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The business situation.

the BUSINESS SITUATION

U.S. economic activity picked up somewhat and inflation picked up considerably in the first quarter of 1990 (chart 1).

* Real GNP, a measure of U.S. production, increased at an annual rate of 2 percent after increasing 1 percent in the fourth quarter of 1989.

* Real gross domestic purchases, a measure of U.S. demand, increased at an annual rate of 1 1/2 percent after little change.

* The GNP price index increased at an annual rate of 6 1/2 percent after increasing 3 1/2 percent; the price index for gross domestic purchases stepped up the same amount, to 7 percent from 4 percent.

Inflation in the first quarter was at its highest rate in 8 years. About one-half of the step-up in the inflation rate was accounted for by energy and food prices, both of which were affected by severe cold weather in December. In January, gasoline and fuel oil prices spurted as suppliers rebuilt stocks that had been reduced in December, and vegetable prices spurted in response to weather-related reductions in supply.

In each of the last two quarters, steep declines in motor vehicle output - more than 20 percent in each quarter - subtracted about 1 percentage point from the growth rate of GNP (table 1). Several components of GNP were affected substantially by motor vehicles. Quarter-to-quarter movements in personal consumption expenditures, producers' durable equipment, and inventory investment (that is, change in business inventories) are markedly different when motor vehicles are excluded.(1) [Tabular Data Omitted]

Motor vehicles. - Motor vehicle output dropped $10 billion in the first quarter after falling $9 billion in the fourth; final sales of motor vehicles (including net sales to foreigners) jumped $14 billion after plummeting $25 1/2 billion. The further cut in production in the first quarter despite the turnaround in sales reflected a continuing effort by manufacturers to reduce inventories.

Early in the fourth quarter, sales-incentive programs were scaled back at the same time that new car prices were raised substantially with the introduction of 1990 models; domestic car sales dropped sharply - to 6.2 million units (seasonally adjusted annual rate), the lowest level since the first quarter of 1983. Thus, although fourth-quarter production was cut to 6.5 million, inventories climbed to 1.7 million, and the inventory-sales ratio jumped to 3.3 - far above the industry target of 2.4.

In the first quarter, manufacturers again enhanced incentive programs. In many cases, the programs were among the most attractive ever offered - covering popular models (such as minivans) that had never been covered before or guaranteeing buyers that they would receive additional benefits if even more attractive programs were introduced later in the model year, or both. First-quarter domestic car sales jumped to 7.0 million. In a related effort to reduce inventories, manufacturers slashed production to 5.5 million, the lowest level since the fourth quarter of 1982. (Production in January was less than two-thirds that in December, and, although production increased in February and March, it remained at low levels in both months.) As a result of the sharp cut in production and the large increase in sales, inventories fell to 1.4 million, and the inventory-sales ratio dropped to 2.4.

Foreign car sales - facing many of the same conditions that confronted domestic car sales - followed a pattern similar to, but not as extreme as, that of domestic car sales. Foreign car sales increased 0.2 million, to 2.8 million, in the first quarter after falling 0.3 million in the fourth.

Sales of new trucks increased in the first quarter after falling sharply in the fourth. Sales of light domestic trucks, many of which were also covered by the more attractive incentive programs, more than accounted for this increase; sales increased 0.3 million, to 4.1 million, in the first quarter after falling 0.8 million in the fourth. Sales of other domestic trucks were unchanged at 0.3 million, and sales of imported trucks declined to 0.4 million from 0.5 million. Truck inventories fell in the first quarter after increasing sharply in the fourth.

Components of Real GNP

The step-up in GNP growth in the first quarter was accounted for by a strengthening in final sales that was partly offset by a sharp cutback in inventory investment. Except for exports, all major components of final sales contributed to the step-up.

The fourth coldest December on record and the second warmest first quarter appears to have had substantial impacts on personal consumption expenditures (PCE) for heating and on construction of residential and nonresidential buildings and may have had an impact on other components of GNP.

