A downward revision in State Essay

ACCORDING to the “flash” estimates, real GNP increased at
an annual rate of 2 percent in the first quarter of 1985, compared with
4-1/2 percent in the fourth quarter of 1984. The GNP fixed-weighted
price index increased at an annual rate of 4 percent, up from 3-1/2
percent in the fourth quarter (table 1). sup.1



The “flash” estimate of real GNP includes another large
change in net exports–a decline, following an increase of $13-1/2
billion in the fourth quarter. Based on merchandise trade data for only
1 month of the quarter, imports swung to a large increase, and exports
again declined slight. sup.2 Accordingly, gross domestic purchases,
which includes imports but excludes exports, increased more in the first
quarter than did GNP. As explained in table 2, gross domestic purchases
is a measure of U.S. demand for goods and services–wherever
produced–by persons, investors, and government, and GNP is a measure of
U.S. production. Except in the fourth quarter, U.S. demand recently has
increased more than has U.S. production. Over the year from the first
quarter of 1984, U.S. demand increased about 4-1/2 percent and U.S.
production increased 3-1/2 percent. The corresponding final sales
measures also show a difference of 1 percentage point. Final sales to
domestic purchasers increased about 5-1/2 percent over the last year,
and final sales of GNP increased about 4-1/2 percent.

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The first-quarter increase in U.S. demand was largely accounted for
by personal consumption expenditures (PCE). Changes in fixed
investment, government purchases, and inventory investment were small to
moderate, and partly offsetting. U.S. demand had increased much
less–only 1 percent–in the fourth quarter, as a sharp decline in
inventory investment almost offset increases in the other components.


First-quarter developments in the components of real GNP, in GNP
prices, and in personal income are sketched below on the basis of data
available as of mid-March.



* PCE increased more than the 3-1/2 percent registered in the
fourth quarter. Although durable goods increased less than in the
fourth quarter, non-durable good swung from a small decline to a sizable increase, and services increased slightly more than in the fourth
quarter. In durables, motor vehicles–largely due to trucks–were up
more than in the fourth quarter, but furniture and equipment were up
substantially less than in that quarter. In nondurables, the swing was
largely due to an increase in food following a decline in the fourth
quarter; swings in energy–gasoline as well as fuel oil and coal–also
contributed. In services, electricity and gas increased after a slight
decline in the fourth quarter, reflecting the effects of unseasonable weather on heating ependitures. In the fourth quarter, the weather was
mild in the Eastern part of the country; in the early part of the first
quarter, severe cold was widespread.



* Nonresidential fixed investment was flat after an 8-1/2-percent
increase in the fourth quarter. Structures increased, although slightly
less than the 17-percent increase in the fourth quarter. This pattern
largely reflected that of commercial structures; other types of
structures have registered smaller, and partly offsetting, changes in
recent quarters. A decline in producers’ durable equipment was
more than accounted for by equipment other than motor vehicles. A
decline in equipment other than motor vehicles–the first in over 2
years–was largely due to a sharp drop in computers.



* Residential investment was unchanged following two consecutive
quarters of decline. Construction of multifamily housing, which had
held up earlier, slipped in the first quarter. Single-family housing
stabilized, reflecting the lagged effect of the decline in mortgage
rates since last July. The “other” component (largely
additions and alterations, mobile homes, and commisssions on house
(sales) again changed little.



* Business inventories appear to have accumulated at a moderately
faster rate than in the fourth quarter. Motor vehicle inventories–the
only part of inventories based on more than 1 month of source data for
the first quarter–registered another substantial increase, as
automakers continued to build inventories from a low level at the
beginning of the 1985 model year. Only fragmentary information is
available about farm inventories; it appears that accumulation continued
in the first quarter. Nonfarm inventories other than motor vehicles
appear to have increased somewhat more than the $5-u/2 billion
registered in the fourth quarter. It is likely that the ratio of total
business inventories to total final sales moved up in the first quarter,
but remained in the 3.01-3.09 range within which it has fluctuated for
the past 2 years. * Net exports, as mentioned earlier, appear to have
declined substantially. Imports registered a large increase, and
exports registered another slight decline. In merchandise imports,
which more than accounted for the increase, most nonpetroleum enduse
commodity categories increased after declining in the fourth quarter;
petroleum imports declined. Investment income payments appear to have
declined again, partly reflecting lopwer interest rates on portfolio
investment. In exports, a decline in investment income receipts more
than offset in increase in merchandise trade.


* Government purchases increased less than the 6 percent registered
in the fourth quarter. The slowing was in Federal purchases, both
defense and nondefense. Defense purchases, which tend to be erratic,
had increased 17-1/2 percent in the fourth quarter; a much smaller
increase in the first reflected smaller increases in purchases of
durable goods and services. Nondefense purchases showed little change
across the several categories of purchases, including those of the
Commodity Credit Corporation. State and local purchases increased
slightly, reflecting slight increases in the several categories, except
structures. In the fourth quarter, a decline in structures had offset
slight increases in the other categories.



