Monetary Policy Report submitted to the Congress on February 11, 2004,
pursuant to section 2B of the Federal Reserve Act
Section 2
ECONOMIC AND FINANCIAL DEVELOPMENTS IN 2003 AND EARLY 2004
The pace of economic expansion strengthened considerably in the second
half of 2003 after almost two years of uneven and, on balance, sluggish
growth. In early 2003, accommodative monetary policy and stimulative
fiscal policies were in place, but economic activity still seemed to be
weighed down by a number of factors that had restrained the recovery
earlier: Geopolitical tensions were again heightened, this time by the
impending war in Iraq, businesses remained unusually cautious about the
strength of the expansion, and economic activity abroad was still weak.
In June the continued lackluster economic growth and a further
downshift in inflation from an already low level prompted a further
reduction in the federal funds rate. In addition, the tax cuts that
became effective at midyear provided a significant boost to disposable
income. In the succeeding months, the macroeconomic stimulus began to
show through clearly in sales and production, and some of the business
caution seemed to recede. Real GDP increased at an annual rate of 6
percent, on average, in the third and fourth quarters of last year. In
contrast, between late 2001 and mid-2003, real GDP had risen at an
annual rate of only 2-1/2 percent.
![Change in real GDP. Percent, annual rate. Bar chart. Date range is 1997 to 2003. Change in real GDP begins at about 4.7 percent, it then decreases to about 3.8 percent in the first half of 1998. Then it increases to about 6 percent by the end of 1999. In the first half of 2001 it decreases to about negative 3 percent and then it increases and ends at about 6.2 percent. NOTE: Here and in subsequent charts, except as noted, change for a given period is measured to its final quarter from the final quarter of the preceding period.](gifjpg/mpr204_c3.gif)
During the period of recession and subpar economic expansion,
considerable slack developed in labor and product markets. The firming
of economic activity in the second half of last year produced modest
increases in rates of resource utilization. Sustained efforts by
businesses to control costs led to further rapid gains in productivity.
As a result, unit labor costs declined, and core rates of inflation
continued to slow in 2003; excluding food and energy, the PCE
chain-type price index increased just 0.9 percent last year. Measures of
overall inflation, which were boosted by movements in food and energy
prices, were higher than those for core inflation.
![Change in PCE chain-type price index. Percent, annual rate. Bar chart. There are two series (Total and Excluding food and energy). Date range is 1997 to 2003. As shown in the figure, total begins at about 1.25 percent, then it decreases to about 1.9 percent in 1998. In 2000 it increases to about 2.3 percent and it ends at about 1.5 percent in 2003. Excluding food begins at about 1.3 percent in 1997, it then increases to about 2.1 percent in 2001. It then decreases and ends about 0.8 percent. NOTE: The data are for personal consumption expenditures (PCE).](gifjpg/mpr204_c4.gif)
Domestic financial market conditions appeared to become increasingly
supportive of economic growth last year. The economic expansion lowered
investors’ perception of, and perhaps aversion to, risk, and continued
disinflation was interpreted as a sign that monetary policy would
remain on hold, even as the economy picked up steam. Although yields on
Treasury coupon securities rose modestly on balance over the year, risk
spreads on corporate debt narrowed to the point that yields on
corporate issues declined. The low-interest-rate environment spurred
considerable corporate bond issuance and generated a massive wave of
mortgage refinancing activity by households. Equity markets began to
rally when the uncertainty over the timing of military intervention in
Iraq was resolved. The climb in stock prices continued for the rest of
the year, driven by improving corporate earnings reports and growing
optimism about the prospects for the economy. At the same time, with
economic conditions abroad improving and with concerns about the
financing burden of the U.S. current account deficit gaining increased
attention in financial markets, the dollar fell appreciably on a
trade-weighted basis.
The Household Sector
Consumer Spending
Early in 2003, consumer spending was still rising at about the same
moderate pace as in 2001 and 2002. In the late spring and in the
summer, however, households stepped up their spending sharply. As a
result, in the second half of last year, real personal consumption
expenditures rose at an annual rate of 4-3/4 percent after having
increased at a rate of just under 3 percent in the first half. Although
wage and salary earnings rose slowly during most of the year, the
midyear reductions in tax rates and the advance of rebates to
households eligible for child tax credits provided a substantial boost
to after-tax income. In 2003, real disposable personal income increased
3-1/4 percent, after having risen 3-1/2 percent in 2002. Low interest
rates provided additional impetus to household spending by reducing
borrowing costs for new purchases of houses and durable goods; they
also indirectly stimulated spending by facilitating an enormous amount
of mortgage refinancing.
![Change in real income and consumption. Percent, annual rate. Bar chart. There are two series (Disposable personal income and Personal consumption expenditures). Date range is 1997 to 2003. As shown in the figure, disposable personal income begins at about 4.2 percent, then it increases to about 5.5 percent in 1998. From 1999 to first half of 2003 it fluctuates within the range of about 4.5 and about 1.2 percent. It ends at about 2.9 percent.](gifjpg/mpr204_c5.gif)
The personal saving rate has fluctuated within a fairly narrow range
around 2 percent over the past three years. Although households
continued to see the value of their homes appreciate over this period,
they also were adjusting to the substantial drop in equity wealth that
occurred after the peak in the stock market in 2000. By itself, a fall
in the ratio of household wealth to income of the magnitude that
households experienced between 2000 and 2002 might have triggered a noticeable increase in the personal saving rate. However, in this case, the tendency for households to save more as their wealth declines appears to have been tempered in part by their willingness to take advantage of the attractive pricing and financing environment for consumer goods.
![Personal saving rate. By percent. Line chart. Date range is 1981 to 2003. As shown in the figure, series begins at about 10 percent, then it generally increases to about 12 percent in 1982, then it decreases to about 8.5 percent in 1983. Then increases to about 11 percent in 1984. Then it generally decreases and ends at about 1.4 percent. NOTE: The data are quarterly and extend through 2003:Q4.](gifjpg/mpr204_c6.gif)
![Wealth-to-income ratio. Ratio. Line chart. Date range is 1981 to 2003. As shown in the figure, series begins at about 4.5. During 1992-1995 it fluctuates within the range of about 4.3 to about 4.9. It generally increases to about 6.3 in 2000, then it decreases and ends at about 5.1. NOTE: The data are quarterly and extend through 2003:Q3. The wealth-to-income ratio is the ratio of household net worth to disposable personal income.](gifjpg/mpr204_c7.gif)
Real consumer expenditures for durable goods surged more than 11
percent in 2003. Sales of new motor vehicles remained brisk as many
consumers responded to the low financing rates and various incentive
deals that manufacturers offered throughout the year. Falling prices
also made electronic equipment attractive to consumers, and spending on
home furnishings likely received a boost from the strength of home
sales. Altogether, real outlays for furniture and household equipment
jumped 13-1/2 percent in 2003.
In contrast, real consumer expenditures on nondurable goods and on
services continued to rise at a moderate pace, on balance, last year.
Outlays for food and apparel increased a bit faster than in 2002, and
the steady uptrend in spending for medical services was well
maintained. However, consumers responded to the higher cost of energy
by cutting back their real spending on gasoline, fuel oil, and natural
gas and electricity services.
