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Inventories Lead to Jump in 4th Quarter GDP Growth

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January 29, 2010 (GDP Byte)

By Dean Baker

Net national income in the 3rd quarter was 0.3 percent below the level in the 2nd quarter of 2005.

GDP grew at a 5.7 percent annual rate in the fourth quarter, driven by a sharp decline in the rate at which firms are reducing their inventories. Taking out the effect of inventory fluctuations, final sales of domestic product increased at a 2.1 percent annual rate.

Among categories of final demand, the biggest standouts were exports, which grew at an 18.1 percent annual rate and equipment investment, which rose at a 13.3 percent rate. The surge in exports was entirely driven by a 28.1 percent rise in the export of goods; service exports were flat. The rise was spread across categories, but capital goods were the biggest contributor. This reflects increased demand from China and elsewhere in the developing world. Imports rose at a 10.5 percent annual rate, leaving a net contribution to GDP growth from the trade sector of 0.5 percentage points. It is likely that trade will be a drag on growth in future quarters as imports increase to restock inventories.

The jump in equipment purchases was largely driven by increased purchases of computers.  Equipment and software purchases added 0.8 percentage points to GDP growth for the quarter and computers accounted for 40.7 percent of this growth even though they are only about 9 percent of spending in the sector. Since the December data on durable goods orders showed a 5.3 percent drop in new orders for computers, this fourth quarter surge is likely a blip.

A 15.4 percent decline in non-residential structures largely offset the increase in equipment spending, leaving a net contribution to growth by non-residential investment of 0.29 percentage points.  With the enormous overbuilding in the non-residential sector, it is likely that spending will continue to decline through the first half of 2010. Residential investment grew at a 5.7 percent annual rate, its second consecutive positive quarter. However, recent declines in starts and sales indicate that spending in the sector is likely to level off or even dip somewhat in 2010.

Consumption grew at a 2.0 percent rate. This figure was somewhat depressed by a falloff in car sales following the end of the cash for clunkers program. However, there were also erratic numbers on the upside as well, such as a 5.9 percent jump in the category “other non-durable goods” and a big increase in spending on housing and utilities (likely weather driven) that added 0.44 percentage points to growth. The savings rate for the quarter was 4.6 percent. With house prices resuming their decline, the savings rate is more likely to rise than fall, ensuring that consumption growth will remain slow.

The government sector was a very small net negative in GDP, with a 0.3 percent drop in state and local spending slightly outweighing a 0.1 percent rise in federal spending. Government is likely to be more of drag on growth in future quarters. The stimulus is already being spent at its maximum rate so there will be little further boost from the federal sector, while state and local governments will be cutting back, especially after their new fiscal years begin in July. 

While the economy is now growing, it is striking how much damage was caused by the recession. Net domestic product (GDP minus depreciation) was still 0.3 percent lower in the fourth quarter of 2009 than in the fourth quarter of 2006. The drop in net domestic income was even more dramatic, with the third quarter level (4th quarter data is not available yet) being 0.3 percent below the level of the second quarter of 2005. Such prolonged downturns have not occurred since the Great Depression.

The jump in output, combined with near flat hours worked in the quarter, will lead to another impressive productivity number when the Labor Department releases the data next week. There is no reason to believe that this will presage a burst of hiring. In fact, the latest data on unemployment insurance filings indicate that the economy is still shedding jobs. With final demand growth remaining weak, there is little prospect for a turnaround of employment in the near future.

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