The expansion of U. S. economic activity maintained considerable momentum through the early months of 2000 despite the firming in credit markets that has occurred over the past year. Only recently has the pace of real activity shown signs of having moderated from the extremely rapid rate of increase that prevailed during the second half of 1999 and the first quarter of 2000. Real GDP increased at an annual rate of 5-1/2 percent in the first quarter of 2000. Private domestic final sales, which had accelerated in the second half of 1999, were particularly robust, rising at an annual rate of almost 10 percent in the first quarter.
Underlying that surge in domestic spending were many of the same factors that had contributed to the considerable strength of outlays in the second half of 1999. The ongoing influence of substantial increases in real income and wealth continued to fuel consumer spending, and business investment, which continues to be undergirded by the desire to take advantage of new, cost-saving technologies, was further buoyed by an acceleration in sales and profits late last year. Export demand posted a solid gain during the first quarter while imports rose even more rapidly to meet booming domestic demand.
The available data, on balance, point to another solid increase in real GDP in the second quarter, although they suggest that private household and business fixed investment spending likely slowed noticeably from the extraordinary first-quarter pace. Through June, the expansion remained brisk enough to keep labor utilization near the very high levels reached at the end of 1999 and to raise the factory utilization rate to close to its long-run average by early spring.
Inflation rates over the first half of 2000 were elevated by an additional increase in the price of imported crude oil, which led to sharp hikes in retail energy prices early in the year and again around midyear. Apart from energy, consumer price inflation so far this year has been somewhat higher than during 1999, and some of that acceleration may be attributable to the indirect effects of higher energy costs on the prices of core goods and services. Sustained strong gains in worker productivity have kept increases in unit labor costs minimal despite the persistence of a historically low rate of unemployment.
Consumer spending was exceptionally vigorous during the first quarter of 2000. Real personal consumption expenditures rose at an annual rate of 7-3/4 percent, the sharpest increase since early 1983. At that time, the economy was rebounding from a deep recession during which households had deferred discretionary purchases. In contrast, the first-quarter surge in consumption came on the heels of two years of very robust spending during which real outlays increased at an annual rate of more than 5 percent, and the personal saving rate dropped sharply.
Outlays for durable goods, which rose at a very fast pace in 1998 and 1999, accelerated during the first quarter to an annual rate of more than 24 percent. Most notably, spending on motor vehicles, which had climbed to a new high in 1999, jumped even further in the first quarter of 2000 as unit sales of light motor vehicles soared to a record rate of 18. 1 million units. In addition, households’ spending on computing equipment and software rebounded after the turn of the year; some consumers apparently had postponed their purchases of these goods in late 1999 before the century date change.
Outlays for nondurable goods posted a solid increase of 5-3/4 percent in the first quarter, marked by a sharp upturn in spending on clothing and shoes. Spending for consumer services also picked up in the first quarter, rising at an annual rate of 5-1/2 percent. Spending was quite brisk for a number of non-energy consumer services, ranging from recreation and telephone use to brokerage fees. Also contributing to the acceleration was a rebound in outlays for energy services, which had declined in late 1999, when weather was unseasonably warm.
In recent months, the rise in consumer spending has moderated considerably from the phenomenal pace of the first quarter, with much of the slowdown in outlays for goods. At an annual rate of 17-1/4 million units in the second quarter, light motor vehicles sold at a rate well below their first-quarter pace. Nonetheless, that level of sales is still historically high, and with prices remaining damped and automakers continuing to use incentives, consumers’ assessments of the motor vehicle market continue to be positive.
The information on retail sales for the April-to-June period indicate that consumer expenditures for other goods rose markedly slower in the second quarter than in the first quarter, at a pace well below the average rate of increase during the preceding two years. In contrast, personal consumption expenditures for consumer services continued to rise relatively briskly in April and May. Real disposable personal income increased at an annual rate of about 3 percent between December and May–slightly below the 1999 pace of 3-3/4 percent.
