U.S. economy to grow at a moderate pace the next two years

August 18, 1998

U.S. economy to grow at a moderate pace the next two years

ANN ARBOR—While the ongoing Asian financial crisis and the recent General Motors strike has considerably slowed U.S. economic growth this summer, the American economy should continue to expand at a moderate pace through the year 2000, say University of Michigan economists.

In their mid-year review and forecast of the U.S. economy, Prof. Saul H. Hymans and researchers Joan P. Crary and Janet C. Wolfe of the U-M Department of Economics predict that the economy will grow overall by 3.1 percent this year, but just 1.4 percent in 1999 and 2.1 percent in 2000. [Last fall’s forcast] According to the U-M researchers, the economic slowdown that occurred in the United States during the second quarter of this year—growth slowed from a “whopping” 5.5 percent rate in the first quarter of 1998 to 1.4 percent in the second—will continue, with real growth forecast to rise at an average annual rate of 1.3 percent until mid-1999. Although the effects of GM’s labor woes will be temporary, with falling exports to Asia and a decrease in the pace of non-vehicle inventory investment, the economy will not be able to sustain the nearly 4 percent pace of the last two years, the economists say.

“There’s no way that aggregate demand factors are going to stay strong enough to keep the U.S. economy on the 3.9 percent per year growth track that was experienced all during 1996 and 1997,” Hymans says. “And it’s a good thing, too. We just don’t have the resources to keep production rising that rapidly, and if demand factors did stay that strong, the Fed would certainly have to move to a far tighter monetary policy.”

Hymans and colleagues predict that the Federal Reserve Board will keep interest rates at or below current levels throughout the next two years. The 30-year Treasury bond rate will remain at about 5.8 percent, while the three-month Treasury bill rate will edge downward from 5 percent in 1998 to 4.6 percent in 2000 and the conventional mortgage rate will decline from 7 percent this year to 6.7 percent in 2000.

“While watching carefully for any signs of accelerating inflation, the Federal Reserve has held its interest rate targets steady for over a year, despite robust economic growth and tightening labor markets,” Hymans says. “Since last fall, the policy question has focused increasingly on whether the economic crisis in Asia, by reducing demand for our exports, would help slow the growth of aggregate demand sufficiently to preclude an interest rate hike.

“We believe the Fed will not raise interest rates in the near term and, indeed, will opt for a somewhat more expansionary monetary policy next year.” The researchers say, however, that declining interest rates in the next two years will be accompanied by slightly higher unemployment and inflation. Unemployment is expected to be about 4.5 percent this year—down from 4.9 percent in 1997—4.8 percent in 1999 and 5.2 in 2000. After falling from 1.9 percent last year to 0.9 percent in 1998, inflation will rise, but remain subdued at 1.9 percent next year and 2.3 percent in 2000. “A return to rising import prices as the dollar weakens and more rapidly rising medical care costs contribute to the acceleration in consumer prices,” Hymans says.

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 predicts that: