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1986-09-26
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The Business Situation, August 1986
the Business Situation
August 1986
REVISED (45-day) estimates show that real GNP increased at an
annual rate of 1/2 percent in the second quarter of 1986;
preliminary (15-day) estimates had shown a 1-percent increase
(table 1). The downward revision was more than accounted by
inventory investment and net exports; personal consumption
expenditures and Federal Government purchases of goods and
services were revised up. Revisions in other components of GNP
were small. The GNP price index (fixed weights) was essentially
unrevised at a 2-percent annual rate of increase./1/
_____________________________________________________________________________
1. Quarterly estimates in the national income and product
accounts are expressed at seasonally adjusted annual rates, and
quarterly changes in them are differences between these rates.
Quarter-to-quarter percent changes are annualized. Real, or
constant-dollar, estimates are expressed in 1982 dollars.
_____________________________________________________________________________
Generally, the revisions reinforce the changes in individual
components reported in the preliminary estimates. Inventory
investment and net exports, which had declined according to the
preliminary estimates, declined more in the revised estimates.
Personal consumption expenditures and Federal Government
purchases, which had increased, increased more. Overall, the
revisions do not alter the picture of sharp, largely offsetting
changes in several components of GNP that was presented in the
July "Business Situation."
Corporate profits
Profits from current production--profits before tax with
inventory valuation adjustment (IVA) and capital consumption
adjustment (CCAdj)-- declined $5 billion in the second quarter,
following an $11 billion increase in the first.
Domestic profits of nonfinancial corporations declined $7
billion, following an increase of $2 billion, reflecting declines
both in real gross corporate product and in profits per unit of
product. The decline in unit profits resulted from a larger
increase in unit labor cost than in unit price; unit nonlabor
costs were unchanged.
Domestic profits of financial corporations increased $3
billion, following an increase of $5 1/2 billion, and profits
from the rest of the world declined $1 billion, following an
increase of $3 1/2 billion.
Profits before tax.--Profits before tax (PBT) increased $7
1/2 billion in the second quarter, following a decline of $11 1/2
billion in the first. The contrast between the increase in PBT
and the decline in profits from current production is due to the
CCAdj, which declined $4 billion, and to the IVA, which declined
$8 1/2 billion. Both of these adjustments are reflected in the
current production measure but not in PBT.
The CCAdj is the difference between depreciation based (like
PBT) largely on tax accounting, on the one hand, and economic
depreciation as defined by BEA, on the other. In the second
quarter, as in the first, tax-based depreciation declined
slightly while economic depreciation continued to increase; as a
result, the CCAdj declined. The decline in tax-based
depreciation reflected the provisions of the Economic Recovery
Tax Act of 1981, under which new assets are depreciated in 1986
at a lower rate than 5-year-old assets that drop out of the
depreciation base.
The IVA removes the capital-gains-like element from profits
based on tax accounting when inventory prices increase; likewise,
it removes the capital-loss-like element when inventory prices
decline. In the second quarter, the IVA was positive--indicating
losses--but smaller than in the first, as overall inventory
prices continued to decline but by less than in the first. In
manufacturing, inventory prices dropped more than in the first
quarter, while in trade, inventory prices generally increased
after declining in the first quarter.
Profits with IVA but without CCAdj.--The quarterly measure
of profits available by industry declined $1 billion, following
an increase of $14 1/2 billion. A $3 billion decline in the
profits of nonfinancial corporations was more than accounted for
by trade; profits in manufacturing and in transportation and
public utilities increased.
In both wholesale and retail trade, the increases in
inventory prices mentioned above contributed to drops in profits.
In retail trade, the drop was intensified by declines in the
prices of goods sold.
Manufacturing profits increased after two quarters of
decline. The increase was concentrated in durables
manufacturing, especially electric and nonelectric machinery. In
nondurables, petroleum profits increased but the increase
represented only a partial rebound from a very low first-quarter
level that reflected the payment of a large fine to the U.S.
Department of Energy by a major corporation; in the absence of
the fine, profits would have declined in both quarters,
reflecting the path of petroleum prices. In transportation and
public utilities, lower petroleum prices contributed to increased
profits.
