Economic And Financial Developments In 2000 Essay Example

oil, resulting in significant increases in retail energy prices at the beginning and middle of the year. Aside from energy, consumer price inflation this year has been somewhat higher than in 1999, potentially influenced by indirect effects from higher energy costs on core goods and services prices. Despite having historically low unemployment rates, sustained strong increases in worker productivity have kept unit labor costs minimal.

Between early 1983 and the first quarter of 2000, consumer spending witnessed a significant rise. Real personal consumption expenditures increased by 7-3/4 percent during this period, marking the highest growth rate since the previously mentioned timeframe. In addition to this, there was a consistent upward trend in spending over the past two years, with real outlays growing by more than 5 percent annually and personal saving rates declining. Furthermore, durable goods expenses saw an even greater acceleration in the first quarter of 2000, surpassing an annual growth rate of 24 percent after already experiencing rapid expansion in both 1998 and 1999.

In the first quarter of 2000, there was an increase in spending on motor vehicles following a peak in 1999. This increase was driven by a record rate of 18.1 million units sold for light motor vehicles. Additionally, households' expenditure on computing equipment and software rebounded after the year turned, as some consumers had postponed their purchases in late 1999. Expenditure on non-durable goods also experienced solid growth of 5-3/4 percent during this period, primarily due to increased spending on clothing and shoes. Consumer services saw an annual growth rate of 5-1/2 percent in the first quarter, with strong spending observed in various non-energy consumer services such as recreation, telephone use,

and brokerage fees.

The acceleration of the economy was impacted by an increase in spending on energy services, which had previously declined due to warm weather in late 1999. Consumer spending growth has significantly slowed down since the first quarter, especially in the purchase of goods. Despite lower light motor vehicle sales in the second quarter compared to the first quarter, they remained high relative to historical levels. Consumers have a positive outlook on the motor vehicle market because of attractive prices and incentives offered by auto-makers. Retail sales data for April-June show that consumer spending on other goods grew at a slower rate compared to the first quarter and fell below the average increase observed over the past two years. However, consumer spending on services continued to experience rapid growth in April and May.

Between December and May, real disposable personal income grew at a slightly slower rate of about 3% compared to the 3-3/4% growth rate observed in 1999. Nonetheless, household spending remained robust due to increased net worth, strong labor markets, and high confidence levels. As a result, households continued to spend more than their current income, causing the personal saving rate to drop below 1% in the first five months of the year. Initially, stock prices drove up household net worth to reach a record high ratio relative to disposable income in the first quarter. However, these prices have since declined, indicating reduced motivation for future consumer spending.

Despite higher energy prices and fewer job gains, the recent growth in real income has been limited. Nevertheless, according to the University of Michigan Survey Research Center (SRC) survey, households are still optimistic about their future

finances. Although there was a slight decrease in optimism regarding business conditions, there is an increased worry about potential unemployment within the next year. The housing market stayed strong during the first half of this year as homebuilders had numerous projects to finish due to high demand and limited capacity in the previous year.

The number of new single-family home starts per year remained steady at 1.33 million units from January to April, matching the strong pace seen in 1999. Factors such as job and income growth, as well as previous increases in wealth, helped sustain demand for single-family homes from households and offset the impact of rising mortgage interest rates on affordability. In March, there was a record high in sales of new homes; however, sales of existing units decreased compared to 1999. As a result, the homeownership rate reached its highest level ever in Q1. However, with the arrival of spring, both consumers and builders started experiencing the effects of higher mortgage rates.

The Michigan SRC survey revealed that households' perceptions of home buying conditions dropped to the lowest level in over nine years between April and June. Participants in the survey attributed this decline to increased financing costs and higher home prices, which affected their assessment of market conditions negatively. The purchase of existing homes remained relatively stable during April and May compared to the average of the first quarter. However, since these sales are recorded at closing time, they may not reflect current demand accurately due to a delay. In contrast, sales of new homes, a more timely indicator, experienced a decrease in April and May, leading homebuilders to report further declines in

June. This suggests that weaker demand is potentially impacting construction activities as well. In May, the construction rate for new single-family homes declined to 1-1/4 million units.