Personal consumption expenditures

Real PCE increased 2 1/2 percent in the first quarter after increasing only 1/2 percent in the fourth (table 2). Expenditures for durable goods more than accounted for the first-quarter pickup and for the fourth-quarter slowdown. [Tabular Data Omitted]

Expenditures for durable goods jumped 17 percent in the first quarter after falling almost that much in the fourth. Consumer expenditures for new cars and trucks surged, largely in response to sales-incentive programs. Expenditures for furniture and household equipment, led by consumer electronics and appliances, also surged in the first quarter (after changing little in the fourth). Expenditures for "other" durables declined in the first quarter after increasing in the fourth.

Expenditures for nondurable goods declined 4 percent in the first quarter after changing little in the fourth. Expenditures for energy, food, and clothing and shoes each declined; expenditures for "other nondurables" increased. Expenditures for energy goods tumbled 26 percent after increasing 16 1/2 percent in the fourth quarter. Food expenditures declined about 2 1/2 percent in each quarter, reflecting, in part, consumer response to higher prices.

Expenditures for services increased 2 1/2 percent in the first quarter after increasing 6 percent in the fourth. The falloff primarily reflected a swing in expenditures for energy services, down 28 percent after increasing 24 1/2 percent; expenditures for transportation services and for "other" household operations also contributed.

In the first quarter, the major factors usually considered in analyses of consumer spending weakened a little for the second consecutive quarter. Real disposable personal income increased less than in the fourth quarter. (Over the past four quarters, real disposable personal income increased 2 1/2 percent, only about one-half the rate of increase over the preceeding four quarters.) Consumer confidence, as measured by the Index of Consumer Sentiment prepared by the University of Michigan's Survey Research Center, declined for the third time in four quarters; although it was 5 percent below the first-quarter 1989 level, it remained at a level that has historically been associated with a healthy economy. The unemployment rate changed little over the past year, and it remained low in the first quarter. Consumer prices, which accelerated sharply, were probably the biggest negative factor affecting consumer attitudes.

Nonresidential fixed investment

Real nonresidential fixed investment rebounded in the first quarter after declining in the fourth; both structures and producers' durable equipment (PDE) contributed to the upswing (table 3). [Tabular Data Omitted]

Structures increased 5 percent ($1 1/2 billion) after little change. Nonresidential buildings, which composes about two-thirds of total structures, increased $2 billion after a $1 1/2 billion decline; they more than accounted for both the first-quarter upswing in structures and the fourth-quarter downswing. The monthly pattern of nonresidential buildings suggests that the weather may have had a substantial impact. After hovering around $78 1/2 billion between August and November, nonresidential buildings dropped $5 billion in December (the largest monthly drop since March 1986) and then jumped $4 billion in January and another $4 billion in February.

PDE increased 8 percent in the first quarter after dropping almost that much in the fourth. The first-quarter increase was more than accounted for by transportation equipment and information processing equipment. In transportation equipment, purchases of both cars and trucks increased after sharp drops in the fourth quarter, and purchases of civilian aircraft rebounded from a fourth-quarter level that had been depressed by a strike at a major aircraft manufacturer. In information processing equipment, increased purchases of computers and of communication equipment more than offset small declines in purchases of scientific instruments and of photocopy equipment.

A Census Bureau survey in January and February found that businesses plan to increase expenditures for plant and equipment about 7 1/2 percent in 1990. Most of the other factors that are usually considered in assessing the outlook for investment spending point toward a more moderate increase: Corporate profits and cash flow have been weak since the end of 1988, increases in real final sales tended to be modest or nonexistent before the first-quarter strengthening, and the rate of capacity utilization in manufacturing has been edging down. Interest rates, one of the few factors that had been pointing capital spending upward, may have turned around; the yield on new issues of high-grade corporate bonds, which dropped almost 1 percentage point from the first to the fourth quarter of 1989, moved up in the first quarter of 1990. (It is not clear if the real interest rate also moved up in the first quarter.)

Residential investment

Real residential investment increased 8 1/2 percent in the first quarter after a small decline in the fourth. Single-family construction increased sharply after a small increase; multifamily construction registered a third consecutive decline of 15 percent or more. The "other" component of residential investment (which includes additions and alterations, major replacements, mobile home sales, and broker's commissions) declined after an increase.

