(Archived Content)
When you were here three months ago, the economy had completed a strong first quarter and seemed poised for further growth. It was recognized at the time that there had been a boost early in the year from unseasonably mild winter weather. For that and other reasons, it was widely anticipated that growth would be slower in the second quarter. The results are in now and that did prove to be the case. Growth slowed from a revised 5.5 percent annual rate in the first quarter to 1.4 percent in the second -- a drop of about 4 percentage points.
That, in itself, may seem like quite a sizable move. But there was a phase during which an even larger decline was projected by many economists with growth expected to turn negative in the second quarter. Fortunately, we have been spared the potentially adverse effects on confidence that even a transitory negative quarter might have triggered. The fact of the matter is that the economy was strong in both the first and second quarters. If the economy was strong, how could growth fall by 4 percentage points? Since the now-settled GM strike cut from « to 1 full percentage point from the second quarter, the net decline might be taken as 3-1/2 percent or a little less.
Domestic final sales (the bulk of GDP) grew about as rapidly in the second quarter as in the first -- over 6 percent annual rate increases in real terms in both quarters. What about Asia and foreign demand generally? That was an area of weakness. But net exports subtracted somewhat more than 2 percentage points in both the first and second quarters, dampening activity throughout. Hence, in a narrow arithmetic sense, this would not be a part of the 3-1/2 percent drop in growth. Instead, it was a swing in inventory investment which accounts for the entire 3-1/2 percent. The change in business inventories added 1.2 percentage points in real terms to growth in the first quarter when inventories rose by more than $90 billion, but subtracted 2.3 percentage points in the second quarter when inventories rose by nearly $45 billion -- about one-half as much.
When inventories are piling up because sales are slow, there is cause for concern. A sharp rise in inventory-sales ratios has been a clear sign of trouble in the past, sometimes signaling oncoming recession. But sales have not been slow this year, inventory-sales ratios generally remain at low levels by historical standards and business surveys do not suggest that inventories are regarded as excessive by those that hold them. It makes a world of difference whether inventory adjustments take place when aggregate demand is strong, as has been the case this year; or whether unsold goods pile up when demand is weak, which has not been the case this year.
In any event, a sizable inventory adjustment did take place in the second quarter. Domestic demand continued to run close to its first-quarter pace, while production grew much more slowly, with selective cutbacks taking place, some of which were undoubtedly attributable to the Asian situation. With strong demand and flatter production, the rate of inventory accumulation fell sharply and pulled down growth in GDP.
It seems questionable whether the macroeconomic situation has really changed very much in the first half of this year, despite the big difference in first and second quarter growth rates. The feel that one had from monitoring the flow of statistics from week to week and month to month was not that things ran at a 5-1/2 percent annual rate part of the way and then dropped sharply to 1-1/2 percent. There seemed to be much more consistency in the way the economy performed. This may be a case in which the first half rate of growth gives a better picture of what was happening than either of its quarterly components.
It is a striking feature of recent economic performance that the economy could grow at a 3-1/2 percent annual rate in the first half of the year while extending its record of good inflation performance.
- The chain-weighted GDP price index (one of the broadest measures of inflation) rose at a little under a 1 percent annual rate in the first half of this year, down from about 1-3/4 percent during all of last year. (Recent GDP revisions introduced some technical changes in the indexes which slightly lowered these readings.)
- The consumer price index rose at a 1.4 percent annual rate in the first half of this year, down from a rise of 1.7 percent during all of last year. The core CPI, which excludes food and energy components, shows some acceleration, rising at a 2.5 percent annual rate, compared to 2.2 percent during all of last year.
- The employment cost index, released last week, also showed some acceleration. It rose 3.5 percent over the year ended in June, up from 2.8 percent a year earlier, and the biggest increase in 4-1/2 years. Wage growth accelerated from 3.2 percent to 3.8 percent, and benefits from 2.0 percent to 2.4 percent. Even so, the combination of productivity developments with these compensation costs can be taken to suggest little increase in inflationary pressure. Over the year ended in the first quarter, private nonfarm productivity growth was a rapid 2.1 percent, offsetting all but about 1-1/2 percentage points of the 3.5 percent increase in private industry compensation costs through the first quarter. It remains to be seen whether or not a similar productivity offset will persist in the future.
So, by and large, the economy did very well in the first half of the year. Real growth shaded down a little from about 3-3/4 percent last year to 3-1/2 percent in the first half of this year and might be expected to moderate somewhat further in the second half. Some key inflation rates actually edged lower in the first half and others showed only modest upward drift. The Asian situation continues to introduce an element of uncertainty into the economic outlook; but domestic considerations alone would seem to suggest a path of fairly steady expansion.
That is a summary of recent economic developments and the near term economic outlook.