The rate of new home construction has decreased compared to previous seasons, but it remains slightly lower than the peak observed in 1998. Single-family housing starts reached their highest point in twenty years during that time. Although multifamily housing units grew earlier this year, they declined in April and May. Household debt continues to rise due to robust spending and a positive outlook for income, employment, and increasing wealth. Despite higher interest rates on mortgages and consumer loans, household debt increased by almost 8% in the first quarter and is expected to have a similar increase in Q2. Mortgage debt also expanded at a rate of 7% during Q1 as a result of heightened housing activity.

Household debt unrelated to real estate, such as credit card balances and auto loans, increased by 10% during the first quarter. This growth can be attributed to higher consumer spending, particularly on vehicles. Although mortgages were the main driver of household debt growth, it is expected that this growth slowed down in the second quarter compared to 1999.

In contrast, margin account debt has recently decreased after a surge towards the end of 1999. It's important to note that margin account debt is not included in reported credit market debt. Despite declines in stock prices, there is no evidence of widespread repayment issues or systemic concerns.

However, households are currently facing a burden of debt service due to rapid debt growth and rising interest rates. This level hasn't been seen since the late 1980s. Nevertheless, with

household income and net worth increasing rapidly and positive employment prospects, there are few indications of worsening credit problems among households.

The Federal Reserve's recent surveys indicate that commercial banks have shown a favorable inclination towards providing consumer loans and mortgages.

The first quarter of this year has seen positive trends in household financial indicators. Personal bankruptcy filings have reached their lowest level since 1996. Delinquency rates for home mortgages, auto loans, and credit cards either remained low or slightly decreased. It should be noted that these delinquency rates may appear artificially low due to the increase in new loan originations. New loans are less likely to become delinquent compared to older loans.

Furthermore, businesses have continued investing in capital spending and benefiting from more efficient technologies. Real business fixed investment experienced a significant increase of nearly 24 percent in the first quarter of 2000, following a slower period at the end of 1999 when certain projects were delayed due to Y2K concerns.

There has been a high demand for nondefense capital goods in recent months due to the current economic expansion. This growth is primarily fueled by increased investment spending, particularly in new equipment and software. Businesses are leveraging advancements in computer and information technologies to improve various business processes. Favorable conditions in credit and equity markets, combined with strong domestic demand, have facilitated firms' ability to seize these opportunities. Moreover, the efficient production of high-technology goods has led to substantial price reductions, further encouraging rapid investment.

The stock of capital in use by businesses has significantly increased and there has been a faster flow of services from that capital as newer equipment replaces older ones. This prolonged period

of upgrading plant and equipment has led to improved productivity in the economy. In the first quarter of this year, real outlays for business equipment and software increased by almost 25 percent. This followed a small increase in the final quarter of 1999 and brought spending for business equipment and software back on the upwards trend seen throughout the current economic recovery. Concerns about potential issues with the Y2K change had the biggest impact on spending patterns for computers, peripherals, communications equipment, and software in the fourth and first quarters. Despite this, the impressive resurgence in business purchases early this year confirms that the demand for high-tech capital goods had only been temporarily interrupted by the Y2K change.

Shipments of office and computing equipment, along with communication devices, saw a significant boost in the April-May period. In Q1, business spending on computers and peripheral equipment increased by about 40% compared to the previous year, reflecting the ongoing expansion trend. Additionally, expenditure on communications equipment grew as well, with a surge in Q1 resulting in a year-over-year increase of 35%, which is twice the rate of the previous year. This surge can be attributed to the demand for new network architectures due to expanding Internet usage and heavy investments by cable companies preparing for their entry into telephony and broadband internet services markets. Furthermore, there was strong demand for non-high-tech business equipment at the beginning of this year.

