January 30, 2015

Trade was a major drag on 4th quarter growth and will continue to be if the dollar stays high.

A weak trade performance and a sharp reversal in military spending held GDP growth to 2.6 percent in the fourth quarter. This brought the full year growth (Q4 to Q4) to 2.5 percent, a modest slowing from the 3.1 percent rate in 2013. The growth rate of final demand in the fourth quarter was even weaker at 1.6 percent, as inventory accumulations added 0.82 percentage points to growth.

The slowdown in the fourth quarter was predictable as third quarter growth was driven in part by a 16.0 percent jump in military spending. Military spending is highly erratic and sharp swings are usually reversed, as was the case in this quarter. Military spending declined at a 12.5 percent annual rate, subtracting 0.58 percentage points from growth in the quarter. The general path for military spending is likely to be downward in the near future, although not enough to be a major drag on growth. Other categories of government spending rose modestly in the quarter, with non-military federal spending rising at a 1.7 percent rate and state and local government spending growing at a 1.3 percent rate. We are likely to see continued modest growth in these sectors.


Trade was also a big subtraction from growth, as imports grew much more rapidly than exports. After adding 0.78 percentage points to growth in the third quarter, net exports subtracted 1.02 percentage points from growth in the fourth quarter. Trade is likely to be an ongoing drag to growth in future quarters as the higher dollar makes U.S. goods and services less competitive and austerity policies in Europe continue to depress growth in a major trading partner.

Investment spending was also weak in the quarter. Non-residential investment rose at just a 1.9 percent annual rate with equipment investment actually shrinking at a 1.9 percent annual rate. The slow pace of growth in investment spending likely reflects both the continuing weakness of demand growth and probably an ongoing shift to production offshore. The latter will accelerate if the recent rise in the dollar is not reversed. Housing construction grew at a 4.1 percent annual rate, adding 0.13 percentage points to growth. Housing is likely to continue to increase at roughly the same pace in future quarters.

Health care spending continues to be reasonably well-contained, with nominal spending rising at a 5.2 percent annual rate. This is somewhat above the 4.0 percent rate over the last year, but down from last quarter’s 6.1 percent rate. Other areas of consumer spending grew rapidly, with overall consumption growth rising at a 4.3 percent annual rate. Durable goods were again a driving factor, growing at a 7.4 percent rate, but non-durable consumption also saw strong growth, rising at a 4.4 percent annual rate. Gasoline and energy consumption rose at a 12.2 percent annual rate adding 0.25 percentage points to growth.

The pace of growth of consumption is likely to be slower in future quarters. With car sales already at a very high level, they are unlikely to increase much in the future. Similarly, the jumps in gasoline consumption and also clothes will probably not be repeated. The current saving rate of 4.6 percent is low by historical standards, so it is not plausible to expect it to fall still lower on a sustained basis.

The sharp drop in energy prices brought the rate of inflation as measured by the GDP deflator to zero. The core PCE deflator rose at just a 1.1 percent annual rate in the quarter, well below the Fed’s 2.0 percent inflation target.

The surge in inventory accumulation brought the annual rate to $113.1 billion. This is probably about $50-$60 billion higher than the trend rate, which means that inventory accumulation will likely be a drag on growth in future quarters.

On the whole this report suggests that the economy will continue on a modest growth path that is not qualitatively different from prior years in the recovery. The relatively weak 4th quarter numbers may be a surprise to fashion driven economists, but it was predictable given the composition of growth in prior quarters.