Falling Inventories Dampen Growth in the Second Quarter

July 29, 2016

July 29, 2016 (GDP Byte)

By Dean Baker

Non-residential investment was a serious drag on growth in the first half of 2016.

A sharp slowing of the rate of inventory accumulation led to a lower than expected 1.2 percent GDP growth rate in the second quarter. The weakness of inventories subtracted 1.16 percentage points from the quarter’s growth. Final demand grew at a moderate 2.4 percent annual rate. The first quarter’s data were also revised down from 1.1 to 0.8 percent, meaning that the economy grew at just a 1.0 percent annual rate in the first half of the year.

Consumption is by far the main factor driving growth in the quarter, growing at a 4.2 percent annual rate. Most of this growth was on the goods side, which grew at a 6.8 percent annual rate, while consumption of services grew at a more modest 3.0 percent rate. There were some anomalies driving this growth. Food grew at a 8.6 percent rate adding 0.41 percentage points to the quarter’s growth, while housing and utilities grew at a 4.2 percent rate, adding 0.52 percentage points to the quarter’s growth. The jump in both areas is likely to be at least partially reversed in future quarters, slowing growth. This is especially likely in the housing category where utility use is driven to a large extent by the weather.

Nominal spending on health care grew at a 5.4 percent annual rate, exceeding the 3.5 percent growth rate of nominal GDP. While health care spending has been growing modestly as a share of GDP in recent quarters, its growth rate remains well below the pace of the first half of the last decade.


Most categories of investment were negative, with non-residential structures falling at a 7.9 percent rate and equipment investment falling at a 3.5 percent rate. The decline in structure investment is due to serious overbuilding in many categories. The drop may not continue, but we are unlikely to see a substantial turnaround. Equipment investment has been weak both due to the plunge in energy prices and also the rising trade deficit reducing demand in the U.S. manufacturing sector. Investment in intellectual property products grew at a modest 3.5 percent rate.

Residential construction fell at a 6.1 percent rate, after six consecutive quarters of strong growth. This drop will almost certainly be reversed in the next two quarters, as the sector remains a modest positive for the economy.

Trade was a small positive, adding 0.23 percentage points to growth in the quarter. Exports grew at a 1.4 percent annual rate while imports declined at a 0.4 percent rate. The weakness of imports is likely associated with the drop in inventories, as a large portion of inventories are imported. Interestingly, the rise in exports was all on the goods side as exports of services fell at a 0.9 percent annual rate, its fourth drop in the last five quarters. Imports of services rose at a 1.5 percent annual rate, its fifth consecutive increase.

Government spending fell at a 0.9 percent annual rate, subtracting0.16 percentage points from this quarter’s growth. Federal, state, and local spending declined in the quarter, but most of the drop was due to a 1.3 percentage drop in state and local spending.

The core personal consumption expenditure deflator increased at a 1.7 percent annual rate in the quarter, and is still under the Fed’s targeted 2.0 percent average rate. The inflation rate by this measure has averaged just 1.6 percent over the last five years.

The savings rate was 5.5 percent in the second quarter, the lowest rate since the first quarter of 2015. This may call into question all the compelling explanations as to why households were not spending their dividend from falling energy prices, since it seems they were.

The revisions released with this quarter’s data had a modest positive effect on the growth picture of the last three years, with both the growth numbers for 2013 and 2015 being revised up by 0.2 percentage points. The average growth for these three years now stands at 2.2 percent.

While the second quarter’s drop in inventories will be reversed in future quarters, leading to a positive contribution to growth, it is questionable whether growth will even cross 2.0 percent for the year. Concerns at the Fed and elsewhere about overly rapid growth seem to be seriously misplaced.


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