The manufacturing sector has rebounded from the impact of the Asian crisis, resulting in consecutive quarters of increased spending on industrial equipment. Additionally, investment in farm and construction machinery, which had been declining in 1999, is now rising again. Shipments

of civilian aircraft to domestic customers have also shown an increase. The backlog of unfilled orders placed with domestic companies for equipment and machinery (excluding high-tech items and transportation equipment) continues to grow, indicating sustained demand. However, business purchases of motor vehicles are expected to decrease in the second quarter compared to the beginning of the year due to higher fuel costs and a shortage of drivers affecting heavy trucks. Real investment in private nonresidential structures experienced a significant rise of over 20 percent during the first quarter after declining in 1999.

Explaining both the weakness experienced last year and the sudden widespread revival this year is a challenging task. However, the higher levels of spending on office buildings, other commercial facilities, and industrial buildings recorded early this year align with the overall strength in aggregate demand. Despite this positive trend, the fundamentals in this sector of the economy are mixed. Available information suggests that property values for offices, retail space, and warehouses have been increasing at a slower pace compared to previous years. Nevertheless, there has been a decrease in office vacancy rates which indicates that construction in the office sector is not excessive overall. The vacancy rate for industrial buildings has also declined; however, only few industries like semiconductors and other electronic components are facing enough capacity pressures to drive significant expansion of production facilities.

The inventory-to-sales ratio in many nonfarm industries decreased earlier this year. Companies that had stockpiled additional inventory at the end of 1999 as a precautionary measure for the Y2K transition had no trouble selling off those extra stocks after the smooth transition to the new year. Additionally, the increased demand

in the first quarter may have exceeded businesses' expectations. Non-auto manufacturing and trade establishments increased their inventories at a slightly faster rate in April and May compared to the first quarter, but it was still in line with their sales growth. Therefore, the inventory-to-sales ratio for these businesses remained relatively unchanged from the first quarter.

In recent years, businesses have been using new technologies and software to improve their inventory management. This has resulted in a decline in the ratios of inventories to sales. The motor vehicle industry has experienced a more noticeable change in inventory investment. During the first quarter, dealer stocks of new cars and light trucks decreased as sales reached record levels. As a result, auto and truck makers continued producing vehicles at a high level until June to ensure an ample supply of popular models.

Despite a decrease in demand and an accumulation of inventory for certain models, scheduled assemblies for the third quarter remain higher than the elevated level seen in the first half of the year. In the first quarter, nonfinancial U.S. corporations experienced a solid increase in economic profits. The domestic operations of these corporations saw profits rise by 10 percent compared to the previous year, pushing the share of profits in this sector's nominal output close to its peak in 1997. However, even with rapid expansion in investment, businesses' external financing requirements, which is measured by the difference between capital expenditures and internally generated funds, remained high throughout the first half of this year.

Business credit demands were also supported by cash-financed merger and acquisition activity. Total debt of nonfinancial businesses increased at a rate of 10-1/2 percent in

the first quarter, similar to the pace in 1999, and available information indicates that borrowing remained strong in the second quarter. Overall, businesses have changed their funding composition this year to rely more on short-term sources of credit and less on the bond market, although this mix has fluctuated due to market conditions. Following the end of the year, corporate borrowers returned to the bond market in volume in February and March, but subsequent capital market volatility in April and May led to a decline in activity. Moreover, corporate bond investors have shown less interest in smaller, less liquid offerings, a trend that has persisted. In response to investor concerns about interest rates and credit prospects, bond issuers in the investment-grade market have shortened the maturities of their offerings and increased issuance of floating-rate securities.

Many borrowers in the below-investment-grade market issued convertible bonds and other equity-related debt instruments in February and March. However, as equity market volatility increased and investor uncertainty grew, credit spreads widened in the corporate bond market. This led to a sharp drop in issuance in the below-investment-grade market in April and May. However, conditions in the corporate bond market improved in late May and June, and issuance almost matched the pace seen in the first quarter.
During the spring, businesses sought financing from banks and the commercial paper market as the bond market became less favorable. Consequently, commercial and industrial loans at banks grew rapidly, despite more banks tightening standards and terms for such loans according to Federal Reserve surveys.
Lenders' concerns about borrowers' creditworthiness are evident as the ratio of liabilities of failed businesses to total liabilities has further increased this year.