Consumer confidence was shaken temporarily early in 2003 by concerns
about the consequences of a war in Iraq, but it snapped back in the
spring. Toward year-end, sentiment appeared to brighten more as
households saw their current financial conditions improve and gained
confidence that business conditions would be better during the year
ahead. Those positive views became more widely held in January, and the
index of consumer sentiment prepared by the Michigan Survey Research
Center (SRC) reached its highest level in three years.
![Consumer sentiment. Line chart. There are two series Conference Board (1985 = 100) and Michigan SRC (1966 = 100). Date range is 1990 to 2004. Conference Board begins at about 106, then it fluctuates within the range of about 84 and about 45 from 1990-1994. In 2000 it increases to about 145, then it decreases to about 84 in 2001. Then increases to about 110 in 2002. In 2003 it decreases to about 60. Then increases and ends at about 98. Michigan SRC begins at about 93, then it fluctuates within the range of about 90 and about 62 from 1990-1994. In 2000 it increases to about 106, then it increases to about 112 in 2000. In 2003 it decreases to about 79 and then it increases and ends at about 105. NOTE: The data are monthly and extend through January 2004. SOURCE: University of Michigan Survey Research Center and The Conference Board.](gifjpg/mpr204_c8.gif)
Residential Investment
Housing activity was robust for a second consecutive year in 2003.
After having risen 7 percent in 2002, real expenditures on residential
construction jumped more than 10 percent in 2003. These gains were
fueled importantly by the lowest levels of mortgage interest rates in
more than forty years, which, according to the Michigan SRC's survey of
consumer sentiment, buoyed consumer attitudes toward homebuying
throughout the year. The average rate on thirty-year fixed-rate
mortgages dropped sharply during the first half of 2003 and reached a
low of 5-1/4 percent in June. Although the thirty-year rate
subsequently firmed somewhat, it remained below 6 percent, on average,
in the second half of last year.
Construction of new single-family homes accelerated during 2003, and
for the year as a whole, starts averaged 1.5 million units, an increase
of 10 percent compared with the level in 2002. Sales of both new and
existing single-family homes also picked up sharply further last year.
The brisk demand for homes was accompanied by rapid increases in the
average price paid for them. The average price paid for new homes rose
10 percent over the four quarters of 2003, and the average price of
existing homes was up 7-3/4 percent over the same period. However,
house price inflation was lower after adjusting for shifts in the
composition of transactions toward more expensive homes. The
constant-quality price index for new homes, which eliminates the influence of
changes in their amenities and their geographic distribution, increased
4-3/4 percent over the four quarters of 2003--down from an increase of 6
percent during 2002. The year-over-year increase in Freddie Mac’s index
of the prices paid in repeat sales of existing homes stood at 5-1/2
percent as of the third quarter of 2003, compared with a rise of 7-1/4
percent as of the third quarter of 2002.
![Private housing starts. Millions of units, annual rate. Line chart. There are two series (Single-family and Multifamily). Date range is 1991-2003. As shown in the figure, single-family begins at about 0.7 then it generally increases to about 1.3 in 1993. From 1994 through 2002 it fluctuates within the range of about 1 percent and about 1.4. The series ends at about 1.65. Multifamily starts at about 0.2 in early 1991, it than increases to end at about 0.4. NOTE: The data are quarterly and extend through 2003:Q4.](gifjpg/mpr204_c9.gif)
Starts in the multifamily sector totaled 350,000 units in 2003, a pace
little changed from that of the past several years. Vacancy rates for
these units rose and rents fell during the year, but falling mortgage
rates apparently helped to maintain building activity.
Household Finance
Household debt increased 10-3/4 percent last year, in large part
because of the surge in mortgage borrowing induced by record-low
mortgage interest rates. Refinancing activity was torrid in the first
half of the year, as mortgage rates declined. Some of the equity that
households extracted from their homes during refinancings was
apparently used to fund home improvements and to pay down
higher-interest consumer debt. When mortgage rates rebounded in the second
half of the year, mortgage borrowing slowed from the extremely rapid
clip of the first half, but it remained brisk through year-end.
Consumer credit increased at a pace of 5-1/4 percent in 2003, a little
faster than a year earlier, as revolving credit picked up somewhat from
the slow rise recorded in 2002. Despite the pickup in household
borrowing, low interest rates kept the household debt-service and
financial-obligation ratios--which gauge pre-committed expenditures
relative to disposable income--at roughly the levels posted in 2002.
Most measures of delinquencies on consumer loans and home mortgages
changed little on net last year, and household bankruptcies held
roughly steady near their elevated level in 2002.
![Mortgage rates. By Percent. Line chart. There are two series (Fixed rate and Adjustable rate). Date range is 2000 to 2004. As shown in the figure Fixed rate begins at about 8.2 percent then it increases to about 8.5 percent in Q2 2000 and then it generally decreases to about 5 percent in Q2 2003. In Q3 2003 it increases to about 6.3 percent, then it decreases and ends at about 5.8 percent. Adjustable rate begins at about 6.7 percent, then it increases to about 7.2 percent in Q3 2000. Then it generally decreases and ends at about 3.5 percent. NOTE: The data, which are monthly and extend through January 2004, are contract rates on thirty-year mortgages. SOURCE. Federal Home Loan Mortgage Corporation.](gifjpg/mpr204_c10.gif)
![Delinquency rates on selected types of household loans. By Percent. Line chart. There are three series (Mortgages, Credit card pools, and Auto loans at domestic auto finance companies). Date range is 1991 to 2003. All series begin in early 1991. As shown in the figure, mortgages begin at about 1.6 percent, then it fluctuates but stays at about 1.6 percent by the end. Credit card pools begins at about 6 percent, then it decreases to about 4 percent in 1995. Then it increases to about 5.25 in 1997. In 2000 it decreases to about 4.5 percent. The series ends at about 5.25 percent. Auto loans at domestic auto finance companies begins at about 2.6 percent, then it increases to about 3.5 percent in 1997. It decreases and ends at about 2 percent. NOTE. The data are quarterly. The rates for credit card pools and mortgages extend through 2003:Q3; the rate for auto loans extends through 2003:Q4. SOURCE: For mortgages, the Mortgage Bankers Association; for auto loans, the Big Three automakers; for credit cards, Moody's Investors Service.](gifjpg/mpr204_c11.gif)
Even with the rapid expansion in debt, net worth of the household
sector increased as the value of household assets rose noticeably.
Stock prices were boosted by the rise in corporate earnings and the
ebbing of uncertainty about future economic growth. Households directed
substantial flows into stock mutual funds in the third and fourth
quarters despite highly publicized scandals in the mutual fund
industry. Although the companies directly implicated in wrongdoing
experienced heavy outflows from their funds, most of these withdrawals
apparently were transferred to other mutual funds with little effect on
the industry as a whole. A considerable rise in real estate wealth
further augmented household assets. Although prices of existing homes
climbed more slowly than they had in the previous year, the rate of
increase remained sizable. Overall, the advance in the value of
household assets outstripped the accumulation of household debt by
enough to boost the ratio of net worth to disposable income over the
year.
