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A REVIEW OF BANK PERFORMANCE
IN THE FIFTH DISTRICT, 1982
Ward McCarthy and John Walter

Fifth District Profile
The banking industry in the Fifth Federal Reserve
District is characterized by both a moderate concentration of assets and a large number of small banks,
reflections of the regional and local dimensions of
banking in the District. At year-end 1982, there
were 670 commercial banks in the District with total
assets of approximately $108 billion, or 5 percent of
nationwide banking assets. The largest 32 banks,
24 of which held assets of a billion dollars or more,
accounted for 66 percent of Fifth District assets. By
contrast, the 558 small banks, with average assets of
less than $100 million, collectively held 18 percent
of the banking assets in the District. Summary data
on the size distribution of Fifth District banks are
presented in table I.

Table I

SIZE DISTRIBUTION OF FIFTH DISTRICT
COMMERCIAL BANKS AT YEAR-END 1982
Average
A s s e t s1
($ millions)

Number
of Banks

Percent of
Average
Assets

65

1

10-25

170

3

25-50

197

6

50-100

126

8

100-750

80

16

Over 750

32

66

670

100

Table II summarizes the major components of
income and expense relative to average assets for all
commercial banks in the Fifth District for the years
1979 through 1982. The aggregate profitability of
Fifth District banks increased marginally in 1982,
after declining in both 1980 and 1981. Dollar profits
rose more than 12 percent, and the .87 percent
earned on average assets was a slight improvement
over the .86 percent return for 1981. However, the
rate of return on average equity capital increased 56
basis points, or 56/100 of 1 percent, to 13.12 percent,
as asset growth exceeded equity growth for the
second consecutive year.
In spite of a strong gain of 7 basis points in net
interest margins, the pre-tax return on assets increased only 1 basis point from a year earlier. Rapid
increases in net noninterest expenses and loan loss
provisions contributed equally in offsetting most of
the improvement in net interest margins. Cash dividends grew faster than assets, while the ratio of retained earnings to average assets declined 3 basis
points. The rate of retained earnings and the rate of
internal equity growth also declined. The 11.5 percent growth in assets was a 142 basis point increase
over the comparable 1981 figure.

Less than 10

Total

1 Average assets are based on fully consolidated volumes outstanding at the beginning and at the end of the year.

The authors acknowledge the considerable assistance
of Martha Mangold, Research Department, Federal Reserve Bank of Richmond, and Frank Fry, Division of
Research and Statistics, Board of Governors of the
Federal Reserve System, in the construction of the data
base.

Interest Revenue
Gross interest revenue as a percent of average
assets declined in 1982, after strong gains in both
1980 and 1981. This reduction in gross interest
ratios was due primarily to falling market yields
during the third and fourth quarters. As a consequence of the pattern of interest rate movements over
the year, the ability to generate interest revenue was
influenced by the composition of asset portfolios as
well as the timing of asset acquisitions. In contrast
with the previous two years, when strong gains in
interest revenue were associated with a portfolio mix
characterized by high yield sensitivity, banks with
higher proportions of long-term and fixed-rate assets
in their portfolios were likely to experience higher
gross interest revenue relative to average assets.

FEDERAL RESERVE RANK OF RICHMOND

3

Table II

INCOME AND EXPENSE AS A PERCENT OF AVERAGE ASSETS
FIFTH DISTRICT COMMERCIAL BANKS, 1979-1982

Assets acquired in the first half of the year contributed more revenue per dollar invested than did assets
acquired in the third and fourth quarters.
Gross interest ratios declined an average of 60
basis points at the large banks, where bank loans
and other assets with yields that are sensitive to
movements in market interest rates dominate portfolios (see chart 1). However, not all banks were so
vulnerable to the change in market conditions, and
revenue gains were reported for other bank size
categories. Gross interest ratios improved 50 basis
points for the small bank group which benefited from
average yields that typically adjust more slowly to
changes in market conditions.
As demonstrated in table III, the timing of asset
acquisitions and the composition of asset portfolios
were important determinants of gross interest ratios
for Fifth District banks in 1982. Banks with increased gross interest ratios typically had a relatively
higher rate of asset growth in the first half of the
year when market rates were high, and a slower rate
of growth over the second half of the year when
market rates declined. These banks also benefited
from a large inventory of high yielding long-term
and fixed-rate assets, and enhanced their ability to
maintain high average yields by acquiring a larger
proportion of long-term and fixed-rate assets in the
4

