FROM THE OFFICE OF PUBLIC AFFAIRS
For the Treasury Borrowing Advisory Committee of the Bond Market Association
The three months since the previous meeting of the Advisory Committee saw the economy continue to grow at a lively pace. The strong gains in real GDP that we experienced in the last two quarters of 2003 extended into the first quarter, with GDP rising at a 4.2 percent annual rate. The 5.5 percent average pace in the latest three quarters was the largest since 1984. With the assistance of tax cuts, growth has become self-sustaining. It is also more balanced than earlier in the recovery, with numerous supports providing a strong platform for continued economic momentum going forward.
Business investment in equipment and software posted its third straight double-digit increase in the first quarter, rising at an 11.5 percent rate. Demand for capital goods continues to be supported by the expensing provisions of the stimulus legislation of the past two years, as well as the renewed strength in corporate profits in recent quarters. Corporate profits in economic terms (from current production, as measured in the GDP accounts) were almost 30 percent higher at the end of last year than a year earlier, and the profit margin (profits in relation to gross domestic income) hit a 6-year high, in large part because sizable gains in productivity are holding down unit costs. Increased inventory building also added to growth in each of the past two quarters, although by only a small amount in the first quarter. Inventory-sales ratios are extremely low by any measure, suggesting that future sales increases will have to be met through additional production rather than by drawing down already-low stocks. In addition, as business confidence in the durability of aggregate demand strengthens further, inventory investment should be a positive influence on real growth in coming quarters. The resumption of inventory accumulation and strong demand for investment and consumer goods has already led to increased production, with manufacturing output rising at approximately a 6 percent annual rate in each of the past two quarters.
Rising profits and investment, as well as renewed optimism, spurred businesses to hire additional workers. After modest gains in the prior six months, employment roared back in March with a 308,000 surge in the number of payroll jobs. Combined with sizable upward revisions to the figures for January and February, that brought total job growth to 759,000 over the past seven months. Other indicators of labor market activity are also showing signs of strength. For example, initial unemployment insurance claims are in a range that is consistent with job growth, corporate layoff announcements as measured by the job placement firm Challenger, Gray and Christmas diminished, and the purchasing managers’ indexes for both manufacturing and non-manufacturing are signaling job growth.
Renewed job gains have already led to improved growth of aggregate wages and salaries. Combined with lower taxes, this helped boost growth of disposable personal income (DPI) to a 4.3 percent annual rate in the first quarter in real terms and by 4.1 percent over the past year, representing the largest 4-quarter increase in real DPI in almost two years. Strength in income has supported personal spending. Led by increased purchases of services and nondurable goods such as apparel, real personal consumption expenditures accelerated from a 3.2 percent pace in the fourth quarter to 3.8 percent in the first, despite reduced expenditures on motor vehicles. Stronger job and wage growth should provide a solid impetus to consumption in coming quarters.
The housing market also provided a lift to the economy in the first quarter. New home sales hit a record 1.2 million unit annual rate in March, as performance continues to surprise on the upside. Mortgage rates came down in the last two quarters which helped spur home sales, though rates crept up in April. Strong underlying fundamentals have supported the high level of housing demand, including favorable demographic trends, greater levels of affordability due to rising after-tax incomes, innovations in housing finance that expanded the market to more creditors without compromising credit quality, and the low interest rates. These factors have helped push the homeownership rate to a record 68.6 percent in the last two quarters.
Exports posted a third straight quarterly increase in the first quarter, though the pace slowed substantially. Exports grew at a 3.2 percent annual rate compared to an outsized gain of more than 20 percent in the previous quarter. Imports rose as well but the changes were offsetting, leaving the net export trade deficit virtually unchanged at $514.6 billion in real (2000 $) terms.
Inflation remains generally subdued with the exception of energy prices and prices of selected commodities at the earliest stages of processing, such as lumber and metals. The price index for core personal consumption expenditures (excluding food and energy), probably the best barometer of underlying inflation trends, rose 2.0 percent at an annual rate in the first quarter but was up just 1.3 percent over the past year. Special factors can cause inflation to move around from quarter to quarter but the underlying fundamentals suggest that it will remain benign for some time to come. Excess capacity in both product and labor markets, along with strong productivity growth, indicates that prices should remain well contained.
The U.S. economy is poised for a continuation of solid growth in real GDP through the rest of the year and into 2005. Productivity, corporate profits and investment are expected to maintain strong rates of growth, and consumption will also be supported by rising employment and income.