However, the impetus to spending from the rapid rise in household net worth was still considerable, labor markets remained tight, and confidence was still high. As a result, households continued to allow their spending to outpace their flow of current income, and the personal saving rate, as measured in the national income and product accounts, dropped further, averaging less than 1 percent during the first five months of the year. After having boosted the ratio of household net worth to disposable income to a record high in the first quarter, stock prices have fallen back, suggesting less impetus to consumer spending going forward.
In addition, smaller employment gains and the pickup in energy prices have moderated the rise in real income of late. Although these developments left some imprint on consumer attitudes in June, households remained relatively upbeat about their prospective financial situation, according to the results of the University of Michigan Survey Research Center (SRC) survey. However, they became a bit less positive about the outlook for business conditions and saw a somewhat greater likelihood of a rise in unemployment over the coming year. Housing activity stayed at a high level during the first half of this year.
Homebuilders began the year with a considerable backlog of projects that had developed as the exceptionally strong demand of the previous year strained capacity. As a result, they maintained starts of new single-family homes at an annual rate of 1. 33 million units, on average, through April–matching 1999’s robust pace. Households’ demand for single-family homes was supported early in the year by ongoing gains in jobs and income and the earlier run-up in wealth; those forces apparently were sufficient to offset the effects that higher mortgage interest rates had on the affordability of new homes.
Sales of new homes were particularly robust, setting a new record by March; but sales of existing units slipped below their 1999 high. As a result of the continued strength in sales, the homeownership rate reached a new high in the first quarter. By the spring, higher mortgage interest rates were leaving a clearer mark on the attitudes of both consumers and builders. The Michigan SRC survey reported that households’ assessments of homebuying conditions dropped between April and June to the lowest level in more than nine years.
Survey respondents noted that, besides higher financing costs, higher prices of homes were becoming a factor in their less positive assessment of market conditions. Purchases of existing homes were little changed, on balance, in April and May from the first-quarter average; however, because these sales are recorded at the time of closing, they tend to be a lagging indicator of demand. Sales of new homes–a more current indicator–fell back in April and May, and homebuilders reported that sales dropped further in June.
Perhaps a sign that softer demand has begun to affect construction, starts of new single-family homes slipped to a rate of 1-1/4 million units in May. That level of new homebuilding, although noticeably slower than the robust pace that characterized the fall and winter period, is only a bit below the elevated level that prevailed throughout much of 1998, when single-family starts reached their highest level in twenty years. Starts of multifamily housing units, which also had stepped up sharply in the first quarter of the year, to an annual rate of 390,000 units, settled back to a 340,000 unit rate in April and May.
Fueled by robust spending, especially early in the year, the expansion of household debt remained brisk during the first half of 2000, although below the very strong 1999 growth rate. Apparently, a favorable outlook for income and employment, along with rising wealth, made households feel confident enough to continue to spend and take on debt. Despite rising mortgage and consumer loan rates, household debt increased at an annual rate of nearly 8 percent in the first quarter, and preliminary data point to a similar increase in the second quarter.
Mortgage debt expanded at an annual rate of 7 percent in the first quarter, boosted by the high level of housing activity. Household debt not secured by real estate–including credit card balances and auto loans–posted an impressive 10 percent gain in the first quarter to help finance a large expansion in outlays for consumer durables, especially motor vehicles. The moderation in the growth of household debt this year has been driven primarily by its mortgage component: Preliminary data for the second quarter suggest that, although consumer credit likely decelerated from the first quarter, it still grew faster than in 1999.
Debt in margin accounts, which is largely a household liability and is not included in reported measures of credit market debt, has declined, on net, in recent months, following a surge from late in the third quarter of 1999 through the end of March 2000. There has been no evidence that recent downdrafts in share prices this year caused serious repayment problems at the aggregate level that might pose broader systemic concerns.
The combination of rapid debt growth and rising interest rates has pushed the household debt-service burden to levels not reached since the late 1980s. Nonetheless, with household income and net worth both having grown rapidly, and employment prospects favorable, very few signs of worsening credit problems in the household sector have emerged, and commercial banks have reported in recent Federal Reserve surveys that they remain favorably disposed to make consumer installment and mortgage loans.