ECONOMIC

REVIEW,

first and second quarters of 1982 than their counterparts with declining or unchanged gross, interest
ratios.
As indicated in table IV, which presents aggregate
data on average yields of selected interest-earning
assets, the average return on interest-earning assets
declined 50 basis points in 1982. Net loan yields

Chart 1
GROSS INTEREST RATIO*
Percent

Percent

JULY/AUGUST

1983

Table III

CHANGES IN GROSS INTEREST INCOME RATIOS IN RELATION TO ASSET COMPOSITION AND
ASSET GROWTH FOR SELECTED1 FIFTH DISTRICT COMMERCIAL BANKS IN 1982
Average
Assets
($ millions)

Asset Growth

Percent
Change in
Interest
Income Ratio

Number
of Banks

Percent of
Rate-Insensitive
Assets 2

Q1Q2

Q3Q4

Increased ratio

418

73

5.2

4.6

6.5

Others

120

64

5.6

8.7

- 7.4

Increased ratio

49

69

4.8

5.1

5.3

Others

31

61

1.7

8.0

- 4.5

Increased ratio

10

66

8.9

6.7

3.9

Others

22

58

1.6

13.6

- 7.5

Less than 100

100 to 750

750 and over

All Banks
Increased ratio

1

477

69

6.6

5.6

5.2

Others

173

59

1.8

12.7

- 7.0

Does not include de novo entrants and merged banks.

Rate-insensitive assets include all assets except the following: Balances with depository institutions, federal funds sold and securities
purchased under agreements to resell, U.S. and state and local securities with one year or less remaining maturity, loons to financial
institutions, loans for purchasing or carrying securities, commercial and industrial loans.

2

declined 34 basis points in the aggregate. This
aggregate figure, however, obscures the markedly
different experience of large and small banks. Specifically, average net loan yields deteriorated quite
rapidly at the large banks, but increased at small
banks. One reason for the improvement in loan
yields at small banks is that they were better positioned to protect the high average yields of the first
two quarters with a relatively large share of fixedrate and long-term loans. The typical small bank in
the Fifth District holds over 75 percent of its loan
portfolios in consumer and real estate loans.

The return from securities for all Fifth District
banks increased 70 basis points in 1982. The timing
of purchases during the year was also an important
determinant of average yields on securities. With
market rates relatively high and fluctuating over the
first two quarters, average yields could be improved
by rolling over maturing instruments or by expanding security holdings at yields that were above the
average yield on the existing portfolio. With market
rates declining steadily throughout the third and
fourth quarters, however, the opportunity for increasing average yields declined accordingly.

