GDP Advances 2.4 Percent; Revised Down from Original 2.5 Percent Estimate

Government spending cutbacks took a big bite from first quarter GDP, although consumers were resilient, even in the face of the end of the payroll tax cut at the beginning of the year. The second estimate for GDP for the first quarter was revised down to 2.4 percent from the first estimate of 2.5 percent. Increases in private inventory investment, exports, and in imports were less than previously estimated. First quarter GDP advanced by a seemingly-small 0.4 percent, so this increase to 2.4 percent may appear to be an improvement; however, inventories distorted the picture. Inventories added 0.63 percentage points to growth in the first quarter, so the measure that many economists focus on, real final sales of domestic product -- GDP less change in private inventories -- increased 1.8 percent in the first quarter. This compares with an increase of 1.9 percent in real final sales in the fourth quarter, so the economy is growing at about the same pace. In the fourth quarter, inventories subtracted 1.52 percentage points from growth. What gets added to inventories in one quarter gets drawn down in another, so the contribution to GDP from inventories is temporary. The underlying trends in real final sales indicates that GDP that is growing a bit below its long term potential, thought to be around 2.5 percent. However, once one excludes government spending cutbacks, economic output from the private sector actually is growing at stronger pace than the headline measure suggests. Consumer spending increased 3.4 percent in the first quarter, compared with an increase of 1.8 percent in the fourth. Consumer spending added 2.40 percentage points to GDP. Consumers bought more durable goods as well as spent more on non-durable goods and services. Durable goods spending increased 8.2 percent, compared with an increase of 13.6 percent. Non-durable goods spending increased 2.2 percent, compared with an increase of 0.1 percent. Spending on services increased 3.1 percent, compared with an increase of 0.6 percent. This stronger momentum from the consumer is encouraging, especially as many economists worried consumers would cut back their spending with the end of the payroll tax cut at the beginning of the year. Real nonresidential fixed investment increased 2.2 percent in the first quarter, compared with an increase of 13.2 percent in the fourth. Nonresidential structures, such as investments in new factories, stores and offices, decreased 3.5 percent, in contrast to an increase of 16.7 percent. Some giveback may be expected in this volatile category. Equipment and software increased 4.6 percent, compared with an increase of 11.8 percent. These business investment categories added 0.23 percentage points to GDP. Continued investment in these categories indicates businesses may see continued expansion on the horizon, and could point to more hiring ahead. Housing construction continued to post strong gains. Real residential fixed investment increased 12.1 percent, compared with an increase of 17.6 percent. Residential construction added 0.30 percentage points to GDP. Real exports of goods and services increased 0.8 percent in the first quarter, in contrast to a decrease of 2.8 percent in the fourth. The expansion in exports is encouraging, given weakness in many of our trading partners, especially Europe. Real imports of goods and services increased 1.9 percent, in contrast to a decrease of 4.2 percent. Because imports – a subtraction from GDP – expanded more than exports, the trade deficit widened, subtracting 0.21 percentage points from GDP. Real federal government spending and investment decreased 8.7 percent in the first quarter, compared with a decrease of 14.8 percent in the fourth. National defense decreased 12.1 percent, compared with a decrease of 22.1 percent. Nondefense decreased 2.1 percent, in contrast to an increase of 1.7 percent. Real state and local government spending and investment decreased 2.4 percent, compared with a decrease of 1.5 percent. Combined, government spending subtracted a large 0.97 percentage points from GDP. The price index for gross domestic purchases, increased 1.2 percent in the first quarter, 0.1 percentage point more than in the advance estimate; this index increased 1.6 percent in the fourth quarter. Excluding food and energy prices, the price index for gross domestic purchases increased 1.4 percent in the first quarter, compared with an increase of 1.2 percent in the fourth. The Fed's target for inflation is 2 percent, so this may give the Fed more room to continue monetary stimulus through its bond purchases, though the Fed will consider many different variables, especially employment-related data, in determining the amount and duration of quantitative easing. Strengthening private growth could mean less need for stimulus.