is not insured, there is no effect on personal consumption expenditures or on GNP.
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Title Annotation:third quarter of 1989
Publication:Survey of Current Business
Date:Oct 1, 1989
Words:3690
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