Kevin L. Kliesen

English

Research Papers in Economics

December 2004 NationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Ringing In the 
New Year with an
Investment Bust?
R
eal outlays by firms for nonresidential capital
equipment and software (E&S) plunged 9 percent
in 2001, a recession year; it was the largest decline
since 1958 and the third largest since World War II. In an
attempt to kick-start business investment, President Bush
signed legislation in March 2002 that, among other things,
allowed firms to immediately expense (depreciate) 30 per-
cent of the cost of E&S purchased between September 10,
2001, and September 11, 2004, and put into service
before January 2005. In subsequent tax legislation signed
in May 2003, this partial expensing provision was raised
to 50 percent and the purchase date was moved back to
December 31, 2004.
An increase in the depreciation allowance for capital
goods increases the present value of the firm’s deductions
for tax purposes, which, all else equal, lowers the cost of
capital. Accordingly, when the partial expensing provision
reverts to its original level on January 1, 2005, the present
value of the depreciation deduction will be less—and
the cost of capital will be higher—than what it was on
December 31, 2004.
Although other factors were also probably at work, the
recent growth of investment expenditures
suggests that firms responded to this
incentive, albeit with a lag. From
2001:Q4 to 2003:Q1, real E&S invest-
ment fell at about a 1 percent annual
rate; however, in the second quarter of
2003, real E&S investment surged at an
11 percent annual rate and has since
increased at a 14.5 percent annual rate
through the third quarter of 2004.
With the expiration of the partial
expensing provision fast approaching,
some forecasters believe that many
firms still plan to shift a portion of
their planned capital expenditures from
2005 into 2004. If these expenditures
are significant, then we would expect to see an upsurge
in business investment in the final quarter of 2004 and
then a drop-off in the first quarter of 2005 (or later). 
Recent surveys compiled by the National Association
of Business Economics and the Federal Reserve Bank of
Philadelphia suggest that some firms have already shifted,
or plan to shift, some of their capital outlays from 2005
into 2004.1 In August, forecasters expected a much larger
slowdown in the growth of business fixed investment
(BFI), from about 11 percent in 2004:Q4 to 6.5 percent
in 2005:Q1.2 Since then, as seen in the table, forecasters
have concluded that there will be both a smaller burst in
investment spending in the fourth quarter and less of a
lull in the first quarter. 
Even though forecasters repeatedly changed their
assessment of the relative strength of investment spending
in 2004:Q4 and 2005:Q1—as viewed by the difference
between the projected growth rates of real BFI in 2004:Q4
and 2005:Q1—they do not foresee such a swing in real
GDP growth. This pattern is consistent with the fact that
business investment (about 10 percent of GDP) tends to be
more volatile than total spending. Thus, while forecasters
expect some slowing in BFI growth in early 2005, they
do not expect an investment bust (or, hence, a markedly
slower growth of real GDP) to ring in the New Year.
—Kevin L. Kliesen
1www.nabe.com/publib/indsum.htm; www.phil.frb.org/files/bos/bos0904.html.
2Business fixed investment includes structures, in addition to equipment and
software.
This issue of National Economic Trends will be the final printed copy.
Future issues will be available at research.stlouisfed.org/publications/net.
Are Forecasters Projecting a First-Quarter Slowdown?
Percent changes at annualized rates
Real GDP growth Real BFI
Forecast date 2004:Q3 2004:Q4 2005:Q1 2004:Q3 2004:Q4 2005:Q1
February 2004 3.9 4.1 3.6 10.4 11.0 8.8
May 2004 4.1 4.0 3.8 11.5 10.3 7.7
August 2004 3.5 4.0 3.8 9.9 10.9 6.5
November 2004 3.9(A) 3.7 3.4 12.9(A) 10.0 8.5
SOURCE: Survey of Professional Forecasters published by the Federal Reserve
Bank of Philadelphia. (A): Actual.

Ringing in the new year with an investment bust?

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Ringing in the new year with an investment bust?

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