Table IV

AVERAGE RATES OF RETURN ON SELECTED INTEREST-EARNING ASSETS
FIFTH DISTRICT COMMERCIAL BANKS, 1979-1982
Item

1979

1980

1981

1982

Gross loans

11.25

12.50

14.48

14.14

Net loans

11.37

12.63

14.64

14.30

Total securities

6.43

7.15

8.57

9.27

U. S. Government

8.14

9.16

11.22

11.79

State and local

5.17

5.56

6.11

6.68

Other

2.88

3.25

4.20

5.82

10.09

11.28

13.18

12.68

Total interest-earning assets

FEDERAL RESERVE BANK OF RICHMOND

Interest Expense
Chart 2

After increasing in both 1980 and 1981, interest
expense as a percent of average assets declined 36
basis points in 1982. This reduction in interest
expense ratios reflected the downward movement of
market rates over the second half of the year which
lowered the average cost of short-term interestbearing liabilities as much as 433 basis points (see
table V). For example, the effective interest paid
for large time certificates of deposit (CDs) was 230
basis points lower in 1982 than in 1981. On the
other hand, the average cost of liabilities with relatively long maturities and fixed interest rates, such as
subordinated notes and debentures, did not adjust as
rapidly to the change in market conditions, and consequently increased slightly. As a result, banks with
large shares of rate-sensitive liabilities were most
successful in reducing the cost of funds. Interest
expense as a percent of assets declined at 78 percent
of the banks with over $750 million in assets, and
decreased 71 basis points for that group as a whole
(see chart 2). On the other hand, interest expense
ratios increased 29 basis points for the small bank
group.
Banks in all size categories reported an erosion of
traditional demand deposits. These deposits declined
4 percent as a share of liabilities and funded only 21
percent of assets in 1982. As demonstrated in chart
3, demand deposits as a proportion of total Fifth

INTEREST EXPENSE RATIO*
Percent

Percent

1979
*Interest

1980

1981

Expense Divided by Average Assets

District liabilities have fallen from over 33 percent
to less than 23 percent since 1979. Motivating the
shift from demand deposits was the ready availability of interest-bearing alternatives, such as negotiable orders of withdrawal (NOW), automatic transfer service (ATS) and cash management accounts,
all of which enabled depositors to economize on noninterest-bearing demand deposits and earn a return
on transactions balances.

Table V

AVERAGE COST OF FUNDS FOR SELECTED LlABlLlTlES
FIFTH DISTRICT COMMERCIAL BANKS, 1979-1982
Item

1982

1979

1980

1981

7.15

8.68

10.63

9.91

9.96

11.33

14.35

12.05

10.28

13.17

15.18

12.79

6.16

7.54

9.23

9.12

8.19

8.20

8.11

8.34

11.94

13.34

15.54

11.21

Other

6.98

8.65

13.49

11.29

Total

7.60

9.13

11.23

10.10

Time and savings accounts
Large time deposits
Deposits in foreign offices
Other deposits
Subordinated notes and
debentures
Federal funds and
repurchase agreements

ECONOMIC

REVIEW,

1982

JULY/AUGUST

1983

Chart 3

DEMAND DEPOSITS AS A
PROPORTION OF LIABILITIES
ALL FIFTH DISTRICT BANKS

The share of total liabilities with below-market,
fixed-rate ceilings also declined again in 1982, continuing the trend of recent years. As a group,. banks
with assets of less than $750 million funded less than
half of their total assets with ceiling rate deposits in
1982. However, many of these banks continued to
utilize a relatively large share of liabilities with costs
that do not adjust rapidly to changes in market conditions and, therefore, did not benefit from declining
market rates in the second half of the year. In addition, since market yields exceeded interest ceilings on
regulated accounts, many of these banks increased
the average cost of funds by restructuring liabilities
with more market-rate deposits and fewer ceiling rate
deposits. Consequently, interest expense grew more
rapidly than assets at 78 percent of small- and
medium-sized banks.

basis points (see chart 4), although nearly half of
these banks reported either a decrease or no change
in net interest margins from 1981. Because large
lenders rely heavily on rate-sensitive assets and liabilities, and accumulated a larger proportion of assets
in the second half of the year, they realized substantial reductions in both the average cost of liabilities
and the average yield on portfolios. Large banks
with increased margins managed to prevent revenues
from falling as fast as expenses.
Over 60 percent of small banks reported expanded
net interest margins in 1982, and the average margin
for banks in this size category rose 21 basis points.
In contrast to the large banks, which improved their
margins by preventing revenues from falling as fast
as expenses, small banks improved interest margins
because interest income grew more rapidly than interest expense. Asset growth at small banks was
fairly evenly distributed over the year.
Within a given bank size category, the two balance
sheet characteristics that were likely to distinguish
banks with improved margins from banks with unchanged or depressed margins were ( 1) the relative
proportions of rate-sensitive assets and liabilities, and
(2) the timing of asset growth within the year. As
table VI demonstrates, banks with improved margins
typically had larger shares of rate-insensitive assets
and rate-sensitive liabilities and, consequently, were
able to benefit from the declines in market yields over