Data on housing starts suggest that the weather played a major role in single-family construction in the first and fourth quarters (chart 2). During February-November 1989, starts fluctuated in the range of 0.969 to 1.029 million (seasonally adjusted annual rate), with an average monthly 42,000 and with the largest monthly change being an increase of 58,000 in July. In contrast, starts dropped 79,000 in December and then jumped 168,000 in January and another 55,000 in February. [c.sup.2] Starts of multifamily units do not present such a clear picture of the impact of the weather: These starts actually increased (albeit very slightly) in December before registering their largest change in 2 years. (A January surge in permits for multifamily units appears to have been a response to new Department of Housing and Urban Development regulations that mandate improved accessibility by the handicapped; units built under permits issued before January 13, 1990, and occupied by January 1, 1991, are not covered by the new regulations.)

The downswing in the "other" component of residential investment was attributable to a decline in brokers' commissions on house sales. Sales of new and existing residences declined 19 1/2 percent (seasonally adjusted annual rate) in the first quarter, perhaps reflecting more cautious mortgage lending practices and higher mortgage interest rates (chart 3).

Inventory investment

Real inventory investment - that is, change in business inventories - fell $19 1/2 billion in the first quarter, as businesses added only $2 1/2 billion to their inventories after adding $22 billion in the fourth quarter (table 4). The first-quarter dropoff in inventory investment was more than accounted for by the sharp downswing in inventories held by retail auto dealers, which plunged $21 1/2 billion after increasing $8 billion in the fourth quarter. [Tabular Data Omitted]

Nonfarm inventories excluding those held by auto dealers increased $19 billion in the first quarter, almost double the rate of accumulation in the fourth. The step-up was attributable to a substantial accumulation in manufacturing inventories after a runoff in the fourth quarter. Within manufacturing, inventories of durables registered the largest gain in more than a year; the first-quarter increase was widespread. Inventories of nondurables increased after a decline; the turnaround was partly accounted for by petroleum and coal products.

Wholesale trade inventories increased less than in the fourth quarter. A sharp downswing in inventories of merchant wholesalers was largely accounted for by groceries, farm products, and machinery, equipment, and supplies. Inventories of nonmerchant wholesalers increased after declining; the sizable changes in these inventories in the past two quarters were largely accounted for by inventories held in petroleum bulk stations and terminals.

Inventories of retailers other than auto dealers declined after three quarters of strong increases. The downswing was accounted for by nondurables, mainly food stores and department stores.

Farm inventories increased $5 billion, about the same amount as in the two preceding quarters. With farm output and market sales by farmers being roughly equal, the inventory accumulations were largely traceable to continued net withdrawals of crops from inventories held by the Commodity Credit Corporation under the commodity loan program.

Reflecting the lower rate of inventory accumulation and the pickup in final sales in the first quarter, the ratio of nonfarm business inventories to final sales of business moved down to 2.78, somewhat below the 2.80-to-2.82 range of the past 2 years.

Net exports

Real net exports increased $6 billion in the first quarter after increasing $10 billion in the fourth (table 5). A drop in imports accounted for most of the first-quarter increase; exports increased only a little. [Tabular Data Omitted]

Merchandise exports increased $8 1/2 billion (or 8 1/2 percent) in the first quarter, somewhat more than in the fourth; however, most of the first-quarter increase in merchandise exports was offset by a $7 billion drop in exports of services, largely in factor income. Agricultural exports increased a little less than in the fourth quarter, and nonagricultural exports increased somewhat more than in the fourth quarter. The increase in nonagricultural exports was more than accounted for by increased shipments of civilian aircraft after a strike-depressed fourth quarter.

Merchandise imports declined $5 1/2 billion (or 4 percent) in the first quarter after increasing $4 billion in the fourth; imports of services increased slightly. Petroleum imports increased substantially, as suppliers attempted to rebuild stocks, but nonpetroleum imports dropped sharply. Within nonpetroleum imports, consumer goods registered the largest decline, but most other major end-use categories also dropped.