Government sector
The fiscal position of the government sector in the national
income and product accounts deteriorated considerably in the
second quarter of 1986, as the combined deficit of the Federal
Government and of State and local governments increased $45 1/2
billion (table 2). The deterioration was the result of an
increase in the Federal deficit and a decrease in the State and
local surplus.
The Federal Sector.--The Federal Government deficit increased
$35 1/2 billion in the second quarter to $237 billion, as
expenditures increased more than receipts.
Receipts increased $6 billion after a decline of the same
amount in the first quarter, when only contributions for social
insurance increased. In the second quarter, indirect business
tax and nontax accruals continued to decline, and all other
categories of receipts increased. In recent quarters, the
movement of indirect business taxes has been influenced by a
rather steady decline, reflecting crude oil prices, in windfall
profit taxes. The windfall profit tax was enacted in April 1980
as a temporary excise tax on domestically produced crude oil.
Receipts from this tax reached a peak of $26 1/2 billion in the
second quarter of 1981; these receipts were only $0.1 billion in
the second quarter of 1986.
Expenditures increased $41 billion after a decline of $22
billion in the first quarter. Over two-thirds of this swing was
accounted for by the effect of farm programs operated by the
Commodity Credit Corporation (CCC) on nondefense purchases of
goods and services and on subsidies less the current surplus of
government enterprises.
Nondefense purchases were essentially unchanged after a $23
1/2 billion decline in the first quarter. The purchases of
agricultural commodities by the CCC accounted for almost all of
the first-quarter decline, and they were unchanged at $5 1/2
billion in the second. Subsidies less the current surplus
increased $18 1/2 billion after a $3 billion decline in the first
quarter; the swing was due to the CCC. The CCC deficit, which
had declined $3 billion in the first quarter, declined only $1/2
billion in the second. Agricultural subsidies accounted for the
remainder of the change in farm programs; these subsidies
increased $19 billion in the second quarter--mainly for advance
deficiency payments--after no change in the first.
The advance deficiency payments amounted to over $15 billion
and were paid in two forms--cash ($11 billion) and
payment-in-kind (PIK) certificates ($4 billion). The cash
payments were made to producers of feed grains ($6 1/2 billion),
wheat ($2 1/2 billion), upland cotton ($1 1/2 billion), and rice
(over $1/2 billion). The PIK certificates are generic; that is,
they can be redeemed at face value for any commodity. The
certificates can also be sold--to other farmers or to, for
example, grain storage operators--or they can be redeemed for
cash from the CCC beginning October 1. If they are redeemed for
cash, the CCC will discount the value of the certificates by 4.3
percent under the Gramm-Rudman deficit-reduction requirements.
In addition, $1 billion of advance diversion payments were also
paid in the form of certificates. (See "Federal Farm Programs
for 1986-90" in the April 1986 SURVEY for the definitions of
these payments.)
Although programs of the CCC accounted far the bulk of the
swing in expenditures, there were also swings from decline to
increase in national defense purchases of goods and services and
in transfer payments to foreigners. National defense purchases
increased $11 1/2 billion after a $1 1/2 billion decline in the
first quarter. The increase was concentrated in military
hardware--especially aircraft and missiles, which included the
delivery of two additional B-1 bombers and the first two MX
missiles--and in research and development. The only major
decline--over $2 billion--was for purchases of petroleum
products, reflecting declining prices. Transfer payments to
foreigners increased $2 1/2 billion after a $5 billion decline in
the first quarter. The first-quarter decline was the result of a
fourth-quarter payment of the entire amount of the fiscal year
1986 economic assistance to Israel. The second-quarter increase
was in both military and economic assistance.
Among other expenditures, grants-in-aid to State and local
governments increased $3 1/2 billion. The increase was accounted
for by payments to five States for settlement of a dispute
between the Federal and State governments over revenue from
leases of the Outer Continental Shelf and from royalties paid on
discovered oil. The largest payments--$1 1/2 billion each--were
to Texas and California.