The Business Sector
Fixed Investment
Business spending on equipment and software was still sluggish at the
beginning of 2003. However, it accelerated noticeably over the course
of the year as profits and cash flow rebounded and as businesses gained
confidence in the strength of the economic expansion and in the
prospective payoffs from new investment. At the same time, business
financing conditions were very favorable: Interest rates remained low,
equity values rallied, and the enhanced partial-expensing tax provision
gave a special incentive for the purchase of new equipment and
software. After having changed little in the first quarter of the year,
real outlays for equipment and software increased at an annual rate of
11-3/4 percent over the remaining three quarters of the year.
![Change in real business fixed investment. Percent, annual rate. Bar chart. There are four series (Structures, Equipment and software, High-tech equipment and software, Other equipment excluding transportation). Date range is 1997 to 2003. Structures begins at about 4 percent, then it decreases to about negative 1 percent in 1999. In 2000 it increases to about 9 percent in 2000 and then it decreases and ends at about negative 3. Equipment and software begins at about 14 percent, then it decreases to about negative 8 percent in 2001. It ends at about negative 3 percent in 2003. High-tech equipment begins at about 31 percent, then it decreases to about negative 11 percent. Then it increases and ends at about 23 percent. Other equipment excluding transportation begins at about 6 percent, and then it decreases to about 2 percent in 1999. From 2000 to 2002 it fluctuates within the range of about 5 and about negative 10. It ends at about 9 percent. NOTE: High-tech equipment consists of computers and peripheral equipment, software, and communications equipment.](gifjpg/mpr204_c12.gif)
Outlays for high-technology items--computers and peripherals, software,
and communications equipment--which had risen a moderate 4-1/2 percent
in 2002, posted a significantly more robust increase of more than 20
percent in 2003. That gain contributed importantly to the pickup in
overall business outlays for equipment and software and pushed the
level of real high-tech outlays above the previous peak at the end of
2000. The increase in spending last year on computing equipment marked
the sharpest gain since 1998, and investment in communications
equipment, which had continued to contract in 2002 after having
plummeted a year earlier, turned up markedly.
In contrast, the recovery in spending on non-high-tech equipment was,
on balance, more muted, in part because outlays for transportation
equipment continued to fall. The prolonged slump in business purchases
of new aircraft continued in 2003 as domestic air carriers grappled
with overcapacity and high fixed costs. By the fourth quarter, real
outlays for aircraft had dropped to their lowest level in ten years. In
the market for heavy (class 8) trucks, sales were quite slow in early
2003 when businesses were concerned about the performance of models
with engines that met new emission standards. But as potential buyers
overcame those concerns, sales recovered. By the fourth quarter of
2003, sales of medium and heavy trucks had moved noticeably above the
slow pace of 2001 and 2002. Apart from outlays for transportation
equipment, investment in other types of non-high-tech equipment was, on
balance, little changed during the first half of the year. Demand was
strong for medical equipment, instruments, and mining and oilfield
machinery, but sales of industrial equipment and farm and construction
machinery were sluggish. In the second half of the year, however, the
firming in business spending for non-high-tech items became more
broadly based.
The steep downturn in nonresidential construction that began in 2001
moderated noticeably in 2003, although market conditions generally
remained weak. After having contracted at an average annual rate of
13-1/2 percent during 2001 and 2002, real expenditures for nonresidential
construction slipped just 1-1/4 percent, on balance, during 2003.
Spending on office buildings and manufacturing structures, which had
dropped sharply over the preceding two years, fell again in 2003. The
high office vacancy rates in many areas and low rates of factory
utilization implied little need for new construction in these sectors
even as economic activity firmed. Investment in communications
infrastructure, where a glut of long-haul fiber-optic cable had
developed earlier, also continued to shrink. In contrast, outlays for
retail facilities, such as department stores and shopping malls, turned
up last year, and the retrenchment in construction of new hotels and
motels ended. In addition, investment in drilling and mining
structures, which is strongly influenced by the price levels for crude
oil and natural gas, increased noticeably in 2003.
Inventory Investment
During 2002, businesses appeared to have addressed most of the
inventory imbalances that had developed a year earlier. But the
moderate pace of final demand during the first half of 2003 apparently
restrained firms from embarking on a new round of inventory
accumulation. Even though final sales picked up in the second half of
the year, the restraint seemed to recede only gradually. Over the first
three quarters of 2003, nonfarm businesses trimmed their inventories at
an average annual rate of $2-3/4 billion in constant-dollar terms, and
the preliminary estimate for the final quarter of the year indicated
only modest restocking. As a result, most firms appear to have ended
the year with their inventories quite lean relative to sales, even
after taking into account the downward trend in inventory-sales ratios
that has accompanied the ongoing shift to improved inventory
management. Motor vehicle dealers were an exception; their days' supply
of new vehicles moved higher on average for a second year in a row.
![Change in real business inventories. Billions of chained 2000 dollars, annual rate. Bar chart. Date range is 1997 to 2003. It begins at about 70 and then it increases to about 74 in 1998. Then it decreases to about negative 35 in 2001. It then increases and ends at about 5.](gifjpg/mpr204_c13.gif)
Corporate Profits and Business Finance
Higher profits allowed many firms to finance capital spending with
internal funds, and business debt rose only slightly faster than the
depressed rate in 2002. Moreover, a paucity of cash-financed merger and
acquisition activity further limited the need to issue debt. Gross
equity issuance was extremely weak in the first half of the year but
perked up in the latter half in response to the rally in equity prices.
Nevertheless, for the year as a whole, firms extinguished more equity
than they issued.
The pace of gross corporate bond issuance was moderate at the start of
the year but shot up in late spring as firms took advantage of low bond
yields to pay down short-term debt, to refund existing long-term debt,
and to raise cash in anticipation of future spending. Bond issuance by
investment-grade firms slowed after midyear as firms accumulated a
substantial cushion of liquid assets and as interest rates on
higher-quality debt backed up. However, issuance by speculative-grade firms
continued apace, with the yields on their debt continuing to decline
dramatically presumably because of investors’ increased optimism about
the economic outlook and greater willingness to take on risk. The sum
of bank loans and commercial paper outstanding, which represent the
major components of short-term business debt, contracted throughout the
year. In large part, this decline reflected ongoing substitution toward
bond financing, but it also was driven by the softness of fixed
investment early in the year and the liquidation of inventories over
much of the year.
