The Growing Us Economy The economy has performed exceptionally well for the past several years, combining rapid growth and very low unemployment with declining inflation. “Not only has the expansion achieved record length, but it has done so with far stronger growth than expected,” stated Federal Reserve Chairman Alan Greenspan in his remarks to the National Community Reinvestment Coalition annual conference in Washington (Business Week, The McGraw-Hill Companies, Economic Outlook, March 6,2000). Figures show that since 1996, the growth of GDP has averaged more than 4 percent, compared with an average of about 3 percent since 1973. Because of those four years of rapid growth, the unemployment rate has fallen to 4.
1 percent, its lowest level since January 1970. Consumer Price Index (CPI) inflation, excluding food and energy prices, had been vacillating at about 3 percent per year earlier in the decade but was roughly 2 percent over the past year (Bank of America, Economic in Brief, November 1, 1999).Much of the auspicious recent economic developments can be attributed to a surge in productivity growth. Alan Greenspan noted in his statement that output per hour in the non-financial corporate sector had increased since 1995 at nearly double the average pace of the preceding 25 years (First Union, Monthly Economic Outlook, March 7, 2000). This rapid productivity growth allowed the economy to grow at a faster pace without raising the rate of inflation. However, the growth of consumer demand is exceeding the increase of productivity – boosting employment, tightening labor markets, and raising concerns that recent growth rates may not be sustainable without sparking a rise in inflation. After spending the past several years extolling the virtues of improved productivity in allowing higher growth with less inflation, the Federal Reserve Chairman, seemed to turn the tables in his Humphrey Hawkins testimony, stating that the spurt in productivity has produced expectation of higher profit growth, which, in turn, have resulted in higher equity valuations. That surge in equity prices is seen as the primary driver of the “wealth effect”, which he believes has created an “imbalance” between demand and supply, raising inflation pressures (Business Week, The McGraw-Hill Companies, Economic Outlook, March 6,2000).
Speculations of this occurrence may over the long term indicate that the higher the trend growth of productivity, the lower the inflation rate – due to the restraint of labor costs. However, in the short-run, if productivity growth jumps rather quickly to a higher level, its impact on demand would outrun the existing supply of recourses to meet that demand.Since supply cannot be increased quickly enough, Alan Greenspan believes demand growth must be brought back into line with supply growth. The concept to achieve a balance, he believes, is higher interest rates.
High interest rates have, in fact, reduced home sales, but the overall economy has not cooled enough to reduce inflationary fears. The Fed is still concerned that strong consumer spending will lead to inflation. Right now, much of the strong demand is being satisfied by imports and expanded U.S. production from increased employment (Bank of America, Economic Research, Economic in Brief, November 1, 1999).Nevertheless, the Fed is worried that there may be limits to employment growth or foreign willingness to hold U.S. dollars earned exporting to the United States.
Fed policymakers would be much more comfortable if the demand for goods would slow, thereby reducing the risk of the economy overheating or the dollar falling. Recent increases in the price of oil have reached their highest level since the Gulf War, and further increases could hurt U.S.
economic growth.With the recent Attacks on America on September 11, OPEC’s decision to cut production last March has lead to rising inflation. Considering the most recent leap in oil prices, inflation reports in the near future could be strong, pushing the twelve-month CPI rate up to 3 percent or more (Business Week, The McGraw-Hill Companies, Economic Outlook, March 6,2000). The question of whether to maintain the status quo or increase production remains in the hands of OPEC members.
At present, Saudi Arabia and Iran appear to favor increasing production, but some other constituents want to extend the production cuts. Oil prices have risen to more than $34 per barrel and growing concerns that a shortage of gasoline could arise this summer if OPEC does not pump more oil begin to circulate. In retrospect, the increase in crude oil prices over the last year is almost the same magnitude as the jump in oil prices going into the Gulf War (Oil and the Economy, “Will higher prices mean a recession?”, March 13,2000). Oil shocks – steep rises in oil prices, have preceded recessions in the US economy over the past 30 years.The most substantial shocks occurred in 1973-74, 1979-80 and 1991, and roughly correspond to the post-1970 recessions. Statistical data has shown a correlation between rising oil prices and diminishing GDP growth. .