Indeed, financial indicators of the household sector have remained mostly positive: The rate of personal bankruptcy filings fell in the first quarter to its lowest level since 1996; delinquency rates on home mortgages and auto loans remained low; and the delinquency rate on credit cards edged down further, although it remained in the higher range that has prevailed since the mid-1990s. However, delinquency rates may be held down, to some extent, by the surge in new loan originations in recent quarters because newly originated loans are less likely to be delinquent than seasoned ones.
The boom in capital spending extended into the first half of 2000 with few indications that businesses’ desire to take advantage of more-efficient technologies is diminishing. Real business fixed investment surged at an annual rate of almost 24 percent in the first quarter of the year, rebounding sharply from its lull at the end of 1999, when firms apparently postponed some projects because of the century date change. In recent months, the trends in new orders and shipments of nondefense capital goods suggest that demand has remained solid.
Sustained high rates of investment spending have been a key feature shaping the current economic expansion. Business spending on new equipment and software has been propelled importantly by ongoing advances in computer and information technologies that can be applied to a widening range of business processes. The ability of firms to take advantage of these emerging developments has been supported by the strength of domestic demand and by generally favorable conditions in credit and equity markets.
In addition, because these high-technology goods can be produced increasingly efficiently, their prices have continued to decline steeply, providing additional incentive for rapid investment. The result has been a significant rise in the stock of capital in use by businesses and an acceleration in the flow of services from that capital as more-advanced vintages of equipment replace older ones. The payoff from the prolonged period during which firms have upgraded their plant and equipment has increasingly shown through in the economy’s improved productivity performance.
Real outlays for business equipment and software shot up at an annual rate of nearly 25 percent in the first quarter of this year. That jump followed a modest increase in the final quarter of 1999 and put spending for business equipment and software back on the double-digit uptrend that has prevailed throughout the current economic recovery. Concerns about potential problems with the century date change had the most noticeable effect on the patterns of spending for computers and peripherals and for communications equipment in the fourth and first quarters; expenditures for software were also affected, although less so.
For these categories of goods overall, the impressive resurgence in business purchases early this year left little doubt that the underlying strength in demand for high-tech capital goods had been only temporarily interrupted by the century date change. Indeed, nominal shipments of office and computing equipment and of communication devices registered sizable increases over the April-May period. In the first quarter, business spending on computers and peripheral equipment was up almost 40 percent from a year earlier–a pace in line with the trend of the current expansion.
Outlays for communications equipment, however, accelerated; the first-quarter surge brought the year-over-year increase in spending to 35 percent, twice the pace that prevailed a year earlier. Expanding Internet usage has been driving the need for new network architectures. In addition, cable companies have been investing heavily in preparation for their planned entry into the markets for residential and commercial telephony and broad-band Internet services. Demand for business equipment outside of the high-tech area was also strong at the beginning of the year.
In the first quarter, outlays for industrial equipment rose at a brisk pace for a third consecutive quarter as the recovery of the manufacturing sector from the effects of the Asian crisis gained momentum. In addition, investment in farm and construction machinery, which had fallen steadily during most of 1999, turned up, and shipments of civilian aircraft to domestic customers increased. More recent data show a further rise in the backlog of unfilled orders placed with domestic firms for equipment and machinery (other than high-tech items and transportation equipment), suggesting that demand for these items has been well maintained.
However, business purchases of motor vehicles are likely to drop back in the second quarter from the very high level recorded at the beginning of the year. In particular, demand for heavy trucks appears to have been adversely affected by higher costs of fuel and shortages of drivers. Real investment in private nonresidential structures jumped at an annual rate of more than 20 percent in the first quarter of the year after having declined in 1999. Both last year’s weakness and this year’s sudden and widespread revival are difficult to explain fully.
Nonetheless, the higher levels of spending on office buildings, other commercial facilities, and industrial buildings recorded early this year would seem to accord well with the overall strength in aggregate demand. However, the fundamentals in this sector of the economy are mixed. Available information suggests that property values for offices, retail space, and warehouses have been rising more slowly than they were several years ago. However, office vacancy rates have come down, which suggests that, at least at an aggregate level, the office sector is not overbuilt.
