GDP Shows Bright Spots but Durable Softness

The Culprits

Two of the most influential factors behind the weak GDP report were inventories and international trade. These components subtracted 0.6% and 0.7%, respectively, from the headline number. Importantly, the December data on both of these components weren't available to the BEA when the fourth-quarter report was compiled -- the government simply estimates the data. The actual results will become available over the next few weeks and will figure prominently in the first revision to the GDP, which will be released on Feb. 28.

The most worrisome side of the GDP report was the weakness in personal consumption expenditures, which represent roughly two-thirds of the economy. This component rose at a meager 1.0% rate, following gains of 4.2% in the third quarter, 1.8% in the second quarter and 3.1% in the first quarter.

The main factor was the large 7.3% annualized decline in spending on consumer durable goods. That was the biggest quarterly decline since the first quarter of 1991, and was mostly due to a drop in spending on automobiles, which had helped boost the consumer durables component in the previous quarter, resulting in a 22.8% rate of gain. The decline in auto sales shaved 0.6% from the GDP tally.

A standout in the report was the gain in government spending, which increased at a 4.6% annual rate, led by a 10.1% annualized gain in spending by the federal government. Federal government spending was boosted by an 11.2% increase in defense spending. Spending by state and local governments, which is a major concern for economic growth in 2003, rose at a slow 1.7% rate.

The strong housing market led to a 6.8% annualized gain in residential investment.

The inflation data contained in the GDP report provide further evidence of low inflation and also of the absence of deflation. The so-called implicit price deflator, the broadest measure of inflation statistically available and a favorite at the Federal Reserve, rose at a 1.8% rate during the quarter, compared with estimates for a gain of 1.4%.

Too Slow to Stop Job Losses

The economy is still growing too slowly to prevent job losses and cuts in capital spending. Growth of closer to 3.5% or more is needed in order to begin using excess capacity. At 75.4%, the capacity utilization rate is well below the long-term average of about 81%. Businesses will refrain from hiring and spending until the excess capacity diminishes.

To get the economy to grow at a 3.5% rate, President Bush's stimulus plan is essential. With the economy growing at a rate of close to 3%, the added economic stimulus could be enough to bring about the needed lift, assuming of course that the Iraq situation is resolved relatively soon. That's why it's fair to say that in some ways the U.S. economic policy is its Iraq policy.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. He appreciates your feedback and invites you to send it to Tony Crescenzi.

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