Current conditions and future economic growth: the potential of technology and education

Business Economics, Jan, 1997 by Cathy E. Minehan

Now is an important time for macroeconomic policy, for, at least at the broad levels, things seem to be going fairly well - solid growth, low unemployment, restrained price increases - in some ways a return to the golden economic years of the 1950s and 1960s. Yet this is also a challenging time as well. How do we extend this long period of economic expansion without, on the one hand, feeding the nascent fires of inflation, or on the other, biting down too hard on the expansion to rein in those very fires? And, most importantly, how do we contribute to that overall goal of macroeconomic policy: rising standards of living for all Americans. I'd like to comment on three areas: the current state of the economy; some issues related to long-term economic growth; and a few lessons we've learned here in Boston in the course of our economic research and conferences this past year.

CURRENT STATE OF THE ECONOMY

During the first six months of 1996, the economy performed quite well. It wasn't always easy to see it through the disruptions caused by winter storms, government shutdowns, more winter storms, huge swings in stocks of inventories, and the GM strike, but with sufficient hindsight it's now clear. Real GDP grew at a 2 percent rate in the first quarter, and the estimate for the second quarter shows growth at more than double that pace. On the employment front, nearly 1 1/2 million jobs were added during the first half of this year, and the unemployment rate fell below 5 1/2 percent in the process.

Throughout this period of strong employment and output performance, the core rate of inflation remained remarkably well behaved. The core consumer price index rose just 2.7 percent over the twelve months ending in June of this year. To be sure, surges in oil and grain prices contributed to a small increase in overall consumer price inflation. But it appears that these industry-specific price disruptions may not feed into overall wages and prices and could thus amount to only temporary disruptions in the longer-run trajectory of inflation.

With regard to employee compensation, the trend has been generally favorable as well. Overall compensation costs have increased at about 3 percent over the past year, down from the 3.5 to 4 percent rates of the early 1990s. Modest increases in wages and atypically small increases in benefits costs, coupled with reasonable gains in productivity, particularly in the manufacturing sector, have kept producers' unit labor costs low, allowing the modest final price increases that we have seen in most industries.

Looking forward, most analysts expect growth in employment and output to moderate somewhat, perhaps to about 2.5 percent this year, largely due to the impact of higher interest rates and to the very length of this expansionary period. By mid-July, long-term credit market rates had risen about 1 percentage point above their year-end 1995 levels. While long-term rates have bounced around somewhat recently, higher rates could restrain spending over the next six to twelve months on residential construction, on autos, and on other consumer durable goods. Higher interest rates have not yet had a clear and sustained effect on housing and autos purchases, but the rapid increases in rates of spending over the past four years on new houses and autos have likely left most consumers in the house that they desire with the desired number and style of automobiles. Purchases of these items may well continue at a healthy pace, but higher interest rates may keep these spending categories from growing, and may make a relatively high level of consumer debt more burdensome.

The modest tightening of credit market conditions could also have a similar effect on businesses. Spending on new business equipment - computers, business vehicles, and manufacturing equipment - has grown by 10 percent or better over the past three years. With these recent additions to productive capacity in place, with somewhat higher borrowing rates, and with the expectation of slowing demand during the coming quarters, businesses will likely gauge further additions to their capacity as less profitable, thus reducing the growth rate of business investment.

Finally, while healthy U.S. income growth and spending have added substantially to the national income of our trading partners, foreign spending on U.S. goods and services has done relatively little to add to our income. This pattern is unlikely to be reversed in the near term, given projections of fairly healthy growth in the United States coupled with only gradual recovery towards more robust growth among our trading partners.

In sum, reduced rates of growth from the most vigorous sectors of the past year should slow the growth of spending and employment during the next year. Will this be sufficient to keep inflation in check? That's the $64,000 question at the moment. To say this is a time for considerable vigilance at the Fed is not an understatement by any means.

LONGER TERM GROWTH OUTLOOK