![Corporate bond yields. By percent. Line chart. There are two lines (High yield and AA). Date range is 1990-2004. Both lines start in early 1990. High yield begins at about 16 percent. Then it generally increases to about 21 percent in the second half of 1990. Then it decreases to about 10 percent in 1994. From 1995-2003 it fluctuates within the range of about 9 and about 13 percent. Then it generally decreases and ends at about 7.5 percent. AA begins at about 9 percent, then it decreases and ends at about 4.9 percent. NOTE. The data are monthly averages and extend through January 2004. The AA rate is calculated from bonds in the Merrill Lynch AA index with a remaining maturity of seven to ten years. The high-yield rate is the yield on the Merrill Lynch 175 high-yield index.](gifjpg/mpr204_c17.gif)
![Financing gap and net equity retirement at nonfarm nonfinancial corporations. In billions of dollars. Line chart. There are two series (Net equity retirement and Financing gap). Date range is 1990 to 2003. They start in 1990 at about 60 percent. 'Net equity retirement' decreases to about negative 25 in 1992. Then it generally increases to about 220 by the middle of 1998. It then decreases and ends at about 50. Financing gap increases to about 310 billions of dollars in 2000. Then it generally decreases and ends at about negative 50. NOTE: The data are annual; 2003 is based on partially estimated data. The financing gap is the difference between capital expenditures and internally generated funds. Net equity retirement is the difference between equity retired through share repurchases, domestic cash-financed mergers, or foreign takeovers of U.S. firms and equity issued in public or private markets, including funds invested by venture capital partnerships.](gifjpg/mpr204_c16.gif)
![Major components of net business financing. Billions of dollars. Bar chart. There are three series (Commercial paper, Bonds, and Bank loans) and one line 'Sum of major components'. Date range is 2001 to 2003. Bank loans begins at about negative $40 billion in 2001. From Q2 2001-Q3 2003 it fluctuates but stays at about negative $50 billion. It ends at about negative $40 billion. Bonds begins at about $420 billion in 2001. Then it decreases to about $40 billion in the second half of 2002. In Q2 2003 it increases to about $300 billion, then it decreases and ends at about $40 billion. Commercial paper begins at about negative$90 billion in 2001. From second half of 2001 through Q2 2003 it fluctuates within the range of about negative 10 and about negative $60 billion. Series ends at about negative$40 billion. 'Sum of major components' begins at about $200 billion in early 2001, then it decreases to about negative $100 billion in the middle of 2001. In the second half of 2001 it generally increases to about $240 billion and then decreases to about negative $60 billion. It then increases to about $150 billion in Q2 2003. Series ends at about negative$ 100 billion. NOTE: Seasonally adjusted annual rate for nonfinancial corporate business. The data for the sum of major components are quarterly. The data for 2003:Q4 are estimated.](gifjpg/mpr204_c15.gif)
Respondents to the Senior Loan Officer Opinion Survey on Bank Lending
Practices noted that terms and standards on business loans were
tightened during the first half of the year but that both had been
eased considerably by year-end. They also reported that demand for
business loans was quite weak for much of the year. However, despite
the fact that outstanding levels of business loans continued to
decline, survey responses in the last quarter of the year indicated
that demand for loans had begun to stabilize. Many banks cited
customers’ increased investment and inventory spending as factors
helping to generate the increase in loan demand toward the end of the
year. The apparent divergence between survey responses and data on
actual loan volumes may suggest that demand for lines of credit has
increased but that these lines have not yet been drawn. In other
short-term financing developments, nonfinancial firms that issued commercial
paper in 2003 found a very receptive market, in large part because of
the scarcity of outstanding issues. Many of the riskiest borrowers had
exited the market in 2002, and remaining issuers improved their
attractiveness to investors by continuing to restructure their balance
sheets.
![Spread of low-tier CP rate over high-tier CP rate. In basis points. Line chart. Date range is 1997 to 2004. As shown in the figure it starts in the beginning of 1997 at about 20. It fluctuates within the range of 20 and 40 from 1997-2004. Five times it increases and then quickly decreases. In the end of 1998 (to about 90), in 1999 (to about 110), in 2000 (to about 140), in early 2002 (to about 100), in early 2003 (to about 70). It ends at about 5. NOTE: The data are daily and extend through February 4, 2004. The series shown is the difference between the rate on A2/P2 nonfinancial commercial paper and the AA rate.](gifjpg/mpr204_c18.gif)
Gross equity issuance rose over the course of 2003 as the economic
outlook strengthened and stock prices moved higher. The market for
initial public offerings continued to languish in the first half of the
year but showed signs of life by the end of the summer. The volume of
seasoned offerings also picked up in the second half of the year. On
the other side of the ledger, merger and acquisition activity again
extinguished shares in 2003, although only at a subdued pace. In
addition, firms continued to retire a considerable volume of equity
through share repurchases. For the year as a whole, net equity issuance
was negative.
Corporate credit quality improved, on balance, over the year. Notably,
the default rate on corporate bonds declined sharply, delinquency rates
on commercial and industrial (C&I) loans at commercial banks turned
down, and the pace of bond-rating downgrades slowed considerably. Low
interest rates and the resulting restructuring of debt obligations
toward longer terms also importantly contributed to improved business
credit quality. Bank loan officers noted that the aggressive tightening
of lending standards in earlier years was an important factor
accounting for the lower delinquency and charge-off rates in
recent quarters.
![Ratings changes of nonfinancial corporations. By percent. Bar chart. There are two series (Upgrades and Downgrades). Date range is 1995 to 2003. Upgrades begin at about 20 percent, then it decreases to about 9 percent in 1997. Then it increases to about 15 percent in 1998 and then it decreases and ends at about 4 percent. Downgrades begin at about negative 8, then it decreases to about negative 36 in 2002. It ends at about negative 18 percent. NOTE: For a given year, the percentage is calculated as the par value of bonds that were upgraded or downgraded in that year and outstanding in the fourth quarter of the previous year divided by the par value of the outstanding bonds of all nonfinancial corporations in that quarter: SOURCE. Moody's Investors Service.](gifjpg/mpr204_c21.gif)
![Net interest payments of nonfinancial corporations as a percent of cash flow. By percent. Line chart. Date range is 1977-2003. As shown in the figure, the series begins at about 8 percent, then increases to about 21 percent in 1989. In 1996 it decreases to about 11.5 percent and increases to about 20 percent in 2002. Then series generally decreases and ends at about 16 percent. NOTE: The data are quarterly and extend through 2003:Q3. SOURCE: Bureau of Economic Analysis.](gifjpg/mpr204_c19.gif)
Commercial mortgage debt increased noticeably during most of 2003
despite persistently high vacancy rates, falling rents, and sluggish
growth in construction expenditures. Low interest rates on this type of
collateralized debt may have induced some corporate borrowers to tap
the market to pay down more-costly unsecured debt. Delinquency rates on
commercial mortgages generally remained low throughout 2003, and risk
spreads were relatively narrow. Loan performance has held up well
because of low carrying costs for property owners and because the
outstanding loans generally had been structured to include a sizable
equity contribution, which makes default less attractive to borrowers.
The Government Sector
Federal Government
The federal budget deficit continued to widen in fiscal year 2003 as a
result of the slow increase in nominal incomes, outlays associated with
the war in Iraq, and legislative actions that reduced taxes and boosted
spending. The deficit in the unified budget totaled $375 billion, up
substantially from the deficit of $158 billion recorded in fiscal 2002.
The Congressional Budget Office is projecting that the unified federal
deficit will increase further in fiscal 2004, to more than $475
billion.
Federal receipts have fallen in each of the past three years; the drop
of nearly 4 percent in fiscal 2003 brought the ratio of receipts to GDP
to 16-1/2 percent, 2 percentage points below the average for the past
thirty years. About half of the decrease in receipts last year was a
consequence of legislation that shifted due dates for corporate
payments between fiscal years. In addition, personal income tax
collections dropped sharply because of the slow rise in nominal wages
and salaries, diminished capital gains realizations in 2002, and the
tax cuts enacted under the Jobs and Growth Tax Relief Reconciliation
Act of 2003. The act advanced refund checks to households eligible for
the 2003 increment to the child tax credit and resulted in lower
withholding schedules for individual taxpayers. The act also expanded
the partial-expensing incentive for businesses, but because corporate
profits accelerated sharply last year, corporate tax receipts rose
appreciably after adjusting for the shifts in the timing of payments.