Cyclically adjusted surplus or deficit.--When measured using
cyclical adjustments based on middle-expansion trend GNP, the
Federal fiscal position moved from a deficit of $214 billion in
the first quarter to a deficit of $244 billion in the second (see
table 2). The cyclically adjusted deficit as a percentage of
middle-expansion trend GNP increased from 5.2 percent in the
first quarter to 5.9 percent in the second.
The State and local sector.--The State and local government
surplus declined $10 billion in the second quarter to $60
billion, as expenditures increased more than receipts. A decline
in the surplus of other than social insurance funds more than
accounted for the total decline.
Receipts increased $3 billion, compared with $15 1/2 billion
in the first quarter, when receipts were boosted by the payment
of a fine ($8 billion at an annual rate) by a major petroleum
corporation as a result of a Supreme Court ruling on pricing
violations. Excluding the effects of this fine, receipts
increased $11 billion in the second quarter compared with $7 1/2
billion in the first; the acceleration was due to Federal
grants-in-aid and corporate profits tax accruals.
Expenditures increased $13 billion, compared with $8 billion
in the first quarter. The acceleration was largely in purchases
of goods and services; they increased $12 billion in the second
quarter, compared with $6 billion in the first. The stronger
pace of purchases was largely in purchases of structures; highway
construction increased $5 1/2 billion after declining $2 billion
in the first quarter. Among other types of purchases, a $2
billion decline in nondurable goods was offset by increases in
durable goods and services. The decline in nondurable goods was
more than accounted for by a drop in purchases of petroleum
products, reflecting declining prices.
Inventory-Sales Ratios
Inventory-sales ratios are often analyzed to help predict
inventory behavior. If a ratio is "low", it may suggest the need
to rebuild inventories; if it is "high," it may suggest the need
to liquidate inventories. In recent years, rapid growth of
imports and large transactions of the Commodity Credit
Corporation (CCC) have been suspected of reducing the predictive
value of the aggregate ratios calculated within the national
income and product account (NIPA) framework. The following
discussion compares one of these ratios--the constant-dollar
ratio of business inventories to business final sales--with two
variants of it to examine whether the usefulness of the ratio has
been reduced.
The import-adjusted variant
The first variant, as indicated in line 10 of table 3, is
derived by adding imports of merchandise and nonfactor services
to business final sales, the denominator of the published ratio.
(Imports of factor services--that is, of labor and property--are
not added, consistent with the general exclusion of nonbusiness
factor services from the denominator.) The rationale for this
modification follows from an implicit assumption--necessary
because of data limitations--about imports in the denominator.
Data are not available to split imports between final sales and
inventories, and the implicit assumption is made that all imports
are final sales to consumers, businesses, or governments in the
quarter in which they take place. The assumption is apparent in
that, in deriving GNP--a measure of U.S. produced goods and
services--as the sum of final sales and change in business
inventories, all imports are deducted from final sales. In
reality, however, some imports go into inventories and not into
final sales in the quarter of import. (The numerator, in fact,
includes inventories of imported goods.) To the extent that
imports go into inventories in the quarter of import, final sales
of GNP and business final sales, which is derived from final
sales of GNP, are understated. On the other hand, when imports
are added back into the denominator, on the assumption that all
imports go into inventories, business final sales are probably
overstated. The ratio and the import-adjusted variant therefore
provide--with respect to treatment of imports--upper and lower
estimates, respectively, of the "true" ratio.
The import-adjusted variant lies below the published ratio,
reflecting the larger denominator of the variant. From the first
quarter of 1972 to the second quarter of 1986, the variant and
the ratio registered generally similar quarter-to-quarter
changes. The differences in movement were as much as 0.04 in
only two quarters. The ratio and the variant moved in opposite
directions in only three isolated quarters, and even in these
instances, the differences in movement were small.
During the economic expansion from the third quarter of
1982, the ratio and the variant registered quite similar changes
except in the fourth quarter of 1982, when the ratio fell more
sharply than the variant, and in the first quarter of 1985, when
the ratio fell and the variant increased. These two quarters are
the only quarters in the expansion when imports of merchandise
and nonfactor services declined. However, the ratio and the
variant slowly drifted further apart: From its peak in the third
quarter of 1982 to the second quarter of 1986, the ratio dropped
from 3.54 to 3.24, while the variant declined slightly more--from
3.17 to 2.82. A strong increase in imports gave rise to this
slow drift; constant-dollar imports of merchandise and nonfactor
services increased at an annual rate of over 12 percent.
