U.S. Economy Performs Relatively Well in 1996
J. Robert Gillette
In 1996 the United States economy achieved moderately high growth with high levels of resource utilization and low inflation. The unemployment rate dipped to levels not seen since 1973, and the economy moved well into its sixth year of economic expansion since the last recession in early 1991. In fact, over the entire period from 1983 to 1996, the U.S. economy has recorded only two quarters of declines in total output.
Before explaining the performance of the U.S. economy has been in 1996, and its potential for 1997, I first summarize the 1995 economy. The relatively high growth of 1996 came on the heels of the 1995 "soft landing."
1995 Economy Experienced "Soft Landing"
With the economy in 1994 on the verge of overheating, the Federal Reserve launched a preemptive strike against inflation with eight interest rate hikes from February 1994 to February 1995. The Federal Reserve accomplished the delicate balance of slowing the economy without also causing a recession, as the 1995 economy experienced a "soft landing" with moderate to low growth and low inflation.
Real gross domestic product (GDP), the value of all final goods and services produced in the U.S. adjusted for inflation, grew 1.3 percent. As Figure 1 shows, real GDP barely grew at all during the first two quarters, with annual growth rates of only 0.4 percent and 0.7 percent, but grew rapidly in the third quarter at 3.8 percent. The economy slowed in the fourth quarter with an anemic 0.3 percent growth, and produced some fear about a possible recession in 1996.
The unemployment rate, as Figure 2 shows, equaled 5.6 percent for six months in 1995 and ranged only from a low of 5.4 percent to a high of 5.7 percent. The economy generated a healthy increase in jobs (as measured by the increase in nonfarm payroll employment) of 2.2 million, for an average of 185,250 additional jobs per month.
Inflation from December 1994 to December 1995, as measured by the rise in the Consumer Price Index (CPI), remained low at 2.7 percent. The core inflation rate, which excludes volatile food and energy prices, was a bit higher at 3.0 percent.
1996 Economy Performs Relatively Well
The economy in 1996 achieved moderately high growth, low inflation, and historically low unemployment. As Figure 1 shows, real GDP grew substantially faster in 1996 than in 1995. During the first quarter of 1996, the economy grew at a 2.0 percent annual rate, eliminating any fears of a recession following the stagnant 1995 fourth quarter performance. The economy soared in the second quarter at a 4.7 percent rate, causing substantial concerns over overheating and rising inflation. In the third quarter the economy settled back to a more sustainable growth of 2.3 percent. The forecast for the fourth quarter has the economy growing from around 2.2 to 2.4 percent, and if the economy realizes this growth, it will have grown a respectable 2.8 percent for 1996.
Employment and Industry
Unemployment rates dropped to their lowest levels in 23 years. As Figure 2 shows, unemployment equaled 5.8 percent in January, dipped to 5.1 percent in August, and rose slightly to 5.2 percent in October. Through October, the unemployment rate had averaged 5.4 percent for the year. These are historically low rates, and to see how low one needs to consider the fact that the Bureau of Labor Statistics in 1994 revised the way it calculates unemployment, implementing several significant improvements in the data collection procedures. These revised procedures, however, raise unemployment rates about 0.5 percent over rates calculated using the old procedures. As a result, to compare unemployment rates of 1996 with periods before 1994, one needs to subtract about 0.5 percentage points from the 1996 rates. (For example, the 5.4 percent average for 1996 becomes 4.9 percent.) Making this adjustment, unemployment rates in 1996 dropped to their lowest levels since 1973.
The U.S. economy continues to be an incredible job-creating machine. Since 1974 the economy has generated an average of over 1.8 million jobs per year. In 1996 the economy did even better in creating jobs. Nonfarm payroll employment increased through October by 2.1 million, for an average of 209,100 additional jobs per month. At this rate the economy will create over 2.5 million additional jobs in 1996, a 2.1 percent increase in total employment from 1995 levels.
Industrial production the output of factories, mines, and utilities picked up in 1996. As Figure 3 shows, the monthly index of industrial production remained basically flat in 1995 (increasing only 1.1 percent) but increased at a healthy 4.7 percent annual rate through the first nine months of 1996. The index of industrial production began in January at 122.5 percent of its 1987 (baseline) average and rose to 127.1 percent by September.
Prices and Inflation
Inflation continued to remain low in 1996 for the fifth year in a row, hovering around 3.0 percent. From January through September, inflation (as measured by the CPI) equaled 3.2 percent. The core rate of inflation, however, which excludes food and energy prices, equaled only 2.6 percent. Both food and energy prices increased considerably in 1996, pushing up the overall inflation rate.