![Federal receipts and expenditures. By percent of nominal GDP. Line chart. There are three series (Expenditures, Receipts, and Expenditures excluding net interest). Date range is 1985 to 2003. Expenditures and Expenditures excluding net interest generally moving together with Expenditures excluding net interest being about 2.5 percent lower. Expenditures begins at about 23 percent in early 1985 and Receipts and Expenditures excluding net interest begins at about 19 percent. Then during 1986-1999 they generally decrease. Expenditures to about 18.5 percent and Expenditures excluding net interest to about 16 percent. Expenditures end at about 20 percent and Expenditures excluding net interest ends at about 18.5 percent. Receipts start at about 17.5 percent. From 1985 to 2001 it increases to about 21 percent, then it generally decreases to end at about 17 percent. NOTE. The budget data are from the unified budget and are for fiscal years (October through September); GDP is for the year ending in Q3.](gifjpg/mpr204_c22.gif)
At the same time, federal outlays other than for interest expense rose
rapidly for the second consecutive year in fiscal 2003; these outlays
increased about 9 percent after having risen 11 percent in fiscal 2002.
Spurred by operations in Iraq, defense spending soared again, and
outlays for homeland security rose further. Spending for income
support, such as unemployment insurance, food stamps, and child credits
under the earned income tax credit program, also posted a sizable
increase. The ongoing rise in the cost and utilization of medical
services continued to push up spending for Medicare and Medicaid.
Overall, real federal consumption and investment (the measure of
federal spending that is included in real GDP) increased 6 percent over
the four quarters of 2003, after having risen 10 percent a year
earlier.
![Change in real government expenditures on consumption and investment. Percent. Bar chart. There are two series (Federal and State and local). Date range is 1997 to 2003. Federal begins at about negative 1 percent, then it increases to about 4 percent in 1999. In 2000 it decreases to about negative 2 percent. In 2002 increases to about 10 percent. It ends at about 6 percent. State and local begins at about 2 percent. Then it generally increases to about 5 percent in 1998. From 1999 it decreases and ends about 0.5 percent.](gifjpg/mpr204_c23.gif)
The federal government had contributed increasingly to national saving
in the late 1990s and 2000 as budget deficits gave way to accumulating
surpluses. However, with the swing back to large deficits in recent
years, the federal government has again become a drain on national
saving. Using the accounting practices followed in the national income
and product accounts (NIPA), gross federal saving as a percent of GDP
dropped sharply in late 2001 and has trended down since then; the drop
contributed to a decline in overall gross national saving as a percent
of GDP from 18 percent in calendar year 2000 to 13 percent, on average,
in the first three quarters of 2003. Federal saving net of estimated
depreciation fell from its recent peak of 2-1/2 percent of GDP in 2000
to negative 4 percent of GDP, on average, in the first three quarters
of 2003. As a result, despite a noticeable pickup in saving from
domestic nonfederal sources, overall net national saving, which is an
important determinant of private capital formation, fell to less than
1-1/2 percent of GDP, on average, in the first three quarters of 2003,
compared with a recent high of 6-1/2 percent of GDP in 1998.
![Net national saving. By percent of nominal GDP. Line chart. There are three series (Nonfederal saving, Total, and Federal saving). Date range is 1984 to 2003. All series start in early 1994. Nonfederal saving and Total generally moving together with Total being about 4 percent lower. Nonfederal saving begins at about 10.5 percent, then it generally decreases to about 7 percent in 1986. Total begins at about 6.5 percent, then it generally decreases to about 3 percent in 1986. From 1987 to 1997 they fluctuate within the range of about 9 and about 6 percent, with total being about 4 percent lower. In 1998 they split. Total decreases to end at about 1.5 percent. Nonfederal saving decreases to about 3 percent in 2001, then increases and ends about 6 percent. Federal saving begins at about negative 4 percent, then it increases to about 2.5 percent in 2000, then it decreases and ends at about negative 5 percent. NOTE. The data are quarterly and extend through 2003:Q3. Nonfederal saving is the sum of personal and net business saving and the net saving of state and local governments.](gifjpg/mpr204_c24.gif)
Federal Borrowing
The Treasury ramped up borrowing in 2003 in response to the sharply
widening federal budget deficit, and federal debt held by the public as
a percent of nominal GDP increased for a second year in a row after
having trended down over the previous decade. As had been the case in
2002, the Treasury was forced to resort temporarily to accounting
devices in the spring of 2003 when the statutory debt ceiling became a
constraint, but debt markets were not disrupted noticeably. In May, the
Congress raised the debt ceiling from $6.4 trillion to $7.4 trillion.
With large deficits expected to persist, the Treasury made a number of
adjustments to its regular borrowing program, including reintroducing
the three-year note, increasing to monthly the frequency of five-year
note auctions, reopening the ten-year note in the month following each
new quarterly offering, and adding another auction of ten-year
inflation-indexed debt. As a result of these changes, the average
maturity of outstanding Treasury debt, which had reached its lowest
level in decades, began to rise in the latter half of 2003.
![Federal government debt held by the public. By Percent of nominal GDP. Line chart. Date range of 1962 to 2003. As shown in the figure, the series begins at about 40 percent in early 1962. In 1973 it decreases to about 23 percent. In 1994 it increases to about 50 percent, then it decreases to end at about 35 percent. NOTE: Through 2002, the data for debt are year-end figures, and the corresponding value for GDP is for Q4 at an annual rate; the final observation is for 2003:Q3. Excludes securities held as investments of federal government accounts.](gifjpg/mpr204_c25.gif)
State and Local Governments
State and local governments faced another difficult year in 2003. Tax
receipts on income and sales continued to be restrained by the subdued
performance of the economy. Despite further efforts to rein in
spending, the sector’s aggregate net saving, as measured in the NIPA,
reached a low of negative $40 billion (at an annual rate), or negative
0.4 percent of GDP, in the first quarter of the year. Most of these
jurisdictions are subject to balanced-budget requirements and other
rules that require them to respond to fiscal imbalances. Thus, in
addition to reducing operating expenses, governments drew on reserves,
issued bonds, sold assets, and made various one-time adjustments in the
timing of payments to balance their books. In recent years, many have
also increased taxes and fees, thereby reversing the trend toward lower
taxes that prevailed during the late 1990s.
![State and local government net saving. By percent of GDP. Line chart. Date range is 1980 to 2003. As shown in the figure, the series begins at about 0.4 percent in early 1980. In 1983 it decreases to about negative 0.3 percent. In 1984 it generally increases to about 0.65 percent. During 1995-1993 it decreases to about negative 0.2 percent. In 1998 it increases to about 0.7 percent. Then it decreases to about 0.4 percent. Series ends at about 0.1 percent. NOTE: The data, which are quarterly, are on a national income and product account basis and extend through 2003:Q3.](gifjpg/mpr204_c26.gif)
Recent indications are that the fiscal stress in this sector is
beginning to ease. The improvement reflects a noticeable upturn in tax
collections in recent quarters while restraint on operating
expenditures largely remains in place. On a NIPA basis, real spending
on compensation and on goods and services purchased by state and local
governments was little changed in the second half of 2003, as it was
over the preceding year. However, investment in infrastructure, most of
which is funded in the capital markets, accelerated in the second half
of 2003. As of the third quarter of 2003, state and local net saving
had moved back into positive territory.
