Driving GDP

admin | April 30, 2021

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No supply chain disruption has been more consequential this year than the semiconductor chip shortage plaguing motor vehicle makers.  Consumers and businesses showed robust demand in the first quarter, but automakers had to curtail production beginning in February.  The BEA recorded a massive drop in motor vehicle inventories, a key limit on the still-hefty first quarter real GDP gain.  But production issues are likely to persist through the spring, and, at some point, the lack of inventory will also begin to crimp auto sales.

Production issues

Motor vehicle production was relatively normal through January, but, beginning in February, shortages of critical computer chips forced manufacturers to slow down or halt assembly lines.  Automakers adapted as best they could, shifting the limited supply of chips to their most lucrative models.  In unit terms, motor vehicles went from running between 10 million and 11 million units annualized through January to around 9 million units in February and March, resulting in a drop of close to 10% in first quarter unit assemblies.  Nevertheless, to the extent that automakers shifted production to higher-priced, more profitable models, the BEA tally of motor vehicle output in dollar terms was only down marginally.

As an example, Ford was able to maintain output of its most profitable vehicle, the F-150 pickup truck, through most of March by channeling its supply of chips to that model.  However, the shortage has begun to bite more sharply lately, as production of the F-150 was cut in April and is scheduled to remain below normal until mid-May.  GM has similarly managed to maintain its production of big pickup trucks and SUVS up to now by funneling its supply of chips in that direction.

Manufacturers have been revising down their assembly schedules on a month-to-month basis, so that the latest schedules still officially call for a bounceback in output beginning in May.  However, this seems unlikely.  Ford’s CEO said this week that his company expects the chip shortage to “get worse and bottom out” during the current quarter, which would mean that any recovery in output is unlikely before the third quarter.

Stellar demand

The timing of the production snags is especially unfortunate as households are flush and ready to spend.  Two rounds of rebate checks in early 2021 have only added to consumers’ wherewithal and desire to buy cars and trucks, among other goods and services.  So far, dealers have been able to fulfill their demand, as unit auto sales surprisingly jumped in March despite lean dealer inventories and industry reports point to another solid month in April.  Likewise, firms are looking to replenish and upgrade their fleets after a sharp dip in business investment in vehicles last spring and summer.  In particular, rental car companies are likely going to be in the market to restore their fleets now that travel is picking up, after being forced to sell off much of their stock to survive the pandemic.

In any case, in the first quarter, consumer spending on new motor vehicles surged to a level more than 20% higher than any reading during the prior expansion.  In addition, business investment in vehicles continued to recover, though there could be much more to go, as the level of outlays remained well below pre-pandemic levels.

Draining inventories

With production off slightly and final demand up sharply, the arithmetic points to one clear outcome: inventories must have plunged.  Aside from the second quarter of last year, when manufacturers were forced to shut down their entire operations for almost two months, inventories posted by far the largest reduction over the past decade (Exhibit 1).

Exhibit 1: Quarterly change in motor vehicle inventories

Source: BEA.

In fact, the BEA recorded a $73 billion annualized drop in new motor vehicle inventories, accounting for more than 80% of the $90 billion decline in overall inventories in nominal terms for the quarter.  The contraction in new motor vehicle inventories represented a drag of about 1.3 percentage points on GDP growth.

What next?

As with so many other sectors of the economy, the next shoe to drop is likely to be a rise in prices. Up to now, shoppers have largely been forced to take a vehicle that has a different color or option package than they wanted.  Or perhaps to put down a deposit and wait for a vehicle to be delivered to the dealer soon.  However, as with housing and a number of other manufacturing industries, if the feeding frenzy continues, inventories will dwindle further, and dealers are likely to respond by raising prices to better ration their remaining stock.  Furthermore, used vehicle prices, the obvious substitute for a scarce new vehicle, have been registering surging prices at wholesale auctions since the turn of the year and are likely to surge at the retail level over the next several months.

This is one high-profile example of what Chair Powell has labeled transitory forces likely to push inflation higher for a brief period.  It remains to be seen how much longer the dislocations in the motor vehicle sector will persist and how bad they will get, but they are sure to continue to have a significant impact on the broad economic data, including GDP and inflation in the current quarter.