The effect of oil prices is not an isolated economic phenomenon. It largely depends on the “political economy” component, since the price of oil is affected by the production decisions of the OPEC countries and these OPEC countries may time their price increases in reaction to world economic conditions, especially with the fluctuating United States economy since September 11, – thus complicating attempts to forecast economic behavior. While there has been a definite relation between rising prices and GDP growth, concerns of rising oil prices may not have such a tremendous effect on the economy as in the past. Oil costs have been a shrinking part of the US economy in recent years. Since 1970, energy use as a fraction of GDP has fallen by around 35 percent (Oil and the Economy, “Will higher prices mean a recession?”, March 13,2000).Even if the experiences with increasing oil prices are taken under consideration, the risk of a recession, at this point, is low. In either case, however, high oil prices fuel the risk of recession by making the economy vulnerable to other negative developments (Oil and the Economy, “Will higher prices mean a recession?”, March 13,2000). If oil prices were lower, the economy could endure other problems more easily.
With high oil prices, the economy may not stand up as well to any new unexpected shocks. The current employment situation appears to be another “bright spot” in today’s economy.The unemployment rate rose to 4.1% in February but remains near its lowest level in more than three decades (Bank of America, Economic Research, Economic in Brief, November 1, 1999). Consumer expectations of the economy remain favorable and spending is strong. Wages are rising faster than inflation, allowing families to stretch their incomes further. This “gilded” image of the job market, however, has its own shortcomings as well. Despite the existing prosperity and the tightest labor markets in a generation, more workers are afraid of losing their jobs than at the bottom of the 1991 recession (Market News, Greenspan: Worker Insecurity now more than in last recession by Chris Middleton).
It is a pivotal period, Greenspan went on, that is a direct result of the development of the transistor after World War II. It brought us the microprocessor, the computer, satellite and the joining of laser and fiber-optic technologies. The average worker can no longer obtain skills in high school that will be a sufficient support for an entire career, he noted. For this reason, technological changes make many workers concerned about job security, and as a result, excessive wage increases do not come into view. Wage inflation is only 3.6percent for the twelve-months ended in February, and after adjusting for productivity gains, labor costs to employers are still low.
Consumers remain in a buying mood – and February car sales were at their strongest pace of this economic expansion (First Union, Monthly Economic Outlook, March 7, 2000). Rising incomes and wealth have increased consumers’ willingness to spend and take on more debt. So far, the rise in gasoline prices has not dampened car and truck sales.However, the effect of higher fuel costs could show up in weaker vehicle sales this spring. Consumer debt levels have increased sharply in recent months but remain manageable (First Union, Monthly Economic Outlook, March 7, 2000).
Debt levels only become a problem when unemployment rises and consumers begin to worry about their ability to make debt payments. Here is another area of the economy that is vulnerable to unexpected negative news. The increase in consumer spending shows that Fed rate hikes have not yet cooled this vital sector of the economy, but the increased debt burden also indicates that a slowdown in consumer spending may not be too far in the future. The economy continues to grow faster than the Fed would like. In my opinion, the strong demand for goods and services cannot be indefinitely satisfied by imports and expanded U.S.production.
Consequently, inflation will remain a threat, and another increase in interest rates is likely. If oil prices and interest rates continue to climb up, the economy will lose pace and could become vulnerable to a considerable slowdown should any other problems develop. Consumer price inflation could increase significantly in the next few months because of the recent oil price rise. Slower growth prospects may inhibit the flow of investments into the industry. This, in turn, may trigger an economic recession and unemployment. If, however, OPEC increases production, the fear of inflation could lessen and long-term Treasury interest rates could move lower.
In this case, a disastrous scenario of the US economy may be avoided.Bibliography n/a Economics Essays.