State and Local Government Borrowing
Gross issuance of debt by state and local governments was quite robust
last year. Weak tax receipts from a sluggish economy, significant
demands for infrastructure spending, and low interest rates all
contributed to the heavy pace of borrowing. Borrowing was strongest in
the second quarter of the year, as governments took advantage of the
extraordinarily low longer-term rates to fund capital expenditures and
to advance refund existing higher-cost debt. Because of the financial
stresses facing these governments, the credit ratings of several
states, most notably California, were lowered last year. Although bond
downgrades outnumbered upgrades for the sector as a whole, the
imbalance between the two was smaller than it was in 2002.
The External Sector
Over the first three quarters of 2003, the U.S. current account deficit
widened relative to the comparable period in 2002, a move largely
reflecting developments in the deficit on trade in goods and services.
Net investment income rose over the same period, as receipts from
abroad increased and payments to foreign investors in the United States
declined.
![U.S. trade and current account balances. Billions of dollars, annual rate. Line chart. There are two lines (Trade and Current account). Date range of 1996 to 2003. They start at about negative $100 billion in early 1996. Both series generally move together with Current account being slightly lower. They decrease to about negative $400 billion in 2000, then they increase to about negative $350 billion in 2001. Current account ends at about negative $550 billion and trade ends at about negative $500 billion. NOTE: The data are quarterly and extend through 2003:Q3.](gifjpg/mpr204_c27.gif)
International Trade
The trade deficit widened considerably in the first half of 2003 but
narrowed slightly in the third quarter, as the value of exports
rebounded in response to strengthening foreign economic activity and
the depreciation of the dollar. Available trade data through November
suggest that the trade deficit narrowed further in the fourth quarter,
as an additional strong increase in exports outweighed an increase in
imports.
![Change in real imports and exports of goods and services. Percent, annual rate. Bar chart with 2 series ('Imports' and 'Exports'). Date range of 1996 to 2003. All series start in the beginning of 1996. 'Imports' begins at about 11 percent. During 1997-2000 it fluctuates within the range of about 14 and about 11 percent. Then it decreases to about negative 8 percent in 2001. Then it increases to about 13 percent in 2002. It ends at about 6 percent. 'Exports' begins at about 10 percent and decreases to 2.5 percent in 1998. From 1999 to 2002 it fluctuates within the range of about 7.5 and about negative 12 percent. It ends at about 14 percent.](gifjpg/mpr204_c28.gif)
Real exports of goods and services increased about 6 percent in 2003.
Exports of services rose about 5 percent. They were held down early in
the year by a drop in receipts from foreign travelers, owing to the
effects of the SARS (severe acute respiratory syndrome) epidemic and
the war in Iraq; services exports rebounded strongly later in the year
as those concerns receded. Exports of goods rose about 6-3/4 percent
over the course of the year--considerably faster than in 2002. Exports
increased in all major end-use categories of trade, with particularly
strong gains in capital goods and consumer goods. Reflecting the global
recovery in the high-tech sector, exports of computers and
semiconductors picked up markedly in 2003, particularly in the second
half. By geographic area, exports of goods increased to Western Europe,
Canada, and, particularly, to developing countries in East Asia--a
region where economic activity expanded at a rapid pace last year.
Prices of exported goods rose in 2003, with prices of agricultural
exports recording particularly large increases. In response to poor
crops and strong demand, prices for cotton and soybeans increased
sharply. For beef, disruptions in supply led to notably higher prices
through much of 2003. Beef prices, however, fell back in late December
after a case of mad cow disease was discovered in the state of
Washington and most countries imposed bans on beef imports from the
United States.
Real imports of goods and services rose about 3-1/2 percent in 2003.
Imports of services fell in the first half of the year but bounced back
in the second half, as concerns about the SARS epidemic and the war in
Iraq came and went; for the year as a whole, real imports of services
were about unchanged from the previous year. Real imports of goods
expanded about 4 percent in response to the strengthening of U.S.
demand, but the pattern was choppy, with large gains in the second and
fourth quarters partially offset by declines in the first and third.
Despite a surge in the second quarter, the volume of oil imports
increased modestly, on balance, over the course of the year. Real
non-oil imports were up about 4-1/2 percent, with the largest increases in
capital goods and consumer goods. Imports of computers posted solid
gains, whereas imports of semiconductors were flat.
Despite a substantial decline in the value of the dollar, the prices of
imported non-oil goods rose only moderately in 2003. By category, the
prices of consumer goods were unchanged last year, and prices of
capital goods excluding aircraft, computers, and semiconductors
increased only a little more than 1 percent. Price increases were
larger for industrial supplies. The price of imported natural gas
spiked in March and rose again late in the year; these fluctuations
were large enough to show through to the overall price index for
imported goods. At year-end, prices of industrial metals rose sharply,
with the spot price of copper reaching the highest level in six and
one-half years. The strength in metals and other commodity prices has
been attributed, at least in part, to depreciation of the dollar and
strong global demand, particularly from China.
![Prices of oil and of nonfuel commodities. Two lines chart. Date range of 2001 to 2004. Nonfuel (January 2001 = 100) begins at about 100 in early 2001, then it decreases to about 89 in Q4 2001. Then it increases and ends at about 118. Oil (Dollars per barrel) begins at about 30 in early 2001, then it decreases to about 20 in Q4 2001. It increases and ends at about 35. NOTE: The data are monthly and extend through January 2004. The oil price is the spot price of West Texas intermediate crude oil. The price of nonfuel commodities is a weighted average of thirty-nine primary-commodity prices from the International Monetary Fund.](gifjpg/mpr204_c29.gif)
In 2003, the spot price of West Texas intermediate (WTI) crude oil
averaged more than $31 per barrel--the highest annual average since the
early 1980s. The spot price of oil began to rise at the end of 2002
when ethnic unrest in Nigeria and a nationwide strike in Venezuela
sharply limited oil supplies from those two countries. In the first
quarter of 2003, geopolitical uncertainty in the period leading up to
the war in Iraq also added upward pressure on oil prices. On March 12,
the spot price of WTI closed at $37.83 per barrel, the highest level
since the Gulf War in 1990. When the main Iraqi oil fields had been
secured and it became apparent that the risks to oil supplies had
subsided, the spot price of WTI fell sharply to a low of $25.23 per
barrel on April 29. However, oil prices began rising again when,
because of difficult security conditions, the recovery of oil exports
from Iraq was slower than expected. Prices also were boosted in
September by the surprise reduction in OPEC’s production target. In the
fourth quarter of 2003 and early 2004, strengthening economic activity,
falling oil inventories, and the continued depreciation of the dollar
contributed to a further run-up in oil prices.
The Financial Account
The financing counterpart to the current account deficit experienced a
sizable shift in 2003, as net private inflows fell while foreign
official inflows increased. Private foreign purchases of U.S.
securities were at an annual rate of about $350 billion through
November, about $50 billion lower than in the previous year. Private
foreign purchases of U.S. equities continued to recede, and, although
the level of bond purchases was little changed in the aggregate, foreign
purchases shifted somewhat away from agency bonds and toward corporate
bonds. Over the same period, purchases by private U.S. investors of
foreign securities increased nearly $80 billion. Accordingly, net inflows
through private securities transactions decreased markedly. In contrast,
foreign official purchases of U.S. assets surged to record levels in 2003,
with the accumulation of dollar reserves particularly high in China and Japan.
