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short essays and reports on the economic issues of the day
2004 ■ Number 29

Ringing in the New Year with an Investment Bust?
Kevin L. Kliesen
eal outlays by firms for nonresidential capital equipinto 2004.1 In August, forecasters expected a much larger
ment and software (E&S) plunged 9 percent in 2001,
slowdown in the growth of business fixed investment (BFI),
a recession year; it was the largest decline since 1958
from about 11 percent in 2004:Q4 to 6.5 percent in 2005:Q1.2
and the third largest since World War II. In an attempt to kickSince then, as seen in the table, forecasters have concluded
start business investment, President Bush signed legislation
that there will be both a smaller burst in investment spending
in March 2002 that, among other things, allowed firms to
in the fourth quarter and less of a lull in the first quarter.
immediately expense (depreciate) 30 percent of the cost of E&S
Even though forecasters repeatedly changed their assesspurchased between September 10, 2001, and September 11,
ment of the relative strength of investment spending in 2004:Q4
2004, and put into service before January 2005. In subsequent
and 2005:Q1—as viewed by the difference between the protax legislation signed in May 2003, this partial expensing projected growth rates of real BFI in 2004:Q4 and 2005:Q1—they
vision was raised to 50 percent and the purchase date was
do not foresee such a swing in real GDP growth. This pattern
moved back to December 31, 2004.
is consistent with the fact that business investment (about 10
An increase in the depreciation allowance for capital goods
percent of GDP) tends to be more volatile than total spending.
increases the present value of the firm’s deductions for tax
Thus, while forecasters expect some slowing in BFI growth in
purposes, which, all else equal, lowers the cost of capital.
early 2005, they do not expect an investment bust (or, hence,
Accordingly, when the partial expensing provision reverts to
a markedly slower growth of real GDP) to ring in the New
its original level on January 1, 2005, the present value of the
Year. ■
depreciation deduction will be less—and the cost of capital
will be higher—than what it was on December 31, 2004.
Business fixed investment includes structures, in addition to equipment and
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 investment 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
Are Forecasters Projecting a First-Quarter Slowdown?
provision fast approaching, some forecasters
Percent changes at annualized rates
believe that many firms still plan to shift a
portion of their planned capital expenditures
Real GDP growth
Real BFI
from 2005 into 2004. If these expenditures are
Forecast date
2004:Q3 2004:Q4 2005:Q1 2004:Q3
2004:Q4 2005:Q1
significant, then we would expect to see an
upsurge in business investment in the final
February 2004
quarter of 2004 and then a drop-off in the first
May 2004
quarter of 2005 (or later).
August 2004
Recent surveys compiled by the National
November 2004
Association of Business Economics and the
Federal Reserve Bank of Philadelphia suggest
SOURCE: Survey of Professional Forecasters published by the Federal Reserve Bank of
Philadelphia. (A): Actual.
that some firms have already shifted, or plan
to shift, some of their capital outlays from 2005


Views expressed do not necessarily reflect official positions of the Federal Reserve System.