On February 27, 2009 the Bureau of Economic Analysis (BEA) released its preliminary estimate for fourth quarter real GDP. It shows a 6.2% annualized rate of contraction, considerably worse than the 3.8% downturn of January’s advance estimate. A revision to the estimated change in inventories was the largest factor in the downward revision to real GDP. Revisions to consumer spending and net exports were also material. The silver lining is that the revised inventory figure implies future changes to inventory stocks will be less of a drag on real GDP in the first half of 2009 than previously anticipated. New data indicate greater ongoing deterioration in private business activity than in other sectors, but recent budget legislation implies that increases in government purchases of goods and services will accelerate. The net result leaves our near-term outlook for real GDP about the same as anticipated in the March Notes on the Economy.

Background
The BEA’s advance estimates of the National Income and Product Accounts (NIPA) for fourth quarter 2008 indicated that total inventories grew slightly, boosting the annualize rate of change in real GDP by 1.3 percentage points. The preliminary estimate shows that inventory stocks were, instead, pared back. Since the shrinking of inventories took place more slowly than in the third quarter of 2008, the effect of inventories was still positive, albeit much reduced, adding 0.2 percentage points to the change in real GDP.

Estimates for consumer spending and net exports in the fourth quarter also had sizeable revisions. The advance estimate indicated an annualized decline of 3.5% for consumer spending. The preliminary estimate shows a decline of 4.3%, as consumer spending for nondurable goods and services weakened substantially late in the fourth quarter. Thus, the negative impact on real GDP was revised to 3.0 percentage points from 2.5 percentage points. Likewise, the estimated contraction in exports was revised from 19.7% to 23.6%, while there was little change in the estimate for imports. As a result, the impact on real GDP from net exports was changed from a positive 0.1 percentage points to a negative 0.5 percentage points.

Other revisions to the major sectors in the NIPA were of little effect on real GDP. Minor downward revisions to the level of business fixed investment were offset by higher estimates for homebuilding and government purchases.

Looking Ahead
Cuts to inventories will be a major drag on real GDP during the first half of 2009. The revision to the estimate for the change in inventories was not entirely unexpected. Prior to the publication of the advance NIPA estimates for the fourth quarter, we projected that the change in inventories would push the annualized rate of decline in real GDP down by 0.5 percentage points. Since the preliminary estimate still shows a positive contribution to real GDP, the implication is that businesses remain well behind in their efforts to bring inventories back in line with sales. New figures for December inventories confirm that inventory-to-sales ratios are considerably elevated. However, the downward impact on our projections for real GDP is reduced by roughly the amount of the difference between the advance and preliminary estimates for inventories.

The downward revision for consumer spending is cause for concern. Although retail sales increased in January, this does not signal that a bottom is at hand. Consumer sentiment expressed in University of Michigan and Conference Board surveys plummeted in February. Based on weekly unemployment claims data, we anticipate that payrolls shrunk by more than 700,000 in February and that the unemployment rate, which was 7.6% in January, will close in on 8.0%. So consumer spending will probably still be down about 4.0%, or so, in the current quarter before bottoming out in the second quarter.

The weakness in exports was hardly a surprise and the downward revision was not abnormally large for such a volatile series. Imports were off dramatically, as well, due to the overall weakness in domestic demand, and there was little downward revision to the total import figure. As discussed in the March Notes a bounce-back in next exports is probable in the first quarter, before net exports turn into a consistent drag on GDP growth. However, the outlook for the first quarter bounce has been pared back in view of deteriorating economic conditions abroad.

Large double-digit percentage declines for business fixed investment and residential investment are still a sure thing in the first half of 2009. Recent reports for durable goods orders and new housing permits confirm previous expectations. On the other hand Congress wrapped up the budget for fiscal year 2009 with an omnibus bill containing higher budget authority and proposed outlays for discretionary spending than we had previously anticipated, boosting the outlook for growth of government purchases.

The Bottom Line
The first quarter’s decline in real GDP will be in the range of 6.0% to 6.5% annualized, while the contraction for the full year 2009 will top 3.0%.