![U.S. net financial inflows. Billions of dollars. Bar chart with 2 series (Official and Private). Date range of 2000 to 2003. Private begins at about $6 billion in Q1 2000, then it generally increases to about $125 billion in Q2 2000. From Q3 2000-Q3 2002 it fluctuates within the range of about $50 billion and $165 billion. From Q4 2002 to end series decreases to about $80 billion. Official begins at about $25 billion, then it decreases to about negative $10 billion in Q4 2000. From Q1 2001-Q3 2002 it fluctuates within the range of about negative $20 billion and about $45 billion. In Q4 2002 it is about $30 billion. Then it increases and ends at about 40 billions of dollars. SOURCE: Department of Commerce.](gifjpg/mpr204_c30.gif)
![U.S. international securities transactions. Net private foreign purchases of U.S. securities. Billions of dollars. Bar chart with 2 series (Bonds and Equities). Data range is 2000 to 2003. Bonds starts at about $42 billion. Then it fluctuates between about $ 21 billion and about $90 billion from Q2 2000 to Q1 2002. In Q2 2002 it increases to about $150 billion, then it decreases to about $71 billion in Q1 2003. It ends at about $60 billion. Equities start at about$ 68 billion. It then decreases to about $10 billion in Q3 2001 and then it increases to about$ 32 billion in Q4 2001 and then it decreases and ends at about negative $5 billion. Net private U.S. purchases of foreign securities. Billions of dollars. Data range is 2000 to 2003. Bar chart with 2 series (Bonds and Equities). Bonds begins in the first quarter of 2000 at about $12.5 billion. It decreases to about negative $10 billion in the second quarter of 2000. It fluctuates within the range of about $15 billion and about negative $25 billion from Q3 2000 to Q2 2003.It ends at about negative $8 billion. Equities starts in the first quarter of 2000 at about $20 billion. It increases to about $49 billion in Q2 2000. Then it fluctuates within the range of about $60 billion and about negative $15 billion during Q3 2000 and Q2 2003. It ends at about $32 billion. SOURCE: Department of Commerce and the Federal Reserve Board.](gifjpg/mpr204_c31.gif)
Compared with the pace in 2002, foreign direct investment in the United
States increased, as merger activity picked up and corporate profits
improved. U.S. direct investment abroad held relatively steady at a
high level that was largely the result of continued retained earnings.
On net, foreign direct investment outflows fell about $50 billion
through the first three quarters of 2003.
The Labor Market
Employment and Unemployment
With economic activity still sluggish during the first half of 2003,
the labor market continued to weaken. Over the first eight months of
the year, private nonfarm payroll employment fell, on average, more
than 35,000 per month, extending the prolonged period of cutbacks that
began in early 2001. The civilian unemployment rate, which had hovered
around 5-3/4 percent for much of 2002, moved up to 6-1/4 percent by
June. However, by late in the summer, the labor market began to recover
slowly. Declines in private payrolls gave way to moderate increases in
employment; over the five months ending in January, private nonfarm
establishments added, on average, about 85,000 jobs per month. By
January, the unemployment rate moved back down to 5.6 percent.
![Net change in payroll employment. Private nonfarm. Thousands of jobs, monthly average. Bar chart. Data range is 1992 to January 2004. The series begins at about 80 in 1992. Then it increases to about 300 in 1994. Then it decreases to about 180 in 1995. In 1997 it increases to about 270, then it generally decreases to about negative 200 in 2001. In 2002 series starts to increase and ends at about 130.](gifjpg/mpr204_c32.gif)
![Civilian unemployment rate. By percent. Line chart. Date range is 1971-2004. As shown in the figure, the series begins at about 5.9 percent. From 1973 to 1995 it fluctuates within the range of about 5.3 and 10.5 percent. Then it decreases to about 4 percent in 2001 and then it increases and ends at about 5.8 percent. NOTE: The data are monthly and extend through January 2004.](gifjpg/mpr204_c33.gif)
During the late summer and early fall, prospects for business sales and
production brightened, and firms began to lay off fewer workers.
Initial claims for unemployment insurance dropped back, and the monthly
Current Population Survey (CPS) of households reported a decline in the
number of workers who had lost their last job. However, for many
unemployed workers, jobs continued to be difficult to find, and the
number of unemployed who had been out of work for twenty-seven weeks or
more remained persistently high. The labor force participation rate,
which tends to be sensitive to workers’ perceptions of the strength of
labor demand, drifted lower. Although the CPS indicated a somewhat
greater improvement in employment than the payroll report--even after
adjusting for conceptual differences between the two measures--the
increase in household employment lagged the rise in the working-age
population, and the ratio of employment to population fell further
during 2003.
The modest upturn in private payroll employment that began in September
was marked by a step-up in hiring at businesses supplying professional,
business, and education services, and medical services continued to
add jobs. Employment in both the construction industry and the real
estate industry rose further, although the number of jobs in related
financial services dropped back a bit as mortgage refinancing activity
slackened. At the same time, although manufacturers were still laying
off workers, the monthly declines in factory employment became smaller
and less widespread than earlier. Employment stabilized in many
industries that produce durable goods, such as metals, furniture, and
wood products, as well as in a number of related industries that store
and transport goods. In several other areas, employment remained weak.
Manufacturers of nondurables, such as chemicals, paper, apparel, and
textiles, continued to cut jobs. Employment in retail trade remained,
on net, little changed.
Productivity and Labor Costs
Business efforts to increase efficiency and control costs led to
another impressive gain in labor productivity last year. Output per
hour in the nonfarm business sector surged 5-1/4 percent in 2003 after
having risen a robust 4 percent in 2002 and 2-3/4 percent in 2001. What
is particularly remarkable about this period is that productivity did
not decelerate significantly when output declined in 2001, and it
posted persistently strong gains while the recovery in aggregate demand
was sluggish. Typically, the outsized increases in productivity that
have occurred during cyclical recoveries have followed a period of
declines or very weak increases in productivity during the recession
and have been associated with rebounds in economic activity that were
stronger than has been the case, until recently, in this expansion.
![Change in output per hour. By percent, annual rate. Bar chart. Date range is 1992-2003Q1. As shown in the figure, Change in output per hour begins at about 4 percent in 1992. Then it generally decreases to about negative 0.5 percent by 1993. In 1994 it is at about 3 percent, then it increases by the end to about 5.3 percent. NOTE: Nonfarm business sector.](gifjpg/mpr204_c34.gif)
On balance, since the business cycle peak in early 2001, output per
hour has risen at an average annual rate of 4 percent--noticeably above
the average increase of 2-1/2 percent that prevailed between 1996 and
2000. In the earlier period, an expansion of the capital stock was an
important element in boosting the efficiency of workers and their
firms; that impetus to productivity has weakened in the recent period
as a result of the steep cutbacks in business investment in 2001 and
2002. Instead, the recent gains appear to be grounded in organizational
changes and innovations in the use of existing resources--which are
referred to as multifactor productivity. The persistence of a rapid
rise in multifactor productivity in recent years, along with signs of a
pickup in capital spending, suggests that part of the step-up in the
rate of increase of labor productivity may be sustained for some time.
