Four Percent Fourth Quarter Growth Leaves GDP 2.5 Percent Below Year-Ago Level

January 28, 2021

Consumption spending has been contracting over the course of the fourth quarter

The economy grew at a 4.0 percent annual rate in the fourth quarter, driven largely by strong growth in housing and investment in equipment. This growth, following the extraordinary 33.4 percent post-shutdown growth in the third quarter, still leaves the GDP 2.5 percent below its year-ago level.

The growth reported for consumption is entirely due to strong third-quarter growth.

There is an important timing issue here that can be missed by just looking at the quarterly growth number. The growth rate is based on the average level of GDP in the fourth quarter compared with the average for the third quarter. GDP, and especially consumption, was growing rapidly throughout the quarter. If consumption had just remained at its September level throughout the fourth quarter, its growth rate for the quarter would have been 4.3 percent. Instead, consumption grew at just a 2.5 percent annual rate, which means that it actually contracted in the last three months of the year.

Housing is booming due to low rates and remote work allowing people to relocate.

Housing grew at an extraordinary 33.5 percent annual rate in the fourth quarter after rising at a 63.0 percent rate in the third quarter. This growth added 1.29 percentage points to the quarter’s growth rate and put residential construction 13.7 percent above its year-ago level. This is clearly being driven by low interest rates and also the decision of many people to relocate now that they have increased opportunities for remote work.

Investment in equipment and intellectual products has completely recovered.

Equipment investment grew at a 24.9 percent annual rate after growing at a 68.2 percent rate in the third quarter. This added 1.3 percentage points to the quarter’s growth and put equipment investment 3.4 percent above its year-ago level. Investment in intellectual products is also slightly above its year-ago level, with 7.5 percent growth in the quarter, putting it 1.4 percent higher than the fourth quarter of 2019. Investment in intellectual products had a relatively modest drop of 11.4 percent during the shutdown, so it did not need a sharp rebound to recover lost ground.

Investment in nonresidential structures is way down from year-ago levels.

Investment in nonresidential structures rose 3.0 percent in the fourth quarter but is still down 14.1 percent from year-ago levels. This is due to a sharp drop in construction of offices, manufacturing facilities, and hotels.

Goods consumption is above year-ago levels, but consumption of services is down sharply.

We have seen a sharply divergent path for categories of consumption in the pandemic. While consumption of durable goods was flat, and consumption of nondurables actually fell at a 0.7 percent rate in the quarter, spending in these categories is up from year-ago levels by 11.9 percent and 4.3 percent, respectively. By contrast, spending on services, by far the largest category of consumption, is still down 6.8 percent over the year-ago level despite having grown at a 4.0 percent rate in the quarter.

Falloff in service consumption is directly attributable to the pandemic.

This primarily reflects people’s continuing reluctance to go to restaurants or to travel because of the pandemic. The growth in service consumption in the fourth quarter was overwhelming due to increased spending on medical services, which accounted for 79.2 percent of the quarter’s increase. Spending by nonprofits more than accounted for the rest of the gain.

Some of the spending on goods is simply a shift, as spending on store-bought food is 6.2 percent higher than its year-ago level. Low interest rates have helped to fuel the boom in durable goods consumption, both by reducing the cost of car loans and spurring home buying, which leads to purchases of major appliances.

A record trade deficit subtracts from fourth quarter growth.

The trade deficit expanded again in the fourth quarter as imports grew at a 29.5 percent annual rate, while exports only rose at a 22.0 percent rate. Measured in constant dollars, the deficit hit a record $1121.1 billion in the fourth quarter, as the increase subtracted 1.52 percentage points from the quarter’s growth.

State and local government spending continues to contract due to lost revenue.

The government sector was again a drag on growth, subtracting 0.22 percentage point from fourth quarter growth. Most of this story is on the state and local side, which shrank at an annual rate of 1.7 percent in the quarter. Spending is now 2.5 percent below the year-ago level. State and local spending will likely continue to contract without assistance from the federal government.

The high savings rate indicates a strong basis for recovery once the pandemic is controlled.

The savings rate remains at an extraordinarily 13.7 percent. This compares to a normal rate near 8.0 percent. People who have kept their jobs have considerable money to spend once the fear of the pandemic lessens.

This again points to the urgency of containing the pandemic. Many sectors of the economy are doing fine, or even booming, as they are shielded from the worst effects of the pandemic and benefitted by extraordinarily low interest rates. If we can contain the pandemic, we should see a healthy economic recovery.

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