Because the ratio and the variant represent the upper and
lower estimates of the "true" ratio with respect to the effect of
imports, this slow drift may suggest a slight increase in
uncertainty about the level of the true ratio. Nevertheless, in
the historical context, both the ratio and the variant yield
similar insights into the likely course of inventory investment.
For example, for the period shown in chart 1, both the ratio and
the variant reached their lowest levels in the fourth quarter of
1985. Prior to that, both had been declining for several
quarters and were at levels that appear low by historical
standards. Thus, to the extent that such low levels presage
increases in inventories, both would have provided the same
signal as of that quarter. The slight increases in the ratio and
the variant since then, although smaller for the variant, would
not have clearly changed that signal.
The CCC-adjusted variant
The second variant, as indicated in line 11 of the table, is
derived by adding the stock of inventories held by the CCC to the
stock of business inventories in the numerator of the ratio and
subtracting CCC inventory changes from business final sales in
the denominator. The purpose of the variant is to abstract from
the effect on the inventory-sales ratio of the NIPA treatment of
CCC inventories, in which the CCC commodity loan program has been
the major source of recent quarter-to-quarter volatility. (CCC
programs and their treatment in the NIPA's were summarized in the
April 1986 Survey of Current Business, pp. 34-35.) In the
NIPA's, new CCC loans to farmers are recorded as Federal
Government purchases in business final sales, and farmers'
redemptions--which can be made at any time during the loan
period--are recorded as negative purchases. Accordingly, when a
crop is placed under loan, farm inventories are reduced below,
and CCC inventories are increased above, what they otherwise
would have been. Thus, in the quarter when a farmer places his
crop under loan with CCC, economy-wide inventories are not
changed but both the numerator and denominator of the
inventory-sales ratio are affected--the numerator decreases, the
denominator increases, and the ratio, consequently, declines.
(Total CCC inventories are used in calculating both the numerator
and denominator for this variant because the portion of CCC
inventories not associated with the commodity loan program is
relatively small and can be safely ignored for the purpose at
hand.)
When the two are distinguishable in the chart, the
CCC-adjusted variant lies above the published ratio. From the
first quarter of 1972 to the second quarter of 1986, this variant
and the ratio registered generally similar quarter-to-quarter
changes. The differences in movement were 0.04 or more in only
two quarters. The ratio and the variant moved in opposite
directions in only two isolated quarters. Both of these
instances--the second quarter of 1984 and the fourth of
1985--were during the present expansion.
The difference in the movement of the ratio and the variant
in the fourth quarter of 1985 was the larger of the two instances
of movement in the opposite direction and also the largest
without regard to sign. The ratio declined from 3.23 to 3.20,
while the variant increased from 3.31 to 3.34. The decline in
the ratio occurred as inventories fell and final sales increased,
and the increase in the variant occurred as inventories increased
while final sales were flat. For CCC-adjusted inventories, the
change reflected an unusually large addition to CCC
inventories--$8.0 billion at a quarterly rate (or $32.3 billion
at an annual rate, as shown in the addendum to table 1). For
CCC-adjusted final sales, the change excluded an increase in CCC
inventory change--from $1.0 billion at a monthly rate in the
third quarter to $2.7 billion in the fourth (or, at an annual
rate, from $11.5 billion to $32.3 billion).
In both instances in which the ratio and the variant moved
in opposite directions (and only in those instances), two
conditions were satisfied. First, the change in CCC
inventories--the adjustment to the numerator--and the change in
the ratio were in opposite directions; second, the change in the
change in CCC inventories--the adjustment to the denominator--was
more than $15 billion (annual rate) and was in the direction
opposite to the change in the ratio. More generally, if the
change in the change in CCC inventories is larger than about $10
billion, then changes in the ratio and the variant are likely to
be dissimilar in direction or magnitude. Although the signals
sent by the ratio and variant have not been substantially
different in the past, the variant may provide useful perspective
when these conditions occur.