In 2003, the employment cost index (ECI) for private nonfarm
businesses, which is based on a survey conducted quarterly by the
Bureau of Labor Statistics, rose 4 percent--about 3/4 percentage point
more than the increase in 2002. Compensation per hour in the nonfarm
business sector, which is based on data constructed for the NIPA, is
estimated to have increased 3-1/4 percent in 2003, up from 1-1/2
percent in 2002. In recent years, the NIPA-derived series has shown
much wider fluctuations in hourly compensation than the ECI, in part
because it includes the value of stock option exercises, which are
excluded from the ECI. The value of options exercised shot up in 2000
and then dropped over the next two years.
Most of the acceleration in hourly compensation in 2003 was the result
of larger increases in the costs of employee benefits. The ECI for
wages and salaries rose 3 percent--up slightly from the pace in 2002 but
still well below the rates of increase in the preceding six years. Wage
gains last year likely were restrained by persistent slack in the
demand for labor as well as by the pressure on employers to control
overall labor costs in the face of the rapidly rising cost of benefits.
Employer costs for benefits, which had risen 4-3/4 percent in 2002,
climbed another 6-1/2 percent in 2003. The cost of health insurance as
measured by the ECI has been moving up at close to a double-digit rate
for three consecutive years. In addition, in late 2002 and early 2003,
employers needed to substantially boost their contributions to
defined-benefit retirement plans to cover the declines in the market value of
plan assets.
Prices
Headline consumer price inflation in 2003 was maintained by an
acceleration in food prices and another sizable increase in energy
prices, but core rates of inflation fell for a second year. Although
the strong upturn in economic activity in the second half of last year
began to reduce unemployment and to boost industrial utilization rates,
considerable slack in labor and product markets continued to restrain
inflation throughout the year. A further moderation in the costs of
production also helped to check inflation: As a result of another rapid
rise in productivity, businesses saw their unit labor costs decline in
2003 for a second consecutive year. In contrast, prices for imported
goods excluding petroleum, computers, and semiconductors increased at
about the same rate as prices more generally; between 1996 and 2002,
these import prices fell relative to overall prices for personal
consumption expenditures (PCE). The chain-type price index for PCE
excluding food and energy rose just under 1 percent in 2003, about 3/4
percentage point less than in 2002. A broader measure of inflation, the
chain-type price index for GDP, increased 1-1/2 percent in 2003, the
same slow pace as in 2002. Both measures of inflation were roughly a
percentage point lower than in 2001.
![Change in unit labor costs. By percent. Bar chart. Date range is 1992-2003. Series starts at about 0.5 percent. From 1993 to 2001 it fluctuates within the range of about 0.5 and about 4.2 percent. Then it generally decreases to end at about negative 2 percent. NOTE: Nonfarm business sector.](gifjpg/mpr204_c36.gif)
![Change in consumer prices. By percent. Bar chart with 2 series (Chain-type price index for PCE and CPI). Date range is 1993-2003. Both series generally move together with Chain-type price index for PCE being lower. CPI begins at about 2.7 percent. Chain-type price index for PCE begins at about 2 percent. They then decrease until 1998, when Chain-type price index for PCE at about 2.4 and CPI at about 3.3 percent. In 1998 Chain-type price index for PCE at about 0.9 percent and CPI at about 1.6 percent. Then they start to increase Chain-type price index for PCE to about 2.4 and CPI to about 3.5 in 2000. They end in 2003 Chain-type price index for PCE at about 1.4 and CPI at about 1.9 percent.](gifjpg/mpr204_c37.gif)
![Change in consumer prices excluding food and energy. By percent. Line chart with 2 series (Chain-type price index for PCE and CPI). Date range is 1993-2003. Both series generally move together with Chain-type price index for PCE generally being about 1 percent lower during the entire period. They start at about 3.5 percent in 1993, with Chain-type price index for PCE being lower. They then decrease until 1998. Chain-type price index for PCE to about 1.2 percent and CPI to about 2.5 percent. Then in 2002 they decrease Chain-type price index for PCE to about 2.1 and CPI at about 2.8 percent. Chain-type price index for PCE ends at about 0.9 percent. CPI ends at about 1.2 percent. NOTE: Change is over four quarters, and the data extend through 2003:Q4.](gifjpg/mpr204_c38.gif)
Consumer energy prices fluctuated widely over the four quarters of
2003, and the PCE index for energy was up 7-1/4 percent over the
period. In the first quarter of the year, the combination of a further
rise in the cost of crude oil, increased wholesale margins for
gasoline, and unusually tight supplies of natural gas pushed up
consumer energy prices sharply. Although the prices of petroleum-based
products turned down when the price of crude oil fell back in March, a
number of supply disruptions in late summer resulted in another
temporary run-up in the retail price of gasoline. In the spring, the
price of natural gas began to ease as supplies improved, but it
remained high relative to the level in recent years. Electricity prices
also moved up during 2003, in part because of the higher input costs of
natural gas. In January 2004, a cold wave in the Northeast, together
with the rise in the price of crude oil since early December, once
again led to spikes in the prices of gasoline and natural gas.
The PCE price index for food and beverages increased 2-3/4 percent in
2003 after having risen just 1-1/4 percent a year earlier. Much of the
acceleration can be traced to strong demand for farm products, but
prices paid by consumers for food away from home--which depend much more
heavily on the cost of labor than on prices of food products--were up 3
percent in 2003, also somewhat more than overall consumer price
inflation. Poor harvests abroad, especially in Europe, contributed
importantly to the heightened demand for U.S. farm products. Thus,
despite a bumper crop of corn and some other grains in the United
States, world stocks were tight and prices remained high. In addition,
the U.S. soybean crop was crimped by late-season heat and dryness,
which further tightened world supplies. Concerns about the cases of mad
cow disease that were identified in herds in Japan and Canada supported
strong domestic and export demand for U.S. beef for most of last year
while supplies edged down. But, at year-end, when a case of mad cow
disease was discovered in a domestic herd, export demand for U.S. beef
plunged and drove the price of live cattle down sharply. A portion of
the drop in cattle prices likely will show through to consumer prices
for beef early this year.
The decline in core inflation in 2003 was broadly based. Prices of core
consumer goods fell somewhat faster than a year earlier; the declines
were led by larger cuts in prices of apparel, motor vehicles,
electronic equipment, and a variety of other durable goods. At the same
time, prices of non-energy services rose less rapidly. The deceleration
in core consumer prices measured by the CPI is somewhat greater than
that measured by the PCE index. In each index, the costs of housing
services to tenants and owners rose less in 2003 than in 2002, but
because these costs receive a larger weight in the CPI, their slowing
contributed a greater amount to the CPI’s deceleration. In addition,
the different measurement of the prices of medical services in the two
series contributed to the smaller deceleration in non-energy services
in the PCE. The medical services component of the CPI, which measures
out-of-pocket expenses paid by consumers, increased 4 percent in 2003,
down from 5-1/2 percent a year earlier. Alternatively, the PCE for
medical services is a broader measure that uses producer price indexes
(PPI) to capture the costs of services provided by hospitals and
doctors; it continued to increase more slowly than the CPI for medical
services last year, 3-1/4 percent, but it was up slightly from its
increase of 2-1/2 percent in 2002.
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