The advance estimate of Q4 Real GDP released on Wednesday showed that US output contracted by 0.1 percent in the final quarter of 2012. The effect of fiscal policies as well as weakness of the European economy and the rest of the world can clearly be seen in the negative aspects of the report. The overall decline was due to a reduction in exports (-5.7%) and a rundown in inventories as well as a large decline in government spending (-6.6%) caused by a 22.2% cut in defense.
The negative headline number hides overall positive growth in domestic fundamentals. Consumption expenditures on durables increased at a faster pace than in Q3, and both residential and non-residential fixed investment recorded the highest combined growth since the second quarter of 2010. There are signs that spending on services and non-durables are slowing down, which will be a cause of concern if the trend continues into 2013.
Fiscal policies matter. The expected end of the payroll tax holiday had a large effect on personal income and savings toward the end of the year. In the final two months of 2012, real disposable personal income increased by 1.3% and 2.8% in November and December. This is in stark comparison to the .14% growth in the first 10 months of the year. The run-up in income can almost entirely be attributed to companies shifting dividend payments forward. The result lead to a jump in the savings rate, up to 6.5%, but no apparent change in personal consumption expenditures.
Aug. Sept. Oct. Nov. Dec. (Percent change from preceding month) Disposable personal income: Chained (2005) dollars -0.3 0.1 -0.1 1.3 2.8 Personal consumption expenditures: Chained (2005) dollars 0.0 0.5 -0.2 0.6 0.2 Personal Savings Rate 3.6 3.3 3.4 4.1 6.5
Interpretation of the downward change in business inventories is difficult. The negative view is that businesses are cutting back on production for fear of weak demand in the future perhaps in anticipation of tax and spending cuts in the New Year. The positive view is that sales in the fourth quarter were unexpectedly high. So the question that really should be asked is when are negative inventory changes indicative of a slowdown in output?
A first step is to see how inventories are related to the business cycle. The graph below shows the real change in private inventories adjusted for the level of output (in red) and the business cycle component of real GDP (in blue) since 1970. Inventories are positively correlated with output and tend to lead the business cycle, meaning that generally inventories decline before output. However, the change in inventories is noisy. A quarter decline is much less informative than a prolonged period of inventory depletion. The implication is that we will have to wait a bit longer to understand the full importance of the recent decline.
As always, we show the components of GDP measured from the peak of the business cycle.