U.S. Department of the Treasury

(Archived Content)

FROM THE OFFICE OF PUBLIC AFFAIRS

When you were here three months ago, the economy had completed the third quarter with strong real growth, currently carried at 5.7 percent annual rate. Not much has changed in that respect. Fourth quarter real growth was a broadly similar 5.8 percent, according to last week's advance estimate. Clearly, the economy regained forward momentum in the second half of last year. This raised real growth over the four quarters of last year to 4.2 percent, the fourth successive year of real growth in excess of 4 percent.

This is a remarkable record of stable growth in what will become this month the longest U. S. economic expansion on record. It is more remarkable still that inflation is averaging at the lowest levels in more than three decades, while at the same time the unemployment rate has fallen to its lowest level in more than three decades. This combination of strong real growth, low inflation and a falling unemployment rate is unique in U. S. post-World War II economic experience.

Some boost to the fourth quarter had been widely expected from precautionary inventory-building by both consumers and businesses in advance of Y2K, followed by a corresponding inventory runoff and weak economic growth early this year. Final inventory data are not yet available for the fourth quarter, but it appears from current information and anecdotal reports that such activity did occur, but it did not play a dominant role in the fourth quarter. Instead, the economy displayed considerable strength wholly aside from Y2K effects.

As a consequence, near term economic forecasts have been marked up. For example, the Blue Chip forecast of October 10, made in advance of the fourth quarter, projected a 2 percent growth rate for the first quarter of this year and 2.6 percent growth across all four quarters. Their latest forecast of January 10, made in some knowledge of fourth quarter developments but without the benefit of last week's official estimates, projected 3 percent growth for the first quarter of this year -- a full percentage point higher than three months earlier -- and 3.2 percent growth across all four quarters of this year. That is quite a sizable upward move for this average of 50-some forecasts at major businesses, financial institutions and academic research organizations.

Two key statistical releases late last week -- fourth quarter GDP and the employment cost index for the three-month period through December -- summarized the state of the economy at year-end. The general picture was one of strong real growth combined with good inflation performance. Some special features deserve comment.

Real personal consumption expenditures (roughly two-thirds of GDP) increased at a 5.3 percent annual rate in the fourth quarter, up from 4.9 percent in the third, but in line with the 5.4 percent growth across the four quarters of last year. Consumer outlays are reflecting continuing gains in employment and income, along with sharp increases in consumer net worth from rising equity values. Business fixed investment increased less rapidly in the fourth quarter, possibly because of some Y2K effects in the equipment and software areas. Software corrections were largely completed earlier in the year, while some purchasers of computer equipment later in the year may have deferred their purchases into 2000 to insure that they were Y2K compliant.

Businesses increased total inventories $65 billion in real terms in the fourth quarter, following increases of $38 billion in the third quarter and $14 billion in the second. This rising trend reflects some Y2K preparation, but it is difficult to separate from the normal accumulation stimulated by rising sales. Inventory-sales ratios are still very low and there probably is no sizable inventory overhang that needs to be worked off. While inventory investment added more than a percentage point to real growth in both the third and fourth quarters, it is unlikely to continue to make such a contribution. That is one reason why real growth may begin to moderate this year from its recent pace.

Inflation, as measured by the GDP chain weight price index less food and energy, rose at a 2.3 percent annual rate in the fourth quarter, up from 1.1 percent in the third. Similar, isolated quarterly increases of much the same magnitude have occurred in recent years without signifying any lasting departure from a low trend rate of inflation. But, this is an area where developments will need to be followed closely.

The employment cost index, also released late last week, rose by 1.1 percent during the three months ending in December, following increases averaging 0.8 percent during the first three quarters of the year. During the twelve months of 1999, the employment cost index increased by 3.4 percent, the same as in 1998. Gains in compensation have been largely offset in their cost-increasing impact by rising productivity. While fourth-quarter productivity results are not yet available, rough adjustment of the GDP and workhours data suggests a fourth quarter productivity gain of 4 percent or more. This would obviously outweigh the relatively minor fourth-quarter acceleration in the employment cost index. The general conclusion one reaches is that employee compensation is still in the same moderate range consistent with rising productivity and low inflation that has ruled throughout the expansion.

Information currently available suggests that the economy began this year with considerable forward momentum.

• The surveys of both the Conference Board and the University of Michigan reported sharp increases from December to record levels of consumer confidence in January. The Conference Board felt that consumer spending may very well pick up even more over the next few months, while the January surge in the Michigan index was the largest month-to-month gain in more than five years.
• After a strong Christmas sales season, some sales slowdown might have been anticipated. Industry reports suggest that the holiday sales pace extended into this year on a seasonally adjusted basis with sales generally running at or above plan.
• Recent jobless claims data indicate that labor markets remain extremely tight. In the week ended January 22, initial claims for state unemployment insurance edged up by just 1,000 to 266,000 while claims for the previous week were revised down sharply to 265,000 -- the lowest level since December, 1973.

While the recent indicators have been strong, there is reason to believe that real growth is likely to shade down from the 5 percent pace of the second half of last year. About 1 percentage point of that was due to inventories, influenced in part by Y2K concerns which are now behind us. In addition, some other GDP components seem to have received a boost prior to Y2K that may now begin to fade away or even reverse. All things considered, the economy seems likely to grow at a somewhat more moderate, but still healthy pace going forward with inflation remaining under control.

That is a summary of recent economic developments and the near term economic outlook.