U.S. Growth Surges in the Fourth Quarter

The fourth-quarter GDP surge was produced by a sharp turn in the inventory cycle. Firms still cut inventories in the fourth quarter, but much less severely than in the third. That led to increased production, which boosted GDP. Final sales growth, a better guide to the underlying path of the economy, was much more sedate, at 2.2%, but that was still an improvement on the third quarter's 1.5% pace.

The best news in final sales was on exports and business spending. Exports surged 18.1%, their second strong increase in a row. And there was a 13.3% increase in business spending on equipment and software (two-fifths of which came from computers). The improving trend in capital goods orders suggests more gains in equipment spending ahead. If firms are feeling confident enough to raise their equipment spending, they are probably confident enough to start hiring again. That will support consumer spending, which showed a moderate 2.0% gain in the fourth quarter.

Residential fixed investment was a plus for growth, rising 5.7%, but much less so than in the third quarter, when it rose 18.9%. The improvement in housing starts evident earlier in the year stalled out, temporarily at least, in the fourth quarter.

The weakest spot was business structures spending, down sharply again as the commercial real estate crisis took its toll. Structures spending fell 15.4% overall, the fourth-consecutive double-digit decline. This category includes mining and petroleum drilling, where activity rose sharply in the fourth quarter, so the decline in spending on buildings was more severe than 15.4%.

Government spending was a very small drag on growth. Federal spending edged slightly higher as another strong increase in nondefense spending was offset by a decrease in defense spending (which followed two very strong quarters for defense). State and local government spending fell slightly for the second quarter in a row. The ARRA fiscal stimulus package likely boosted federal nondefense spending growth and prevented a more severe decline in state and local government spending.

We must be careful in drawing implications for the future from today's release. There's more help to come from the inventory cycle, since inventories were still falling in the fourth quarter and have not yet stabilized. But we are unlikely to see another boost as big as 3.4 percentage points. And we're doubtful that foreign trade can continue to be a plus for growth, as we expect imports to rebound.

Also bear in mind that these GDP figures are only estimates, and the story they are telling is not fully consistent with other indicators. In particular, note that real GDP in the goods sector is estimated to have grown at a 20.9% annual rate in the fourth quarter, up from 6.3% in the third. That's the biggest quarterly increase in goods GDP in 26 years. It makes sense that a big inventory swing would be accompanied by a surge in production of goods.

Unfortunately, the separately calculated industrial production (IP) figures don't tell the same story. Manufacturing production growth actually slowed to 5.7% in the fourth quarter, according to the IP figures, from 9.0% in the third quarter. Either the GDP figures are overstating the production rebound, or the IP figures are understating it; it's hard to see how they can both be right.

The 5.7% GDP increase exactly matches our expectation going into the report, although it outpaces the 5.1% increase that we had built into our full forecast update, published at the beginning of January. Consumer spending and business equipment purchases both grew a little faster than in our January forecast, and imports rose less. So, the report shows a bit more momentum in final sales than we had thought at the beginning of the year.

Our January forecast for 2010 growth was 2.6%. The fourth-quarter GDP surge does not change the view that this year's growth is likely to be subdued by historical recovery standards, within the 2.5–3.0% range. But we anticipate that our February forecast (to be released on February 8) will edge up closer toward 3.0%.