Government purchases

Real government purchases increased $5 1/2 billion (or 3 percent) in the first quarter, a little more than in the fourth (table 6). Federal Government purchases increased after two quarters of decline, but State and local government purchases were up less than in the fourth quarter. [Tabular Data Omitted]

Federal defense purchases edged up in the first quarter after declining in the fourth. The fourth-quarter decline had been dominated by military hardware; in the first quarter, an increase in military hardware was largely offset by a drop in nondurables.

Within Federal nondefense purchases, a drawdown of Commodity Credit Corporation (CCC) inventories continued a pattern that began in the second quarter of 1987 and that was interrupted only in the second quarter of 1989. (Changes in the rate of decumulation led to the pattern of change shown in table 6 - up $2 billion in the fourth quarter and down $1/2 billion in the first.)

Federal nondefense purchases excluding CCC inventory transactions increased $2 1/2 billion in the first quarter after little change in the fourth. All components except structures contributed to the step-up.

State and local government purchases increased $4 billion in the first quarter after an unusually large increase in the fourth. Most of the slowdown was in structures.

Prices

Inflation picked up considerably in the first quarter after two quarters of moderate increases. The GNP price index (fixed weights) increased 6 1/2 percent after a 3 1/2-percent increase the price index for gross domestic purchases (fixed weights) increased 7 percent after a 4-percent increase (table 7).

About one-half of the first-quarter pickup in prices of gross domestic purchases was attributable to surges in food and energy prices, which, in turn, were partly related to the very cold December. (For many applications, the price index for gross domestic purchases, which measures prices paid for goods and services purchased in the United States, is preferable to the GNP price index as a measure of inflation.) A breakdown of gross domestic purchases into purchases of food, energy, and "other" shows that food prices increased 12 1/2 percent after increasing 4 1/2 percent and energy prices increased 17 1/2 percent after no change (addenda to table 7). Prices of "other" purchases picked up to a 5 1/2-percent increase from a 4-percent increase in the fourth quarter; a pay raise for Federal military and civilian employees contributed about 0.3 percentage point to the pickup. [Tabular Data Omitted]

Largely reflecting food and energy prices, the increase in PCE prices nearly doubled to 8 percent in the first quarter. PCE food prices accelerated as prices of vegetables soared following the bitterly cold weather in December that damaged crops; prices of meat and eggs increased substantially more than in the fourth quarter, and prices of poultry and fish swung up. PCE energy prices jumped after a decline. Sharp January increases in prices of gasoline and oil and of fuel oil and coal probably reflected the impact of the cold weather, as suppliers rebuilt stocks. Electricity and gas prices were up less in the first quarter than in the fourth. "Other" PCE prices increased a little more than in the fourth quarter. The pickup was mostly accounted for by women's clothing and motor vehicles.

Among the components of fixed investment, PDE prices increased 5 percent, somewhat more than in recent quarters; the step-up was widespread. Prices of nonresidential and residential structures increased at about the same rate as in the fourth quarter.

Prices of government purchases were up 6 1/2 percent, about twice as much as in the fourth quarter. More than one-half of the step-up was attributable to the Federal pay raise. (Such increases in employee compensation are treated in the national income and product accounts as an increase in the price of employee services purchased by the Federal Government.)

Prices of exports and imports both increased considerably more than in the fourth quarter. Prices of merchandise imports increased 11 percent after a 4-percent increase; petroleum prices accelerated to a 56 1/2-percent increase from a 23 1/2-percent increase, and prices of capital goods (except autos) jumped 11 percent after declining 1 percent.

Personal Income

Personal income jumped $99 1/2 billion in the first quarter after increasing $79 1/2 billion the fourth (chart 4). "Special factors" shown in table 8 added $22 billion to the first-quarter increase in personal income. Excluding special factors, proprietors' income was up much more than in the fourth quarter, and wage and salary disbursements, personal interest income, and transfer payments were up less than in the fourth quarter.