The vacancy rate for industrial buildings has also fallen, but in only a few industries, such as semiconductors and other electronic components, are capacity pressures sufficiently intense to induce significant expansion of production facilities. The ratio of inventories to sales in many nonfarm industries moved lower early this year. Those firms that had accumulated some additional stocks toward the end of 1999 as a precaution against disruptions related to the century date change seemed to have little difficulty working off those inventories after the smooth transition to the new year.
Moreover, the first-quarter surge in final demand may have, to some extent, exceeded businesses’ expectations. In current-cost terms, non-auto manufacturing and trade establishments built inventories in April and May at a somewhat faster rate than in the first quarter but still roughly in line with the rise in their sales. As a result, the ratio of inventories to sales, at current cost, for these businesses was roughly unchanged from the first quarter.
Overall, the ongoing downtrend in the ratios of inventories to sales during the past several years suggests that businesses increasingly are taking advantage of new technologies and software to implement better inventory management. The swing in inventory investment in the motor vehicle industry has been more pronounced recently. Dealer stocks of new cars and light trucks were drawn down during the first quarter as sales climbed to record levels. Accordingly, auto and truck makers kept assemblies at a high level through June in order to maintain ready supplies of popular models.
Even though demand appears to have softened and inventories of a few models have backed up, scheduled assemblies for the third quarter are above the elevated level of the first half. The economic profits of nonfinancial U. S. corporations posted another solid increase in the first quarter. The profits that nonfinancial corporations earned on their domestic operations were 10 percent above the level of a year earlier; the rise lifted the share of profits in this sector’s nominal output close to its 1997 peak.
Nonetheless, with investment expanding rapidly, businesses’ external financing requirements, measured as the difference between capital expenditures and internally generated funds, stayed at a high level in the first half of this year. Businesses’ credit demands were also supported by cash-financed merger and acquisition activity. Total debt of nonfinancial businesses increased at a 10-1/2 percent clip in the first quarter, close to the brisk pace of 1999, and available information suggests that borrowing remained strong into the second quarter.
On balance, businesses have altered the composition of their funding this year to rely more on shorter-term sources of credit and less on the bond market, although the funding mix has fluctuated widely in response to changing market conditions. After the passing of year-end, corporate borrowers returned to the bond market in volume in February and March, but subsequent volatility in the capital market in April and May prompted a pullback.
In addition, corporate bond investors have been less receptive to smaller, less liquid offerings, as has been true for some time. In the investment-grade market, bond issuers have responded to investors’ concerns about the interest rate and credit outlook by shortening the maturities of their offerings and by issuing more floating-rate securities. In the below-investment-grade market, many of the borrowers who did tap the bond market in February and March did so by issuing convertible bonds and other equity-related debt instruments.
Subsequently, amid increased equity market volatility and growing investor uncertainty about the outlook for prospective borrowers, credit spreads in the corporate bond market widened, and issuance in the below-investment-grade market dropped sharply in April and May. Conditions in the corporate bond market calmed in late May and June, and issuance recovered to close to its first-quarter pace. As the bond market became less hospitable in the spring, many businesses evidently turned to banks and to the commercial paper market for financing.
Partly as a result, commercial and industrial loans at banks have expanded briskly, even as a larger percentage of banks have reported in Federal Reserve surveys that they have been tightening standards and terms on such loans. Underscoring lenders’ concerns about the creditworthiness of borrowers, the ratio of liabilities of failed businesses to total liabilities has increased further so far this year, and the default rate on outstanding junk bonds has risen further from the relatively elevated level reached in 1999.
Through midyear, Moody’s Investors Service has downgraded, on net, more debt in the nonfinancial business sector than it has upgraded, although it has placed more debt on watch for future upgrades than downgrades. Commercial mortgage borrowing has also expanded at a robust pace over the first half of 2000, as investment in office and other commercial building strengthened. Extending last year’s trend, borrowers have tapped banks and life insurance companies as the financing sources of choice.