Additionally, the default rate on outstanding junk bonds has risen from the already high level reached in 1999.

Moody's Investors Service has downgraded more debt in the nonfinancial business sector than it has upgraded, but it has placed more debt on watch for future upgrades than downgrades. Additionally, commercial mortgage borrowing has increased during the first half of 2000 due to a strengthening investment in office and other commercial building. Borrowers have relied on banks and life insurance companies for financing, with banks experiencing heightened demand for commercial real estate loans. Standards for approving such loans have slightly tightened. Yields for commercial mortgage-backed securities have risen since the beginning of the year. The federal budget indicates that the surplus in the current fiscal year will exceed last year's surplus significantly.

During the first eight months of fiscal year 2000, the unified budget showed a surplus of approximately $120 billion. This was a significant increase compared to the $41 billion surplus during the same period in fiscal year 1999. Both the Office of Management and Budget and the Congressional Budget Office are predicting that the unified surplus will reach $225 billion to $230 billion by the end of the fiscal year, marking a $100 billion rise from the previous year. This would result in a surplus of over 2-1/4 percent of GDP, surpassing the previous high of 1.9 percent in 1951. The shift from a deficit to a surplus in the federal budget has played a crucial role in maintaining national saving. The increase in federal saving as a percentage of gross national product has offset the decline in personal saving over the same period, resulting in gross

saving by households, businesses, and governments remaining above 18 percent of GNP since 1997.

The essential role that a deeper pool of national saving plays in controlling the growth of capital cost and supporting the rapid growth of domestic investment is maintained through the ongoing willingness of foreign investors to finance our current account deficit. This source of national saving may continue to expand as long-term projections indicate an increasing federal government surplus in the next decade. The positive news regarding the federal budget has primarily been on the revenue side. Nonwithheld tax receipts experienced significant growth during the spring, with both final payments for personal income tax liabilities and final corporate tax payments for 1999 showing substantial increases.

So far this year, the withheld tax and social insurance contributions on individuals' earnings have seen a significant increase compared to the previous year. This has resulted in federal receipts for the first eight months of the fiscal year being almost 12 percent higher than the same period last year. Although receipts have been growing at an accelerated pace, federal expenditures have been rising slightly faster than they did during fiscal 1999. However, they continue to decline as a share of nominal GDP. Nominal outlays for the first eight months of the current fiscal year were 5-1/4 percent higher than the year-earlier period.

There has been an increase in discretionary spending this year, especially in defense spending. This increase follows the budget authority enacted last year. The Congress has also increased agricultural subsidies due to a decline in farm income. Non-discretionary spending, such as net interest payments, is still declining. However, categories like Medicaid and other health programs have

been increasing at a faster rate recently. Real federal expenditures for consumption and gross investment decreased sharply early this year but had previously surged in the fourth quarter of 1999, according to the national income and product accounts. These significant changes in federal spending from quarter to quarter are likely because the Department of Defense hastened its payments to vendors before the turn of the century. Actual deliveries of defense goods and services were probably more consistent.

In the fourth and first quarters, real defense spending increased moderately compared to the average level in fiscal 1999. Meanwhile, real nondefense outlays continued to rise slowly. Given higher than expected current budget surpluses and projected large surpluses in the future, the federal government has implemented measures to maintain a high level of liquidity in the market for its securities. In February, the Treasury announced its plan to issue two new five- and ten-year notes and only one new thirty-year bond annually, as part of its efforts to focus debt issuance on highly liquid securities.

The auctions of five- and ten-year notes will occur quarterly, with alternating between new issues and smaller reopenings. The bond auctions will be semi-annual, also alternating between new and smaller reopened offerings. The Treasury is reducing the frequency of its one-year bill auctions from monthly to quarterly and reducing the size of the monthly two-year note auctions. The April auction of the thirty-year inflation-indexed bond has been eliminated and the size of the ten-year inflation-indexed note offerings will be modestly reduced. In May, the Treasury announced a further reduction in the size of the monthly two-year note auctions due to anticipation of larger surpluses resulting

from strong tax receipts in 2000.

