April 30, 2008 (GDP Byte)
by Dean Baker
"A rising savings rate will slow growth for the rest of the year."
GDP eked out a 0.6 percent gain for the second consecutive quarter as a jump in inventories and defense spending kept GDP in positive territory. Sales of final goods actually fell by 0.2 percent in the quarter, only the second decline since the last recession. The 0.6 average growth rate for the last two quarters is the lowest two-quarter rate since the 0.1 percent average growth rate for the 3rd and 4th quarters of 2001.
There are very few bright spots in this quarter’s data. Consumption grew at just a 1.0 percent annual rate, with consumption of durable goods declining by 6.1 percent and consumption of non-durables falling at a 1.3 percent annual rate. Consumption of services grew at a healthy 3.4 percent rate, but even this increase was largely driven by expenses over which people have little control. Increases in medical care, housing (largely imputed rent on owner occupied housing), and utilities accounted for almost two-thirds of the rise in service consumption, with most of the rest contributed by the “other” category. This category is dominated by personal business items like bank services and life insurance. In other words, consumers are cutting back in the areas where they have control over their spending. It is worth noting that the savings rate, at 0.2 percent, still remains very low. The slowdown in consumption thus far is the result of slower income growth, not increased saving.
Residential investment continues to be a drag on the economy, falling at a 26.7 percent annual rate and subtracting 1.23 percentage points from GDP for the quarter. Residential investment is now down by 34.3 percent from its peak in the 4th quarter of 2005. It is likely to fall further in the second quarter, but after that it is likely to level off for the rest of the year.
Non-residential investment also turned negative in the quarter. Equipment investment fell at a 0.7 percent annual rate, while structure investment fell at a 6.2 percent rate. A boom in non-residential structures had been providing a boost to the economy over the last two years as the housing bubble collapsed. It now appears that this boom has ended and non-residential structures will be a drag on the economy at least through the year.
Net exports were a small positive for the economy in the quarter, adding 0.22 percentage points to growth. A 5.5 percent growth rate for exports slightly outweighed the negative impact of a 2.5 percent growth rate for imports. Net exports are likely to be a larger source for growth for the economy in future quarters, although they probably will not add as much as the 1.24 percentage point average for the last three quarters of 2007.
A 6.0 percent jump in defense spending drove a 4.6 percent rise in federal spending. Defense spending is erratic and the increase will likely be at least partly reversed in future quarters. More importantly, growth in state and local government spending slipped to 0.5 percent. With budgets tightening, growth in this sector, which accounts for 12.7 percent of GDP, is likely to be very slow going forward.
There continues to be modest inflation, although mostly in the non-core components. The overall GDP price index rose at a 2.6 percent annual rate, roughly the same as the 2.7 percent rate for 2007. Excluding food and energy, the index rose at just a 2.0 percent rate, down from a 2.4 percent rate for 2007. However, with productivity growth likely coming in at less than 2.0 percent for the quarter, the possibility remains that food and energy costs will start to get passed on in higher core inflation.
It seems likely that growth will turn negative in the second quarter and at least remain weak for the rest of the year. The inventory build-up of the current quarter is likely to be reversed and consumption growth is likely to slow further under the pressure of job loss, declining real wages and plunging home values. With investment and state and local spending also acting as a drag, GDP is likely to fall in the next two quarters.
Dean Baker is the Co-director of the Center for Economic and Policy Research. CEPR’s GDP Byte is published quarterly upon release of the Bureau of Economic Analysis' report on the Gross Domestic Product.