Wage and salary disbursements increased $44 billion, about the same as in the fourth quarter. Private wages and salaries increased somewhat less than in the fourth quarter, reflecting a slowdown in hourly earnings and a continued decline in average weekly hours. Government wages and salaries - boosted $4 billion by the pay raise for Federal employees - were up more than in the fourth quarter.

Farm proprietors' income increased $13 1/2 billion in the first quarter after increasing $2 1/2 billion in the fourth. Federal subsidies to farm proprietors increased in both quarters - $4 billion in the first quarter, $6 billion in the fourth. Deficiency payments - payments made when the market price of a crop is, or is projected to be, below the CCC target price - more than accounted for the first-quarter increase in subsidies. The fourth-quarter increase had been largely in Conservation Reserve Program payments and drought assistance payments. Farm income excluding subsidies jumped $9 1/2 billion in the first quarter after three consecutive quarters of decline; the turnabout largely reflected an upswing in farm prices.

Nonfarm proprietors' income increased $11 billion in the first quarter, substantially more than in recent quarters. The pickup largely reflected the jump in single-family construction (the part of the construction industry in which proprietorships and partnerships are concentrated) and a rebound from the fourth-quarter reduction (of roughly $1 1/2 billion, largely reflecting uninsured losses) caused by the Loma Prieta earthquake.

Rental income of persons increased $4 billion in the first quarter after five consecutive quarters of decline. The first-quarter increase reflected a rebound from a fourth-quarter reduction of roughly $6 billion caused by the earthquake.

Personal interest income increased somewhat less than in the fourth quarter, and increases in other labor income and personal dividend income were similar to those in the fourth quarter.

Transfer payments increased $21 1/2 billion in the first quarter, $8 billion more than in the fourth. The step-up was due to cost-of-living adjustments (effective in January) that added $14 1/2 billion to benefits paid under social security and several other Federal retirement and income support programs.

Personal contributions for social insurance, which are subtracted from the personal income total, increased $8 1/2 billion in the first quarter after a $3 billion increase in the fourth. Most of the first-quarter increase was due to an increase in social security tax rates for employees from 7.51 to 7.65 percent, an increase in the taxable wage base from $48,000 to $51,300, and rate and base changes in social security contributions paid by the self-employed. Contributions were reduced $2 billion as a result of the repeal of the major provisions of the Medicare Catastrophic Act of 1988.

Personal tax and nontax payments increased $9 1/2 billion in the first quarter after a $15 billion increase in the fourth. The first-quarter increase was restrained by an annual adjustment to the withholding tables for Federal income tax to reflect the indexing provisions of the tax law. (This adjustment accounts for the impact of the Tax Reform Act shown in table 8.) [Tabular Data Omitted]

The acceleration in personal income, combined with the deceleration in personal taxes, led to a pickup in disposable personal income (DPI). DPI increased $90 billion (or 9 1/2 percent) in the first quarter after a $64 1/2 billion increase in the fourth. The pickup in DPI did not carry through to real DPI because of the sharp acceleration in PCE prices. Real DPI increased 2 percent in the first quarter after increasing 2 1/2 percent in the fourth.

Personal outlays - largely PCE - accelerated in the first quarter. A larger increase in outlays than in current-dollar DPI led to a slight decline in personal saving in the first quarter. The personal saving rate declined 0.2 percentage point to 5.4 percent.

Corporate Profits and

Property Income in 1989

Profits from current production declined $27 1/2 billion in 1989, to $301 1/2 billion, after increasing $30 billion in 1988 (table 9). [Tabular Data Omitted]

Profits of domestic nonfinancial corporations dropped $23 billion in 1989 after increasing $24 1/2 billion in 1988. Costs rose, partly because of a slowing in productivity growth, but prices were not raised as much as costs, perhaps reflecting restraints imposed by foreign competition as a result of the appreciation of the dollar in foreign exchange markets.

Profits of domestic financial corporations dropped $8 1/2 billion after increasing $1/2 billion. About $3 billion of the drop reflected the effect of Hurricane Hugo and the Loma Prieta earthquake on insurance company profits. Another $1 billion or so of the drop reflected unusually large charges by commercial banks for bad debt, mainly in the fourth quarter. Most of the rest of the drop can be attributed to continuing problems in the savings and loan industry.

