Eye On Housing
In its second estimate, the Bureau of Economic Analysis (BEA) reported that the nation’s economy, measured by real gross domestic product (GDP), grew by 2.5 percent in the fourth quarter of 2017 on a seasonally adjusted annual rate basis. The second estimate is 0.1 percent point less than the 2.6 percent growth rate recorded in the first or “advance” estimate. According to the BEA, the small decline in fourth quarter GDP primarily reflected “a slight downward revision to private inventory investment”. Even with updated information, growth of the US economy slowed from second and third quarter of 2017 readings that exceeded three percent, but fourth quarter GDP growth did outperform its potential for the third consecutive quarter and deeper analysis suggests that the fourth quarter reading was solid.
Growth of the US economy largely reflected the contribution of personal consumption expenditures (PCE), which accounts for nearly 70 percent of the total economy. However, the positive contributions of PCE and, to a lesser extent, gross private domestic investment (GPDI) and government expenditures and investment (GEI), was partially offset by an expansion in the US trade deficit (NX).
GDP growth was supported by strong contributions from PCE growth and GEI. However, the slowdown in GDP growth over the quarter reflected a smaller contribution from GPDI and a subtraction due to the widening of the trade deficit. However, the inset box indicates that the lower contribution of GPDI reflects a subtraction due to the change in private inventories, as inventories were drawn down over the quarter, suggesting that these inventories may be replenished in the future. Meanwhile, fixed business investment accounted for a larger contribution to overall GDP growth in the fourth quarter relative to the third quarter.
NAHB analysis has documented the connection between PCE and disposable personal income (DPI). The figure below confirms that personal spending changes largely track changes in DPI. More recently growth of PCE has exceeded DPI growth. The decline in the savings rate, the share of DPI that is saved, indicates that a larger portion of income is going toward spending and may explain the faster growth in PCE relative to DPI in recent quarters. At the same time, consumption growth may be aided by the rising value of financial wealth, which, in theory, can facilitate household borrowing.
After shrinking for three consecutive quarters, the US trade deficit, the difference between exports and imports (which are adjusted for prices), widened in the fourth quarter of 2017. The figure below indicates that changes in the trade-weighted value of the dollar, a broader exchange rate measure, are related to the trade deficit. When the dollar’s value strengthens, it can purchase more of a good or service denominated in a foreign currency, raising imports at the expense of exports. Conversely, when the dollar’s value weakens, buyers using a foreign currency can purchase more US goods and services, raising US exports at the expense of imports.
Although the US trade deficit subtracted from GDP growth, it may reflect a strong US economy. The strength in imports, US purchases of foreign goods and services, is consistent with PCE and the change in private inventories-adjusted GPDI. This reasoning suggests that the strength of imports is a sign of a strong US economy.
In addition, previous analysis suggested that the strengthening or expected strengthening in the US economy was reflected in interest rates. In theory, interest rates are related to the exchange-traded value of the dollar. Generally, rising US interest rates shift demand from assets denominated in foreign currencies to assets denominated in US dollars (due to the now greater return on US dollar denominated assets relative to assets denominated in a foreign currency), strengthening the value of the US dollar relative to foreign currencies, thereby increasing the amount of imports relative to exports. The figure below shows that the relationship between interest rates and the dollar (changes in the value of the dollar are inverted in the figure below to be consistent with the figure directly above) has held in recent years, but that relationship doesn’t appear visible in 2014 and the first half of 2015.
Isn’t 2.5 percent a lot less than 3.2 percent? Doesn’t that mean GDP fell quarter to quarter? How is such a decline evidence of “solid” growth?