ANN ARBOR—Despite the edging upward of unemployment, inflation and interest rates, the U.S. economy should remain strong over the next couple of years—although growth will slow, say University of Michigan economic forecasters.

“As interest-sensitive sectors respond to the Federal Reserve’s tightening of monetary policy, domestic demand growth backs off from the torrid 5.9 percent pace of the past two-and-a-half years to a solid 3 percent to 3.5 percent pace from mid-2000 through late 2002,” says Saul H. Hymans, U-M professor of economics.

In their annual forecast update of the U.S economy, Hymans and colleagues Joan P. Crary and Janet C. Wolfe say that several factors support the perception that consumption will, on average, post slower growth in the near term: households already have many very new “big-ticket” items on hand; greater volatility and a slower average pace in the stock market should combine to weaken wealth-induced spending growth; and the Fed has moved short rates up six times over the past year.

“That’s got to be impacting interest-sensitive demands going forward,” Hymans says. “And then there’s residential building activity—another sector to feel the impact of tighter credit conditions. After all, conventional mortgage rates are now running at nearly 8.25 percent, up from just 7 percent in the spring of last year.”

The U-M economists expect the Fed to increase the federal funds and discount rates (interest charged by the Fed on loans to banks, which, in turn, affect consumer interest rates) by 25 basis points at its meeting next week—insuring a “hands-off” position through the presidential election season.

The conventional mortgage rate is expected to increase from 8.3 percent this year to 8.4 percent next year and 8.6 percent in 2002. The rate for three-month Treasury bills is forecast to rise from 5.9 percent in 2000 to 6.2 percent in 2001 and 6.4 percent in 2002, while the 10-year Treasury bond rate should climb from this year’s 6.3 percent to 6.5 percent next year and 6.8 percent in 2002.

Unemployment, the forecasters say, will drift upward from 4.1 percent in 2000 to 4.2 next year and 4.3 percent in 2002, and inflation is expected to increase from 2 percent this year to 2.5 percent in 2001 and 3.1 percent in 2002.

“With labor markets remaining tight and world demand for input commodities increasing, U.S. price inflation picks up from the low rates of 1998-99, but still remains moderate,” Hymans says.

In addition to higher inflation, unemployment and interest rates and slower economic growth overall, the U-M forecast (which is based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics) predicts that:

•The federal budget surplus will grow to $277 billion in fiscal 2001 and $289 billion in 2002, up from $222 billion this year.

•Sales of light vehicles will set a new record this year at 17.2 million units, before declining to 16.1 million in 2001 and 15.8 million in 2002.

•Private housing starts will drop from 1.61 million units in 2000 to 1.53 mUillion next year and 1.51 million in 2002.

professorResearch Seminar in Quantitative Economics