ANN ARBOR—Election-year rhetoric notwithstanding, the American economy will expand at a moderate pace through 1998, with low inflation, stable interest rates and flat unemployment, say University of Michigan economists.

In their mid-year review and forecast of the U.S. economy for 1996-98, Prof. Saul H. Hymans and researchers Joan P. Crary and Janet C. Wolfe of the U-M Department of Economics predict that the rate of economic growth will average about 2 percent for the second half of this year, 2.3 percent in 1997 and just under 2 percent in 1998, if tight fiscal and steady monetary policy continue.

Inflation rates are expected to remain stable at 2-2.5 percent and the unemployment rate should hold steady at about 5.5 percent over the next two-and-a-half years, the researchers say. In addition, interest rates are projected to remain fairly constant during that time, with conventional mortgage rates averaging 7.9 percent, the 30-year Treasury bond rate settling in at 6.6 percent, and the 3-month Treasury bill rate measuring 5.1 percent to 5.2 percent through 1998.

“The economy’s heading onto a moderate growth-track that will neither incite inflation nor excite the Fed,” Hymans says. “One might apply the word ‘dull’ to such a forecast, but not to the economy it describes. After all, another two to three years of high employment, stable inflation, rising household purchasing power, medium-to-low interest rates and a declining federal budget deficit shouldn’t be all that hard to take.”

The U-M economists believe that the Federal Reserve Board is unlikely to tighten monetary policy any time soon, with the Fed holding the discount rate at 5 percent and maintaining the federal funds rate at 5.25 percent.

“There is, of course, a wild card in this connection, and that’s the presidential election campaign,” Hymans says. “Fiscal policy appears to be ripe as a tool to buy votes.

“Abandonment of deficit reduction, by either side, in favor of any combination of dramatic tax cuts or spending growth to be implemented in 1997 would be coming at precisely the wrong time in terms of existing utilization of resources. Nothing would lead the Fed to push interest rates up more quickly than a sudden turn to expansionary fiscal policy, regardless of the packaging used to sell it.”

Deficit reduction, however, should remain a top priority for both Congress and the White House, the researchers say. They predict that the federal government deficit of $145 billion (1.9 percent of gross domestic product) in fiscal year 1996 will decrease to $117 billion (1.4 percent of GDP) in fiscal year 1998.

The U-M forecast, based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics, also projects that:

?Federal expenditures will increase by less than 3 percent in each of the next two fiscal years, compared with increases of 4.8 percent in fiscal year 1995 and 3.3 percent in fiscal year 1996.

?Federal revenues will increase by 5.4 percent in fiscal year 1996, 4.5 percent in fiscal year 1997 and 3.3 percent in fiscal year 1998.

?Oil prices will decrease from the current $21 per barrel to $20 per barrel by the end of this year?as a result of Iraq’s re-entry into the oil market, maintenance shut-downs in North Sea production facilities, and strong world demand for oil?and then increase at a 3 percent annual rate thereafter.

?Real export growth will keep pace with the growth in real imports through the end of 1998?thanks to little net movement in the value of the dollar and expected stronger growth among the United States’ major trading partners?thereby maintaining the real net export deficit of the second quarter of 1996.

?Light vehicle sales will total about 15.1 million units for 1996 (up from 14.7 million in 1995) and remain at that rate in each of the next two years. Car sales are expected to decrease from 8.7 million units this year to 8.3 million by 1998, while sales of light trucks are projected to increase from 6.4 million units in 1996 to 6.8 million in two years.

?Housing starts will decline from about 1.48 million in the first half of 1996 to 1.38 million in the second half of this year, and remain at 1.3 million to 1.35 million through 1998.