* The GNP fixed-weighted price index increased 4 percent, up from
3-1/2 percent in the fourth quarter. The first-quarter increase was
boosted 0.5 percentage point by a Federal pay raise in January, which is
reflected in the prices of employee services purchased by the Federal
Government. Thus, other GNP prices in total increased about as much as
in the fourth quarter. Among them, prices of fixed
investment–especially residential–accelerated slightly; PCE
prices–largely due to energy prices, which declined–decelerated
slightly.



* Personal income increased about $47-1/2 billion, only slightly
less than the $49 billion registered in ther fourth quarter. A number
of special factors contributed to substantially different movements in
several components in the two quarters. Without these special factors,
personal income would have increased $40-1/2 billion, compared with $52
billion in the fourth quarter.



Wages and salaries in government and government enterprises in the
first quarter included the Federal pay raise, which added $3 billion,
and a retroactive payment and pay raise for Postal Service employees,
which added $1-1/2 billion. Farm proprietors’ income included a
small decline in subsidies after a $5 billion increase in the fourth
quarter. Among transfer payments, military retirement pay included a
$5-1/2 billion increase, following a decline in the fourth quarter of
the same amount, because the Deficit Reduction Act of 1984 shifted the
payment of benefits scheduled for December 31, 1984 to January 1, 1985.
The impact on transfer payments of this shift was partly offset by a
decline in retroactive Social Security benefit payments of $2-1/2
billion, following an increase of the same amount in the fourth quarter.
These payments result largely from the recalculation of the earnings
base underlying benefits for retirees whose post-retirement work raises
the base. Finally, cost-of-living adjustments added a total of $8-1/2
billion to benefit payments under Social Security and several other
retirement and income-support programs. A change in the Social Security
wage base and tax rate added $8-1/2 billion to the increase in
contributions for social insurance, which are deducted in deriving
personal income.



With the exception of personal interest income, other components of
personal income increased roughly as much as they had in the fourth
quarter. Personal interest income again decelerated, reflecting the
widespread decline in interest rates. The first-quarter increase was
less than the $6-1/2 billion increase in the fourth quarter, which, in
turn, was down from increases that had exceeded $20 billion in the
second and third quarters.



Beginning in the first quarter, personal taxes reflected the
indexing of Federal income taxes under the Economic Recovery Tax Act of
1981. Indexing lowered personal taxes $7 billion, so–despite a
slightly larger increase in the tax base than in the fourth
quarter–they increased less than in the fourth quarter. Thus, the
increase in disposable personal income was about the same in both
quarters. In real terms, however, the increase was less than the 3-1/2
percent registered in the fourth quarter, because prices–as measured by
the implicit price deflator for PCE–increased more. The first-quarter
increase in personal outlays–in which PCE predominates–was large.
Accordingly, after a small decline in the fourth quarter, personal
saving dropped sharply in the first. The saving rate, which had been
6.2 percent in the fourth quarter, fell several tenths of a percentage
point.



The Fourth Quarter: Corporate Profits and the Government Sector



Preliminary estimates of corporate profits for the fourth quarter
of 1984 have been completed. Their compilation makes it possible to
estimate corporate profits tax accruals for the fourth quarter, rounding
out the estimates of receipts and expenditures of the government sector.



The 75-day revisions of the national income and product accounts
for the fourth quarter are shown in table 3.



Corporate profits



Profits from current production–profits with inventory valuation
adjustment (IVA) and capital consumption adjustment (CCAdj)–increased
$10-1/2 billion, to $293-1/2 billion, in the fourth quarter, following
an $8 billion decline in the third. Domestic profits of financial
corporations were unchanged in the fourth quarter; those of nonfinancial
corporations were up $14 billion; and those from the rest of the world
were down $3-1/2 billion.



Real gross product of domestic0 nonfinancial corporations had
remained unchanged in the third quarter and increased 5-1/2 percent in
the fourth. The larger product and increased profits per unit of
product together boosted total profits of nonfinancial corporations in
the fourth quarter. Unit prices received by corporations and unit costs
paid by them both increased, but prices increased more. Labor and
nonlabor costs increased at about the same rate.



Adjustment and disposition of profits its before tax.–Profits
before tax–profits without IVA and CCAdj–increased $6 billion, to
$230-1/2 billion, following a $21-1/2 billion decline. The IVA and
CCAdj convert inventories and depreciation reported by business for tax
purposes to those used in the national income and product accounts
(NIPA’s). The CCAdj was up $6 billion, to $64-1/2 billion, in the
fourth quarter, matching the third-quarter increased and somewhat above
the increases in the first two quarters. The steady increases reflect
mainly the effect of shorter service lives for depreciation of capital
permitted by the Economic Recovery Tax Act of 1981 (ERTA). The effects
of ERTA have become more pronounced as proportionately more investments
have become eligible for shorter service lives. The CCAdj accounted for
about 20 percent of profits from current production in the third and
fourth quarters.