Net Interest Margins
The average net interest margin, interest income
net of interest expense divided by average assets, rose
7 basis points in 1982. Small banks reported the
most rapid expansion in net interest margins, while
margins also improved for large banks as a group.
The timing of asset growth and the composition of
assets and liabilities were important determinants of
net interest margins in 1982.
Margins at the large banks rose an average of 11

*Net Interest Income Divided by Average Assets

FEDERAL RESERVE BANK OF RICHMOND

7

Table VI

CHANGES IN NET INTEREST MARGINS IN RELATION TO ASSET AND LIABILITY COMPOSITION
AND GROWTH RATES FOR SELECTED1 FIFTH DISTRICT COMMERCIAL BANKS IN 1982
Total
Assets
($ millions)

Number
of Banks

Percent of
Rate-Insensitive
Assets2

Asset Growth

Percent of
Rate-Sensitive
Liabilities3

Q1Q2

Q3Q4

Percent
Change in
Net Margin

Less than 100
increased margin

337

73.63

30.77

5.2

4.6

11.6

Others

201

67.64

28.00

5.5

6.8

-7.8

Increased margin

53

68.13

31.74

3.7

3.7

11.5

Others

27

60.47

34.90

2.7

11.5

- 7.4

Increased margin

17

60.76

42.82

4.1

10.6

7.1

Others

15

59.01

38.80

1.5

14.5

- 8.6

Increased margin

407

64.10

39.09

4.2

8.5

8.6

Others

243

60.52

36.61

2.3

12.8

- 8.4

100 to 750

750 and over

All banks

1

See footnote 1, table III.

2

See footnote 2, table III.

Rate-sensitive liabilities include large time deposits, deposits in foreign offices, federal funds purchased, RPs, MMCs, interest-bearing
demand notes issued to the U. S. Treasury and other liabilities for borrowed money.
3

the year. Banks with increased net margins also
tended to grow relatively faster in the first half of
the year. Strong first half growth was especially
profitable if high average asset yields were locked in
but the average cost of funds adjusted rapidly to the
decline in market rates.
Noninterest Revenue and Expenses
The ratio of provisions for loan loss to average
assets expanded and accounted for a deterioration of
3 basis points in aggregate profitability. The increase
in loan loss provisions as a percent of average assets
was slightly larger for banks with over $100 million
in assets.
Actual loan losses net of recoveries increased 1
basis point relative to average assets in 1982. The
dollar amount of cash recoveries actually decreased
by approximately half a percent, while loan chargeoffs rose 15 percent.
Increases in noninterest revenue and noninterest
expense again outpaced asset growth as they have in
recent years. The expansion of noninterest expenses
was 3 times the gain in noninterest revenue, and net
8

ECONOMIC

REVIEW,

noninterest expense reduced the return on assets by
3 basis points. Wages and salaries expanded in
excess of 11 percent throughout the District but did
not affect aggregate expense ratios significantly.
Operating costs such as occupancy expenses accelerated even more rapidly than employee expenses, and
raised noninterest expense ratios by an average of
8 basis points.
Income from fiduciary activities increased at about
the same rate as assets. Service charges on deposits
as a fraction of average assets rose 3 basis points, as
many banks throughout the District increased their
revenue from the explicit pricing of services associated with interest-bearing transactions accounts. The
largest banks accounted for a disproportionate share
of the gains from service charges and lease financing.
Profits and Dividends
The average return for all Fifth District banks in
1982 rose 1 basis point to .87 percent of assets. A
marginal decline in returns for the largest banks was
offset by improved profitability at banks in other
size categories (see chart 5). For example, the small
JULY/AUGUST

1983

Chart 5

Chart 6

RETURN ON ASSETS*

1979

1980

1981

RETURN ON EQUITY*

1982
*Net Income Divided by Average Equity.