The Treasury is considering making additional changes to its auction schedule, which may include eliminating the auctions for one-year bills and reducing the frequency of auctions for two-year notes. Earlier in the year, the Treasury provided details about its reverse-auction program, also known as debt buyback. This program aims to retire older and less liquid debt securities using surplus cash in order to issue more current securities. The Treasury plans on buying back up to $30 billion worth of securities this year. The first buyback took place in March, and a schedule of two buyback operations per month was announced until the end of July. By the middle of the year, eight buyback operations had been conducted, resulting in the redemption of $15 billion in securities. All of the redeemed securities so far have had remaining maturities of at least fifteen years, as a key objective of the buyback program is to prevent further increases in the average maturity of publicly held debt.

In the state and local sector, there has been a strong increase in real consumption and investment expenditures during the beginning of this year. This increase can be attributed partly to the unusually good weather, which has allowed for more construction spending than usual during winter. Additionally, this rise in spending is a continuation of the increase that was observed last year, when real outlays experienced a 5 percent growth after averaging around 3 percent for the previous three years. The boost in spending can also be attributed to higher federal grants for highway construction. Furthermore, many of these jurisdictions have seen significant improvements in their fiscal

conditions, allowing them to undertake new spending initiatives. This improved fiscal outlook has had an impact on both the issuance and quality of state and local debt.

In the first half of this year, borrowing by states and municipalities has grown slowly. Alongside the positive budget situation, the increase in interest rates has dampened the need for new capital funding and significantly restricted refunding issuance. There have been significantly more credit upgrades than downgrades in the state and local sector. The deficits in the U.S. external balances have continued to expand this year.

The current account deficit in the first quarter of 2000 was $409 billion, or 4-1/4 percent of GDP. This is an increase from the second half of 1999 when it was $372 billion and 4 percent of GDP. The deficit in net payments of investment income was slightly lower in the first quarter compared to the second half of last year, mainly due to a significant increase in income receipts from direct investment abroad. The majority of the expansion in the current account deficit can be attributed to trade in goods and services. In the first quarter, the deficit in trade in goods and services rose to $345 billion per year, which is a substantial increase from the deficit of $298 billion recorded in the second half of 1999.

April trade data indicates that the deficit may have further increased in the second quarter. In the first quarter, U.S. exports of real goods and services experienced a 6-1/4 percent annual rate growth, following a strong increase in exports during the latter part of the previous year. The ongoing rise in economic activity internationally, which commenced

in 1999, continued to bolster export demand and somewhat counteracted the adverse impact on price competitiveness for U.S. products resulting from the previous appreciation of the dollar.

U.S. exports to Canada, Mexico, and Europe experienced the highest increase by market destination. Additionally, capital equipment, industrial supplies, and consumer goods showed the most significant growth in terms of product group. Initial data for April indicates that real exports continued to grow at a robust pace.

During the first quarter, the volume of imported goods and services grew rapidly. This increase in imports, which occurred at an annual rate of 11-3/4 percent, was consistent with the growth rate observed in the second half of 1999. The expansion of imports can be attributed to two factors: the ongoing strength of domestic demand within the United States and the impact of previous increases in the value of the dollar on price competitiveness. Notably, there was robust growth in imports of consumer goods, automotive products, semiconductors, telecommunications equipment, and other machinery. Furthermore, data for April indicate that the second quarter began on a strong note.

The first quarter saw a 1-3/4 percent annual increase in the price of non-oil goods imports, following four years of price declines. This marked the second consecutive quarter of significant price increases. However, in the second quarter, non-oil import prices only saw moderate increases. The spot price of West Texas intermediate (WTI) crude experienced a further increase this year, along with a significant level of volatility, due to various factors impacting world oil demand and supply. In 1999, following a drop in world oil prices during 1998, the Organization of Petroleum Exporting Countries (OPEC) implemented production restraints to

restore prices to their 1997 level of approximately $20 per barrel. As a result of ongoing global demand recovery and supply disruptions, the WTI spot price soared above $34 per barrel in March of this year. This was the highest level witnessed since the Gulf War more than nine years ago.