In the fourth quarter, the IVA declined $1-1/2 billion. In the
third quarter, it had increased $7 billion. The fourth-quarter IVA
reflects relative stability of inventory prices during the quarter.



Corporate profits tax liability increased $5 billion in the fourth
quarter, to $88-1/2 billion, following a $12-1/2 billion decline. The
fluctuation in tax liability reflects that in profits before tax.
Dividends increased $2 billion, to $83 billion, matching the previous
increase. Undistributed profits declined $1 billion, to $59 billion,
following a $10 billion decline.



Profits by industry.–Profits with IVA but without CCAdj–the
variant of profits available by industry–increased $4-1/2 billion in
the fourth quarter, to $229 billion, following a $14 billion decline.



Domestic profits of financial corporations were unchanged, at
$26-1/2 billion, following a $2-1/2 billion decline. Domestic profits
of nonfinancial corporations increased $8 billion, to $181-1/2 billion,
following a $15 billion decline. Manufacturing and trade accounted for
most of the increase. Widespread increases in durable goods
manufacturing more than offset a decline in nondurable goods
manufacturing–largely in petroleum and food. Both wholesale and retail
trade profits were up.



Government sector



The fiscal position of the government sector in the national income
and product accounts deteriorated in the fourth quarter; the combined
deficit of the Federal Government and of the State and local governments
increased $8-1/2 billion to $141-1/2 billion. A $16-1/2 billion
increase in the Federal deficit was partly offset by an $8 billion
increase in the State and local government surplus. However, for the
year 1984, the fiscal position of the government sector improved; the
combined deficit, at $122-1/2 billion, was $12 billion lower than in
1983. This improvement was largely accounted for by an increase in the
State and local government surplus.



The Federal sector.–The Federal Government deficit increased
$16-1/2 billion in the fourth quarter to $197-1/2 billion, as
expenditures increased more than receipts. For the year 1984, the
deficit was $175-1/2 billion, down $3 billion from 1983.



Receipts increased $16 billion, compared with $2 billion in the
third quarter; the acceleration was accounted for by corporate profits
tax accruals, which increased $4-1/2 billion following a $10-1/2 billion
decline in the third quarter. Personal tax and nontax receipts
increased $8-1/2 billion, contributions for social insurance increased
$4 billion, and indirect business tax and nontax accruals were
unchanged.



Expenditures increased $33 billion, compared with $19 billion in
the third quarter; the acceleration was largely accounted for by
national defense purchases of goods and services, which increased
$11-1/2 billion following a $1/2 billion decline in the third quarter.
The acceleration in defense purchases was attributable to a strong
rebound in the delivery of military equipment, which declined sharply in
the third quarter. Third-quarter deliveries were depressed by several
factors; a major one was the postponement of deliveries while quality
control problems were resolved. The fourth-quarter rebound also
reflected the delivery of the first B1 bomber (over $i billion at an
annual rate). Transfer payments to foreigners increased $5-1/2 billion
as the result of a large payment to Israel. Grants-in-aid to State and
local governments increased $5 billion and included increases in
medicaid, highways, and education. Net interest paid and subsidies less
the current surplus of government enterprises increased $4-1/2 billion
each; the latter was largely for subsidies to farmers. All other
expenditures increased $2-1/2 billion.



Cyclically adjusted Federal budget.–When measured using cyclical adjustments based on middle-expansion trend GNP, the Federal fiscal
position moved from a deficit of $180 billion in the third quarter to a
deficit of $202 billion in the fourth (see table 3 on page 17). The
cyclically adjusted deficit as a percentage of middle-expansion trend
GNP increased from 4.9 percent in the fourth–a move toward a more
expansionary fiscal position.



The State and local sector.–The State and local government surplus
increased $8 billion, to $56 billion, as receipts increased more than
expenditures. Most of the increase–$6-1/2 billion–was in the surplus
of “other” funds, that is, other than social insurance, funds.
For the year 1984, the surplus was $53 billion, up $9 billion from 1983.
Of that increase, $5 billion was in the social insurance fund surplus
and $4 billion was in the other funds surplus.



Receipts increased $15 billion, compared w with $4 billion in the
third quarter. The acceleration was largely accounted for by Federal
grants-in-aid and by corporate profits tax accruals. Federal grants, as
mentioned, increased $5 billion; corporate profits taxes increased $1
billion, following a $2-1/2 billion decline in the third quarter.
Indirect business tax and nontax accruals increased $6 billion, of which
$3 billion was in sales taxes. Personal tax and nontax receipts
increased $2-1/2 billion, and contributions for social insurance
increased $1 billion.



Expenditures increased $7 billion, compared with $11 billion in the
third quarter; this deceleration was accounted for by a substantial
slowdown in purchases of goods and services. Purchases increased $6
billion in the fourth quarter, compared with $11-1/2 billion in the
third quarter. This decelaration was largely attributable to the
purchase of structures, which declined $1-1/2 billion, following a $3
billion increase; highways accounted for the shift. All other
expenditures increased $1 billion in the fourth quarter.

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