September 2006

Moderating Growth, Elevated Inflation

Moderating growth and elevated inflation continue to characterize the national economy.

Second-quarter GDP growth was revised up to 2.9 percent from the Bureau of Economic Analysis’s “advance” estimate of 2.5 percent.[1] While several components were revised upward, residential investment was revised downward and is now estimated to have shaved 0.6 percentage point off second quarter growth. That -0.6 percentage point contribution from residential investment represents a swing of a full percentage point from the +0.4 that residential investment contributed, on average, over the 13 quarters from first quarter 2003 through first quarter 2006.

The drag from residential investment may yet worsen before it gets better, as Chart 1 seems to suggest. The chart shows four-quarter growth in real residential investment together with the 12-month change in the National Association of Home Builders' Housing Market Index (HMI). The HMI aggregates NAHB members’ responses to questions about current single-family sales, expectations for sales over the next six months and traffic of prospective buyers. As the chart shows, changes in the HMI tend to presage changes in residential investment. The index’s August 2005 to August 2006 decline—the last data point on the chart—is the largest 12-month decline the index has seen.

Data on employment for the month of August, which came out on September 1, showed continued moderate job gains, with nonfarm payroll employment up by 128,000. Over the past five months, payroll growth has averaged about 120,000 net new jobs per month, compared with a pace of about 170,000 per month from the start of 2004 through March of this year. The current pace is probably below what is needed to absorb normal labor force growth.[2]

The pace of consumer spending growth appeared to pick up at the start of the third quarter after modest growth of 2.7 percent, annualized, over the second quarter. Real, or inflation-adjusted, personal consumption expenditures (PCE) grew at a 6.3 percent annualized rate in July. The top contributors to July’s growth were motor vehicles and parts (which contributed 1.7 percentage points), gasoline and other motor fuel (1.3 percentage points) and—perhaps reflecting hotter-than-normal temperatures in July—electricity (0.5 percentage point).

Real PCE data for August are not yet available, but nominal retail sales grew at a 2.9 percent annualized rate during the month. Since these data are not adjusted for inflation, they incorporate the effects of changes in the prices by consumers as well as changes in the quantities purchased by consumers. For example, August saw a much smaller increase in gasoline prices than in prior months and this pulled down overall retail sales growth. Nominal retail sales excluding sales at gasoline stations grew at a 4.7 percent annualized rate.

On the inflation front, conventional “ex food and energy” measures of core consumer price inflation showed signs of deceleration in July and August. The ex food and energy inflation rate for personal consumption expenditures fell to an annualized 1.7 percent in July after posting rates above 2.5 percent for the prior four months. The Consumer Price Index (CPI) excluding food and energy grew at annualized rates of 2.4 percent and 2.9 percent in July and August, respectively, down from the 3.5–4 percent rates the index had posted over the prior few months.

Whether these two months’ worth of data signal a downshift in the rate of core consumer price inflation is unclear. Neither the Dallas Fed’s trimmed mean PCE inflation rate nor the Cleveland Fed’s median CPI showed any significant slowing in July. While the Cleveland Fed measure did decelerate in August, it still came in at an annualized 3.4 percent rate.

An analysis of the underlying components of the PCE index shows a significant fraction of “core” components experiencing price increases at annualized rates better than 3 percent. Chart 2 plots monthly data on the expenditure-weighted share of nonfood, non-energy items growing at a better than 3 percent annualized rate. [3] The raw series, shown in orange, is quite volatile; the blue line is a six-month moving average. The six-month moving average in July was at about the peak it reached in 2001, with around 60 percent of nonfood, non-energy items experiencing better than 3 percent annualized rates of price growth. Prior to 2001, one has to go back to 1993 to reach a similar level.

—Jim Dolmas

Notes The BEA’s “final” estimate is due out September 28. Labor force growth over the past year has been about 1.3 percent. Monthly gains would need to average about 145,000 per month to absorb labor force growth at a 1.3 percent annual rate, assuming payroll employment’s share of overall employment remains stable. Data are through July; August PCE data come out September 29.