Banks, in particular, have reported stronger demand for commercial real estate loans this year even as they have tightened standards a bit for approving such loans. In the market for commercial mortgage-backed securities, yields have edged higher since the beginning of the year. The incoming information regarding the federal budget suggests that the surplus in the current fiscal year will surpass last year’s by a considerable amount.
Over the first eight months of fiscal year 2000–the period from October to May–the unified budget recorded a surplus of about $120 billion, compared with $41 billion during the comparable period of fiscal 1999. The Office of Management and Budget and the Congressional Budget Office are now forecasting that, when the fiscal year closes, the unified surplus will be around $225 billion to $230 billion, $100 billion higher than in the preceding year. That outcome would likely place the surplus at more than 2-1/4 percent of GDP, which would exceed the most recent high of 1. ercent, which occurred in 1951.
The swing in the federal budget from deficit to surplus has been an important factor in maintaining national saving. The rise in federal saving as a percentage of gross national product from -3. 5 percent in 1992 to 3. 1 percent in the first quarter of this year has been sufficient to offset the drop in personal saving that occurred over the same period. As a result, gross saving by households, businesses, and governments has stayed above 18 percent of GNP since 1997, compared with 16-1/2 percent over the preceding seven years.
The deeper pool of national saving, along with the continued willingness of foreign investors to finance our current account deficit, remains an important factor in containing increases in the cost of capital and sustaining the rapid expansion of domestic investment. With longer-run projections showing a rising federal government surplus over the next decade, this source of national saving could continue to expand. The recent good news on the federal budget has been primarily on the receipts side of the ledger. Nonwithheld tax receipts were very robust this spring.
Both final payments on personal income tax liabilities for 1999 and final corporate tax payments for 1999 were up substantially. So far this year, the withheld tax and social insurance contributions on this year’s earnings of individuals have also been strong. As a result, federal receipts during the first eight months of the fiscal year were almost 12 percent higher than they were during the year-earlier period. While receipts have accelerated, federal expenditures have been rising only a little faster than during fiscal 1999 and continue to decline as a share of nominal GDP.
Nominal outlays for the first eight months of the current fiscal year were 5-1/4 percent above the year-earlier period. Increases in discretionary spending have picked up a bit so far this year. In particular, defense spending has been running higher in the wake of the increase in budget authority enacted last year. The Congress has also boosted agricultural subsidies in response to the weakness in farm income. While nondiscretionary spending continues to be held down by declines in net interest payments, categories such as Medicaid and other health programs have been rising more rapidly of late.
As measured by the national income and product accounts, real federal expenditures for consumption and gross investment dropped sharply early this year after having surged in the fourth quarter of 1999. These wide quarter-to-quarter swings in federal spending appear to have occurred because the Department of Defense speeded up its payments to vendors before the century date change; actual deliveries of defense goods and services were likely smoother. On average, real defense spending in the fourth and first quarters was up moderately from the average level in fiscal 1999.
Real nondefense outlays continued to rise slowly. With current budget surpluses coming in above expectations and large surpluses projected to continue for the foreseeable future, the federal government has taken additional steps aimed at preserving a high level of liquidity in the market for its securities. Expanding on efforts to concentrate its declining debt issuance in fewer highly liquid securities, the Treasury announced in February its intention to issue only two new five- and ten-year notes and only one new thirty-year bond each year.
The auctions of five- and ten-year notes will remain quarterly, alternating between new issues and smaller reopenings, and the bond auctions will be semiannual, also alternating between new and smaller reopened offerings. The Treasury also announced that it was reducing the frequency of its one-year bill auctions from monthly to quarterly and cutting the size of the monthly two-year note auctions. In addition, the Treasury eliminated the April auction of the thirty-year inflation-indexed bond and indicated that the size of the ten-year inflation-indexed note offerings would be modestly reduced.
Meanwhile, anticipation of even larger surpluses in the wake of the surprising strength of incoming tax receipts so far in 2000 led the Treasury to announce, in May, that it was again cutting the size of the monthly two-year note auctions. The Treasury also noted that it is considering additional changes in its auction schedule, including the possible elimination of the one-year bill auctions and a reduction in the frequency of its two-year note auctions.