*Net Income Divided by Average Assets

banks reported a sizeable gain of 11 basis points in
the ratio of net income to average assets. The average return on equity rose more rapidly than the
return on assets (chart 6) due to an increase in
leverage.

leverage because of a relatively strong return on
Table VII demonstrates the relationship
assets.
between the return on assets, leverage, and the return
on equity for all Fifth District banks for the period
1979-1982.

Cash dividends declared on preferred and common
stock grew faster than assets, while retained earnings
as a fraction of Fifth District assets declined to .5
percent. At large banks, net profits were divided
about equally between dividends and retained earnings, as the dividend payout ratio-the ratio of dividends to net income-increased to 49 percent in 1982
from 40 percent in 1981. Consequently, retained
earnings scaled to average assets were lower in 1982
than in 1981, and the rate of retained earnings declined to 51 percent of large bank income. With
strong increases in net profit rates, the average small
bank was able to increase dividends and raise retained earnings to .77 percent of assets and 75 percent
of net income.

Retained earnings contributed 82 percent of the
increase in equity capital in 1982, compared with 74
percent in 1981 (table VIII). However, as demonstrated in table IX, the rate of internal equity growth
declined 21 basis points in 1982 due to the sharp
decline in the rate of retained earnings. Since 1979,
the aggregate rate of internal equity growth has declined by an average of 58 basis points per year,
while the rate of asset growth has increased each

The increase in equity capital in 1982 was smaller
than in 1981, and the 8 percent growth rate of capital
failed to keep pace with asset growth. Consequently,
the aggregate leverage ratio, defined as average assets
divided by average equity, increased by 50 basis
points. Increases in leverage were most pronounced
at large banks. However, as a group, small banks
were able to improve return, on equity and reduce

Table VII

RATES OF RETURN AND LEVERAGE FOR
FIFTH DISTRICT COMMERCIAL BANKS1
Year

Return on
Assets

Return on
Equity

1979

.94

x

14.37

=

1980

.89

X

14.35

=

1981

.86

X

14.56

=

1982

.87

X

15.06

=

1

The return is net income; assets and equity are averages. Discrepancies in calculations are due to rounding error.

FEDERAL RESERVE BANK OF RICHMOND

9

Table VIII

RATE OF RETAINED EARNINGS AND SOURCES OF TOTAL EQUITY CAPITAL
FOR FIFTH DISTRICT COMMERCIAL BANKS
(1)

(2)

(3)

(4)

Net Retained
Earnings
($000)

Rate of
Retained
Earnings1

Increase in
Equity Capital

Year

Net Income
($000)

($000)

(5)
Increase in
Equity Capital
from Retained
Earnings2

1979

758,804

517,398

.6819

757,411

.6831

1980

788,145

505,872

.6418

573,805

.8814

1981

840,834

514,278

.6116

694,273

.7408

1982

944,785

538,068

.5695

655,340

.8210

1

2

The rate of retained earnings is calculated by dividing column (2) by column (1).
The increase in equity capital from retained earnings is calculated by dividing column (2) by column (4).

of return on assets and equity as well as reduced
leverage ratios. On a district-wide basis, leverage
increased while the rate of retained earnings and the
rate of internal equity growth declined.

year and has exceeded internal equity growth by an
average of 258 basis points per year. This disparity
in growth rates is the primary cause of the 69 basis
point increase in the aggregate leverage ratio that
has occurred in the Fifth District since 1979.