Largely due to the record high grain prices during the summer, food prices increased 4.4 percent through September. The drought in the southern Plains early in the year decimated wheat fields, and the heavy spring rains in the Midwest delayed corn planting, all of which sent wheat and corn prices soaring. Weather conditions have since improved, and grain prices have dropped substantially since August.
Crude oil prices hit six-year highs and caused energy prices to increase by 6.5 percent through September. West Texas intermediate crude started the year at $19.50 per barrel, reached $25.93 in mid-October, and settled back in mid-November to around $23.50, which still represents about a 25 percent increase over 1995 prices. Oil prices fluctuated over the year as the prospects for the United Nations permission for Iraq to start exporting petroleum on a limited basis (700,000 barrels per day) fluctuated with the actions of Saddam Hussein. Iraq, one of the biggest oil producers in the world, has been barred from selling oil since its 1990 invasion of Kuwait and had not received UN permission to export by mid-November.
Bad weather and increases in oil prices both represent what economists call adverse supply shocks. Other things constant, these two factors cause a drag on the economys growth rate and an increase in inflation, as evidenced by the 1996 core inflation rate (which excludes food and energy prices) of 2.6 percent considerably below the overall 1996 inflation rate of 3.2 percent. With weather conditions improving, grain prices falling substantially, and crude oil prices stabilizing in the $23 range, the gap between the core and overall inflation rate should begin to narrow.
The Federal Reserve in 1996 was as noticeable for what it did not do as for what it did do. Early in the year, worried about the slowdown in the economy at the end of 1995, the Fed backed up its interest rate cut in December 1995 with another cut in late January 1996. Specifically, the Fed cut its target for the federal funds rate (the rate banks charge other banks for overnight loans) by a quarter percentage point on each occasion, lowering the rate to 5.25 percent. With the economy picking up in the latter half of the first quarter, the Fed then held rates steady through the rest of the year as of mid-November. The September meeting of the Feds policy-making arm, the Federal Open Market Committee (FOMC), provided some drama as most analysts predicted FOMC would raise interest rates to slow the economy after the booming 4.7 percent growth rate of the second quarter. Instead, the Fed held rates steady, and, subsequently, when the third quarter numbers indicated a slowing economy growing at the more sustainable 2.2 percent, the Fed policymakers looked like prophets. At its next policymaking meeting on December 17, look for the Fed to continue to hold interest rates steady.
Interest rates went on a bit of a roller coaster ride during 1996 as the expectations of inflation increased and then decreased over the year. The bellwether 30-year Treasury bond rate started the year around 6.0 percent but increased steadily to 7.12 percent in May as inflation fears kicked up with the rise in grain prices, the increase in crude oil prices, and the rapidly improving economy. The long bonds yield then hovered around 7.0 percent (peaking at 7.19 percent in July) through September as inflation fears continued. But, in October with grain prices subsiding and the economy clearly slowing, the 30-year rate dropped, reaching 6.66 percent by the months end. The November election results gave rates another boost down as the market anticipated continued control of government spending and budget deficits, and the long bonds rate dipped to 6.48 percent in mid-November.
The dollar attracted some attention as it hit a 42-month high against the Japanese yen in late October at 114.36 yen per dollar. After declining a couple of yen in early November, the dollar had still gained over 10 yen for the year for a 10 percent increase. Against other currencies, the dollar also gained but by less. Against the German mark, the dollar gained 5 percent, and against the Federal Reserve Boards index of ten major currencies (the currencies of the G-10 countries), the dollar gained 2.7 percent.
1997 Forecast: Not Quite as Good as 1996
For 1997, the economy should experience moderate growth with low unemployment and low inflation. The forecasts for real GDP center just above 2 percent growth. In July, the Federal Reserve in its 1996 semiannual report to Congress predicted real GDP growth for 1997 of 1.75 to 2.25 percent. DRI/McGraw-Hill forecasts growth to be 2.1 percent, with a range of up to 2.5 percent in what it calls its "generous" forecast and down to 1.4 percent for its "stern" forecast. In sum, for 1997 look for real GDP growth of 2.1 to 2.2 percent, with growth of less than 2 percent being a disappointment and growth in the mid-2 percent range being a pleasant surprise.
Unemployment rates will continue to be low in 1997, likely in the mid-5 percent range. The Federal Reserve predicts the unemployment rate will average between 5.5 and 5.75 percent. DRI/McGraw-Hill forecasts an average for 1997 of 5.5 percent, with its generous forecast predicting 5.3 percent and its stern forecast an average of 5.7 percent.
Inflation will continue to remain low in 1997, hovering around 3 percent. The Federal Reserve forecasts an inflation rate for 1997 of 2.75 to 3.0 percent. DRI/McGraw-Hill forecasts a 2.7 percent inflation rate, with its generous and stern forecasts ranging from 2.8 percent to 2.5 percent.