Profits from the rest of the world increased $4 billion after increasing $4 1/2 billion. Profits earned by from foreign affiliates of U.S. corporations increased $4 1/2 billion, reflecting strong economic growth abroad; profits earned by U.S. affiliates of foreign corporations, which are subtracted in calculating rest-of-the-world profits, increased only $1/2 billion.

Property income

Corporate property income - income accruing to investors - consists of net interest payments as well as profits. For domestic nonfinancial corporations, net interest payments increased $23 billion in 1989 after increasing $19 billion in 1988. (Net interest, like other components of the national income and product accounts, is subject to revision in July.)

Chart 5 and table 10 provide perspective on the recent increases in both types of property income generated by domestic nonfinancial corporations. In 1970-89, both types trended up, but the trend in net interest was substantially stronger (an average annual rate of increase of 11.4 percent, compared with an average annual rate of increase of 7.6 percent for profits). As a result, the share of net interest in property income rose from 23 1/2 percent in 1970 to 39 percent in 1989. It is also worth noting that profits showed more sensitivity to the business cycle than did net interest: Profits declined markedly in the recession years of 1974, 1980, and 1982 and in 1989, when economic growth slowed; net interest, in contrast, increased in each of these years. [Tabular Data Omitted]

The large increases in net interest in the past 3 years followed several years of relative flatness. The recent increases presumably reflect high levels of payments associated with leveraged buy-outs and merger activity.

Perspective on property income can also be gained by examining property income in relation to the net reproducible assets and domestic income of domestic nonfinancial corporations. The ratio of property income to the value of net reproductible assets is the rate of return on these assets - that is, the rate of return, or yield, on "capital." (Ideally, nonreproducible assets, such as land, would also be included in the denominator, but the lack of data prevents this.) Net reproducible assets consist of capital stock and inventories, both measured at replacement cost. A rate of return calculated in this way is an estimate of the profitability of new investment (assuming no change in the mix). The use of property income, rather than profits alone, as the numerator of this ratio reflects the assumption that a corporation's decision to invest in plant, equipment, and inventories depends on its estimate of the total income stream that will flow from that investment. Given that estimate, the decision on whether to finance the investment out of equity or debt - that is, whether the income stream will take the form of profits or of interest - is a separate question, one presumably determined by financial considerations. (Rates of return can be calculated in many other ways; several are discussed in some detail in the April 1989 SURVEY.)

The ratio of property income to domestic income is property income's share - that is, the fraction of domestic income that is not used to compensate labor. Property income's share is related to the rate of return by a third ratio - the ratio of domestic income to the value of net reproducible assets, which measures the average annual product per dollar of capital. (It should be noted that this ratio is not appropriate for use in productivity analysis; for productivity analysis, the denominator should measure capital services, not capital stock.)

All three ratios are plotted for 1970 - 89 in chart 6 and are reported, along with related ratios, for 1948 - 89 in table 11. From the table, it seems clear that shifts in the rate of return (column 1) and in property income's share (column 6) occurred around 1970. The rate of return fell from an average of 12.6 percent in 1948 - 69 to an average of 8.6 percent in 1970 - 89; the share fell from an average of 21.4 percent to an average of 16.5 percent. These declines are traceable to profits; net incterest's rate of return (column 5) and share (column 8) increased. The occurrence of the shifts at about the time that the ratios would be expected to fall for cyclical reasons complicates both the dating and the explanation of the shifts. [Tabular Data 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 increased at about the same rate as the GNP fixed-weighted price index in the last two quarters - 6 percent in the first quarter and 3 1/2 percent in the fourth.

The chain price index can be used to calculate an alternative measure of real GNP growth based on more current weights; this measure of GNP increased at annual rates of 1 1/2 percent in the first quarter and 1 percent in the fourth. 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 May Survey of Current Business.

(2.) In the national income and product accounts, most of the effect of single-family starts on single-family construction occurs in the 6 months following the start.
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Title Annotation:first quarter of 1990
Publication:Survey of Current Business
Date:Apr 1, 1990
Words:4847
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