Banks that held relatively more liabilities than
assets carrying interest rates that are highly responsive to changes in market conditions tended to benefit
from the decline in market yields. However, if the
pattern of interest rate movements in 1982 had been
the opposite-that is, had market yields moved up in
the second half of the year-banks with this interestsensitive asset-liability mix would have been vulnerable to rapidly rising interest expenses and more
likely to experience decreased net margins and profitability. It should also be noted that the money
market deposit account (MMDA), which was introduced in December of 1982, has increased the sensi-

Summary and Conclusions
In 1982 the profitability of commercial banks in
the Fifth District improved slightly following reductions in 1980 and 1981. The rate of return on assets
rose from .86 to .87 percent and the rate of return
on equity rose from 12.56 to 13.12 percent. Because
of the sharp decrease in market yields, the positioning of assets and liabilities and the timing of
growth were important determinants of profitability.
As a group, only small banks reported increased rates

Table IX

INTERNAL EQUITY GROWTH RELATIVE TO ASSET GROWTH
FOR FIFTH DISTRICT COMMERCIAL BANKS
Internal
Equity
Growth

Rate of
Retained
Earnings 2

Asset
Growth

Year

Return on
Equity 1

1979

13.51

x

.6819

=

9.21

5.19

1980

12.79

X

.6418

=

8.20

9.43

1981

12.56

X

.6116

=

7.68

10.12

1982

13.12

X

.5695

=

7.47

11.54

1

See footnote 1, table VII.

2

As defined in column (3) of table VIII, the rote of retained earnings is the ratio of
net retained earnings to net income.

10

ECONOMIC

REVIEW,

JULY/AUGUST

1983

tivity of the commercial bank cost structure to
changes in market rates. As a result, commercial
bank performance in 1983 and in the future will be
more responsive to changing market conditions and
more vulnerable to rising market yields. For example, should market rates rise and remain at high
levels due to a resurgence of inflation, then the repercussions for Fifth District banks could be severe.

References
Cole, Roger T. “Financial Performance of Small
Banks, 1977-80.” Federal Reserve Bulletin (June
1981), pp. 480-85.
Lloyd-Davies, Peter R. “Measuring Rates of Return.”
Research paper for the Board of Governors of the
Federal Reserve System.
Negri-Opper, Barbara. “Profitability of, Insured Commercial Banks.” Federal Reserve Bulletin (August
1982), pp. 453-64.

FEDERAL RESERVE BANK OF RICHMOND

11

WHY ECONOMIC DATA SHOULD BE
HANDLED WITH CARE: THE CASE OF THE
SUSPICIOUSLY SLOW GROWTH STATISTIC
Roy H. Webb

Economic statistics should be used with caution.
That admonition is not new, as economists have often
warned of errors of observation, conceptual ambiguities, and spurious accuracy embedded in economic
data (for example, see Morgenstern [1963]). Moreover, official spokesmen routinely warn of probable
errors when releasing new figures. Despite that
advice, however, many users of economic data still
uncritically accept the seemingly straightforward
statistics. The preliminary estimates of gross national product (GNP) and related items for the first
quarter of 1983 are a case in point. The purpose of
this note is to show that the interpretation of the first
quarter statistics can be dramatically changed upon
close inspection, and thereby illustrate the general
need for caution in interpreting economic statistics.
Preliminary estimates indicated that real GNP
grew at a 3.1 percent rate during the first quarter.1
That relatively slow rate of growth was believed by
many observers to be a highly significant indicator
of the modest pace of near-term economic expansion.
For example, Robert Gough, the director of national
forecasting for Data Resources Inc. (a major economic consulting service) asserted, “[The GNP
report] reaffirms initial forecasts that the recovery
will be modest by historic standards. If this were a
typical recovery, you would have a heck of a lot
more growth than we’re seeing.” [1983]
If taken at face value, 3.1 percent real growth
would indeed be quite modest. However, there are
solid reasons for believing that the economy was
stronger than the preliminary report indicated. This
can most easily be seen by first looking at statistics
that are produced in conjunction with the GNP figure and noting that the GNP implicit price deflator

