Growth: Neither Sizzle nor Fizzle

By Rick MacDonald The first reading of U.S. second-quarter gross domestic product growth of 3% fell short of most projections. The shortfall from our 4% forecast reflected three main factors. First, weaker-than-expected consumption was reported. Real consumption rose only 1% on the quarter, vs. our estimate of 1.5% to 2%. This mainly reflected a growth shortfall in service consumption in the second quarter, which came on top of an overall lower trajectory implied by annual benchmarking revisions. In addition, the subdued gain also reflects higher prices on the quarter, mainly for energy.

Second, inventory growth added only $7.5 billion to GDP (the equivalent of 0.3 percentage points), vs. an estimate coming into the report of a $20 billion to $25 billion addition (the equivalent of 1 percentage point). Much of this discrepancy was due to benchmark revisions, which effectively boosted first-quarter inventories by more than the shortfall in this quarter.

Third, government spending fell short of expectations, posting growth of 2.3%. While nondefense spending picked up in the quarter, rising 4.3% following an average shrinkage of 3.6% over the two previous quarters, defense spending rose only 1.9%, compared to average growth over the previous two quarters of roughly 11%.

MODEST REVISIONS. Each of these effects was of equal importance, and the remaining GDP components were largely in line with expectations. The one exception to the upside was a notable surge in residential investment at a 15.4% rate that significantly exceeded estimates and left a solid set of investment figures for the quarter. Overall fixed investment spending jumped 11% in the second quarter, vs. 4.5% in the first quarter.

The broadest measure of inflation for the economy, the GDP chain-price index, accelerated to 3.2% growth in the second quarter. This compares to 2.8% in the first quarter, then 1.6% in the fourth quarter of 2003, 1.4% in the third, and 1.1% in the second quarter of last year. Clearly, the cyclical lows are behind us. The hope remains, however, that the bulk of the acceleration has already occurred.

In total, the second-quarter GDP data, combined with the revisions to earlier quarters, left a weaker growth trajectory heading into the second half of 2004. The data also reveal a more dramatic business investment downturn in 2001 and 2002, followed by a more dramatic rebound through 2003 and 2004, which continued through the second quarter. Combined, these effects should damp forecasts for GDP growth in the latter half of the year, although downward revisions have been modest. At Action Economics, we still see reason to believe that second-half growth could top 4%.

FOUR THEMES. The U.S. GDP revisions to prior quarters revealed four major themes: First, the trade figures for 2003 were revised lower, as was expected from the current-account revisions. This left a lower net-export gap in this year's first and second quarters. Moreover, government-spending figures were generally amended lower in both 2002 and 2003, leaving a lower trajectory.

Third, fixed-investment growth was generally revised lower in 2002 and higher in 2003. This lowered the 2002 trough to the business-investment cycle even further, while exacerbating the rebound. Finally, service consumption was revised lower in 2002 but modified upward more modestly in 2003, leaving a lower trajectory heading into 2004. MacDonald is director of research and analysis for Action Economics

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