August 2006

U.S. Economic Growth Slowing, but CPI Remains Elevated

Recent data continue to portray an economy in which growth is slowing, but also one in which the rate of core consumer price inflation remains elevated.

GDP Growth Slows in the Second Quarter
Real GDP growth slowed to a 2.5 percent annual rate in the second quarter of 2006, down from the first quarter’s robust 5.6 percent rate and about a percentage point less than the average rate at which output grew over the prior three years.

Chart 1 characterizes recent GDP growth in terms of some of its constituent parts. The bars over each component denote the component’s contributions to overall GDP growth, in percentage points. The green bars denote a component’s average contributions over the 13 quarters from first quarter 2003 to first quarter 2006; the orange bars denote first quarter 2006; and the purple bars, the most recent quarter.

SOURCE: Bureau of Economic Analysis

As Chart 1 indicates, much of the slowing in second quarter GDP growth owes to a smaller contribution from personal consumption expenditures. PCE contributed 1.7 percentage points to growth, after adding 3.4 percentage points in the first quarter and 2.5 percentage points, on average, since the start of 2003.

The impact of a slowing housing market was also evident in the second quarter data, as residential investment fell, subtracting 0.4 percentage point off overall GDP growth. That sizable negative contribution marks the first time since late 2001 that residential investment has been a significant drag on growth. Over the period 2003:Q1–2006:Q1, residential investment had been good for about +0.4 percentage point of GDP growth on average.

Business investment cooled somewhat in second quarter 2006. While investment in structures grew at a 12.7 percent annual rate, investment in equipment and software declined at a 1 percent rate. As shown in Chart 1, overall, private nonresidential fixed investment—business investment in structures, equipment and software—contributed 0.3 percentage point to second quarter GDP growth, about half its average contribution since 2003.

Employment Gains Continue at a Slower Pace
The pace of employment growth remains moderate, as it has been for the past four months (Chart 2).

SOURCE: Bureau of Labor Statistics

The downshift in employment growth—from an average 171,000 net new jobs per month from January 2004 to March 2006 to 112,000 per month since then—is almost entirely accounted for by the behavior of two sectors, construction and retail trade:

Growth in the Manufacturing Sector Remains Healthy
In contrast to the signs of cooling elsewhere in the economy, data on the manufacturing sector show growth continuing at a solid pace. Manufacturing output grew a healthy 0.8 percent in June, according to Federal Reserve Board data, and the timely purchasing managers survey from the Institute for Supply Management points to continued growth in July.

The combination of strong growth in manufacturing output with slowing growth in domestic consumer demand raises an obvious concern regarding manufacturers’ inventories. In the past, periods of slower growth have tended to be accompanied by rapid inventory buildups, as producers were slow to adjust production to changing demand. There is, however, no sign as yet of any widespread inventory buildup (Chart 3).

SOURCE: Census Bureau

Inventories have grown relative to sales in a couple subsectors, though, such as wood products and nonmetallic minerals. The culprit behind the buildups is most likely the slowdown in residential construction.[1]

Inflation Remains Elevated
Core consumer price inflation remains elevated, according to both the Consumer Price Index (CPI) and the price index for Personal Consumption Expenditures (PCE). Chart 4 plots recent 12-month inflation rates for the PCE excluding food and energy, the Dallas Fed’s trimmed-mean PCE and the Cleveland Fed’s median CPI.

SOURCE: Bureau of Economic Analysis, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Dallas

The current 12-month PCE excluding food and energy rate of 2.4 percent is the highest value that number has taken since early 1995, apart from a one-month spike due to the effects of 9/11 on insurance costs. The trimmed mean PCE and median CPI were last at their current levels in November 2001 and September 2002, respectively.

—Jim Dolmas

Note According to the Census Bureau: “The Nonmetallic Mineral Product Manufacturing subsector includes establishments that manufacture products, such as bricks, refractories, ceramic products, and glass and glass products, such as plate glass and containers. Also included are cement and concrete products, lime, gypsum and other nonmetallic mineral products including abrasive products, ceramic plumbing fixtures, statuary, cut stone products, and mineral wool. The products are used in a wide range of activities from construction and heavy and light manufacturing to articles for personal use.”