July 29, 2005 (GDP Byte)
Housing and Exports Drive 2nd Quarter GDP Growth
July 29, 2005
By Dean Baker
GDP grew at a moderate 3.4 percent annual rate in the second quarter, driven by 11.0 percent growth in residential construction and 12.6 percent growth in exports. Consumption grew at a solid 3.3 percent annual rate, driven largely by 8.3 percent growth in durable goods consumption (primarily cars). Non-residential investment grew at a 9.3 percent annual rate, approximately the same as its rate of increase over the last year.
There were a number of unusual features in the quarter’s data. There was a sharp fall reported in inventories, which subtracted 2.3 percentage points from GDP growth for the quarter. However, this was accompanied by the first drop in imports in two years. The decline in imports added 0.3 percentage points to growth in the first quarter. By comparison, the growth in imports subtracted an average of 1.5 percentage points from GDP growth over the last year. Effectively, the run-down in inventories and the falloff in imports are largely the same phenomenon. When inventories grow again in the third quarter, it is likely to coincide with a boom in imports, leaving GDP little changed.
The jump in residential investment raised the share of housing construction in GDP to 6.0 percent, surpassing the peak hit in the late seventies, when the baby boomers were first forming their own households. If the housing bubble persists, this share will grow even higher in future quarters.
The strong growth in consumption outpaced income growth, pushing savings rates to a new low. The personal savings rate fell by 0.5 percentage points to 0.2 percent. This is below the previous low of 0.5 percent hit in the fourth quarter of 2001.
This report also included revisions to prior years’ data. GDP growth for the last three years was revised down by an average of 0.3 percentage points, making the average growth rate from 2001 through 2004 just 2.4 percent. The sharpest revisions were in equipment investment, the growth of which was revised down by an average of 1.8 percentage points over the last three years. There was also a downward revision of 3.8 percentage points in the growth of service consumption in 2004.
The downward revisions in output were partly attributable to an upward revision in price indices. The GDP price index for 2004 was revised up by 0.4 percentage points from 2.2 percent to 2.6 percent. The rate of price increase in the personal consumption expenditure index, excluding food and energy, (the inflation measure preferred by Alan Greenspan) was revised up for 2004 by 0.5 percentage points to 2.0 percent. While it shows a drop to 1.8 percent in the second quarter data, this is higher than the 1.5 percent inflation rate being reported in 2004, when Greenspan began raising interest rates.
The downward revisions to the output data also imply that productivity growth will be revised downward as well. Output in the non-farm business sector was revised down by an average of 0.4 percentage points over the last three years. With hours growing at close to a 3.0 percent annual rate in the second quarter, productivity growth will almost certainly be less than 2.0 percent, considerably slower than the 4.2 percent growth rate that had been reported for 2002-04.
Both the most recent quarter’s data and the revisions in this report should prompt some rethinking about the current state of the economy. In assessing the recovery to date, productivity growth has not been as strong, and inflation has not been as low as previously believed. In fact, inflation in the core PCE was almost as high in 2004 as it was in 1994 when Greenspan raised the federal funds rate to 6.0 percent.
The immediate path forward looks very shaky as the economy is ever more dependent on the housing boom and debt. If wage growth does not begin to pick up, it will be difficult for this cycle to continue much further. However, if wage growth does pick up, then inflation will accelerate, pushing up interest rates, which will burst the housing bubble.
Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.
CEPR’s GDP Byte is published quarterly upon release of the Bureau of Economic Analysis' report on the Gross Domestic Product.