Early in the year, the Treasury unveiled the details of its previously announced reverse-auction, or debt buyback, program, whereby it intends to retire seasoned, less liquid, debt securities with surplus cash, enabling it to issue more “on-the-run” securities. The Treasury noted that it would buy back as much as $30 billion this year. The first operation took place in March, and in May the Treasury announced a schedule of two operations per month through the end of July of this year. Through midyear, the Treasury has conducted eight buyback operations, redeeming a total of $15 billion.
Because an important goal of the buyback program is to help forestall further increases in the average maturity of the Treasury’s publicly held debt, the entire amount redeemed so far has corresponded to securities with remaining maturities at the long end of the yield curve (at least fifteen years). In the state and local sector, real consumption and investment expenditures registered another strong quarter at the beginning of this year. In part, the unseasonably good weather appears to have accommodated more construction spending than usually occurs over the winter.
However, some of the recent rise is an extension of the step-up in spending that emerged last year, when real outlays rose 5 percent after having averaged around 3 percent for the preceding three years. Higher federal grants for highway construction have contributed to the pickup in spending. In addition, many of these jurisdictions have experienced solid improvements in their fiscal conditions, which may be allowing them to undertake new spending initiatives. The improving fiscal outlook for state and local governments has affected both the issuance and the quality of state and local debt.
Borrowing by states and municipalities expanded sluggishly in the first half of this year. In addition to the favorable budgetary picture, rising interest rates have reduced the demand for new capital financing and substantially limited refunding issuance. Credit upgrades have outnumbered downgrades by a substantial margin in the state and local sector. The deficits in U. S. xternal balances have continued to get even larger this year. The current account deficit reached an annual rate of $409 billion in the first quarter of 2000, or 4-1/4 percent of GDP, compared with $372 billion and 4 percent in the second half of 1999.
Net payments of investment income were a bit less in the first quarter than in the second half of last year owing to a sizable increase in income receipts from direct investment abroad. Most of the expansion in the current account deficit occurred in trade in goods and services. In the first quarter, the deficit in trade in goods and services widened to an annual rate of $345 billion, a considerable expansion from the deficit of $298 billion recorded in the second half of 1999. Trade data for April suggest that the deficit may have increased further in the second quarter.
U. S. exports of real goods and services rose at an annual rate of 6-1/4 percent in the first quarter, following a strong increase in exports in the second half of last year. The pickup in economic activity abroad that began in 1999 continued to support export demand and partly offset negative effects on price competitiveness of U. S. products from the dollar’s past appreciation. By market destination, U. S. exports to Canada, Mexico, and Europe increased the most. By product group, export expansion was concentrated in capital equipment, industrial supplies, and consumer goods.
Preliminary data for April suggest that growth of real exports remained strong. The quantity of imported goods and services continued to expand rapidly in the first quarter. The increase in imports, at an annual rate of 11-3/4 percent, was the same in the first quarter as in the second half of 1999 and reflected both the continuing strength of U. S. domestic demand and the effects of past dollar appreciation on price competitiveness. Imports of consumer goods, automotive products, semiconductors, telecommunications equipment, and other machinery were particularly robust.
Data for April suggest that the second quarter got off to a strong start. The price of non-oil goods imports rose at an annual rate of 1-3/4 percent in the first quarter, the second consecutive quarter of sizable price increases following four years of price declines; non-oil import prices in the second quarter posted only moderate increases. A number of developments affecting world oil demand and supply led to a further step-up in the spot price of West Texas intermediate (WTI) crude this year, along with considerable volatility.
In the wake of the plunge of world oil prices during 1998, the Organization of Petroleum Exporting Countries (OPEC) agreed in early 1999 to production restraints that, by late in the year, restored prices to their 1997 level of about $20 per barrel. Subsequently, continued recovery of world demand, combined with some supply disruptions, caused the WTI spot price to spike above $34 per barrel during March of this year, the highest level since the Gulf War more than nine years earlier.