was reported to have grown at a 5.8 percent rate.
However, other estimates of inflation were extremely low. The consumer price index, for example,
rose at a sluggish 0.4 percent annual rate in the first
quarter, and the producer price index for finished
goods actually declined at a 3.9 percent annual rate.
Thus one’s suspicions should have immediately been
aroused by the relatively high inflation estimate contained in the income and product accounts.
The estimate of the deflator, moreover, is critical
to the estimate of real GNP. That is, if any factor
caused the deflator to temporarily overstate the rate
of inflation, then that same factor might well cause
the reported growth rate of real GNP to temporarily
deviate from the underlying growth trend of real
economic activity. To see this, note that the Commerce Department receives estimates of spending in
current dollars. In order to estimate real GNP, the
Department’s analysts adjust the current dollar figure for inflation by dividing it by the implicit price
deflator. Consequently, the real GNP estimate depends on the estimated price index used in its construction.
At times, the GNP deflator diverges from many
other price measures due to the fact that the deflator
is affected by changes in quantities produced, whereas
other indexes represent prices of fixed quantities of
items. 2 More specifically, when (1) there is a sub2

An implicit price deflator is simply the ratio of current
period quantities valued at current prices to those same
quantities valued at base period prices. In symbols,

where IPD is the implicit price deflator, p is the price
1

All references to the first quarter income and product
accounts refer to “preliminary” estimates released in
April. Although the statistics are routinely revised, the
conceptual difficulties identified in this article are beyond
the scope of routine revision.
12

ECONOMIC

REVIEW,

of a single item, q is the quantity of a single item, the
subscript t indexes a time period, 1972 is the base year,
and the superscript i indexes all items in the aggregate
to be deflated. Thus the deflator can be changed by a
change in the pattern of output, that is to say, different
qi’s in the formula above.

JULY/AUGUST

1983

stantial change in the quantity of an item that is produced, and (2) the price of that particular item has
changed either much more or much less than average,
(relative to 1972, the base period for the index) then
the GNP deflator will behave in a different manner
than the GNP fixed-weight price index. And during
the first quarter, two factors caused much of the
divergence between the GNP implicit price deflator
and other estimates of inflation. For one, the volume
of federal purchases of agricultural products surged
during the fourth quarter of 1982 and then fell back
to a more normal level in the first quarter of 1983.
Since the particular items purchased had relatively
low prices, the net effect was a relatively low level of
the deflator for the fourth quarter. A second factor
was a significant decline in relatively high priced
imports of petroleum products. Because imports are
subtracted from domestic product in order to calculate GNP, the decline tended to boost the deflator in
the first quarter. Combined with the depressed level
of the deflator in the fourth quarter, the final result
was a relatively high growth rate for the deflator.
Neither of those two effects represents inflation in
the usual sense of a substantial, widespread, and
sustained increase in prices. In addition, neither indicates a sluggish rate of growth of real economic
activity. But each does have a substantial impact on
reported numbers. Thus the GNP fixed-weight price

index, a measure not affected by changes in the
composition of output, rose at a 3.2 percent rate.
Had that index been used to convert nominal to real
GNP, then real growth in the first quarter would
have been placed at 5.7 percent, rather than the reported 3.1 percent. (The higher figure seems to be
consistent with monthly indicators that grew at a
rapid pace, such as housing starts and industrial
production.)
One should not conclude that GNP estimates are
more unreliable than other economic figures. On
the contrary, GNP and related statistics are probably our best single source of economic data. The
point is simply that even the best data can be misleading, especially when considering changes over
intervals as short as one quarter. Therefore one
should not place too much emphasis on short-term
movements of economic data without carefully searching for hidden anomalies.

References
1. Morgenstern, Oskar. On the Accuracy of Economic
Observations. Princeton: 1963.
2. Powell, Eileen Alt. “Economy Grew at a 3.1%
Pace in First Quarter.” Wall Street Journal,
April 21, 1983, p. 3.

FEDERAL RESERVE BANK OF RICHMOND

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