Notes on the U.S. Economy
January 1, 1994
Not all the problems that afflict the U.S. and other industrialized economies today are traceable to the business cycle, but many of them are, and a recovery in the U.S. that was below par for an extended period, plus actual recession in many areas overseas, had made all of them more than ordinarily difficult to cope with. Now, with recovery going forward strongly in the U.S., and with a good chance for upturns getting started abroad in 1994, not only are the cyclical-type problems abating but the possibility of dealing constructively with those that are structural in nature is, of course, markedly improved.
What is happening in the U.S. economy is remarkable for its scope and strength; it is remarkable also for its unexpectedness–no one can rightly claim to have seen it coming on as strongly as it has. Moreover, it is notable for being the work entirely of the private side of the economy. It has helped to have a deficit-reduction program underway and to see some success in it, even if the success to date is due in the main to non-recurring circumstances and to that degree is transient, and it had been helpful to have had a persistently expansionary money policy with low long-term interest rates, but the propelling forces behind what has been happening have been private not governmental: a sizeable increase in the consumer spending (retail sales up in the four months through November at rates that annualize to nearly ten percent a year); large increases in spending by business on capital goods (ranging in amount between ten and twenty percent a year in the five quarters through 3Q93
); and now a sharp rise in the purchase and building of homes. The big question is: How long will it last? Expansions don’t last forever, and this one is already thirty-two months old, but the up phase of the cycle can last longer than three years and has done so more than once, and with no imbalances or excesses that often bring expansion to an end there is a good chance that this one will have a relatively long life. Activity might accelerate to the point where a reversal would be unavoidable (more often than anything else, excessive speed is what interrupts expansions), but there is as yet no identifiable basis for saying that that will happen in the present case. And there is a good chance of being spared the upsurge of inflation that often happens during the cycle’s late expansion phase (it is currently the most frequently cited threat to the expansion’s continuation). Granted, increases since 1991 of ten to fourteen percent a year in the narrowly defined (M1) money s
upply are not reassuring on the inflation risk, but the broader measures of money supply have been either flat or down, there is no evidence in the data on wage rates and productivity improvement that there will be in the foreseeable future the push from unit labor cost that often helps to move the inflation rate up, and price movements in most categories of goods and services have of late been either very small or negative.
Putting all this together, the outlook for 1994 is for growth at a vigorous but manageable rate. On a year-over-year basis price-corrected Gross Domestic Product (real GDP) should rise by about three percent (more likely a bit higher than any lower) and with only a small increase in the inflation rate (to 2.7 percent from a likely 2.6 percent in 1993) nominal GDP (before correction for price changes) should be up about 5.7 percent. Finally, changes on a fourth quarter-to-fourth quarter basis will most likely be somewhat larger: 6.2 percent for nominal GDP; 2.8 for inflation; 3.4 for real growth.
Thus we have an economy in prospect that through 1994 should be favorable for financial markets. Credit use is already rising faster that formerly, and can be expected to speed up further as the economy expands, but this need not induce a major increase in interest rates. Bank Reserves have been rising strongly for months, interest rates have so far moved up only very little, and I think it highly unlikely that the Federal Reserve authorities, at this stage of the cycle and with the inflation rate not above three percent, would take steps such as would lift interest rates to where they would imperil expansion. The prospect, accordingly, is for interest rates that are higher but not by much.
Finally, what happens to stock prices? As things stand, market sentiment is more negative than positive, and it must be acknowledged that there are grounds for this. Stock prices are higher relative to earnings than at any time in several decades, and we are just now off a sizeable increase in 1993. Still, it is hard to see how there could be more than a moderate and short-lived correction of prices in an economy in which growth continues at a good rate for another year, with a fair prospect of lasting longer, in which growth continues at a good rate for another year, with a fair prospect of lasting long, in which the inflation rate continues to be low, and the interest rate increases are not large. Accordingly, the odds are that the broad indexes of stock prices will continue to trend up–moderately, one would hope–responding to the increases in corporate profits that can be expected to accompany economic expansion.
Mr. Saulnier was Chairman of the Council of Economic Advisors from 1956-1961 and served on the graduate faculty of Columbia University before retiring in 1973.