Speech

Growth Prospects for the U.S. Economy AAIMManagementAssociation St.Louis,Missouri December20,2002 It is a pleasure to participate once again in 5.6percentinthefourthquarterof2001to5.9 an AAIM program. The end of the year is percentfourquartershence. a traditional time to take stock of the state Asweapproachtheendof2002,theeconomy oftheeconomyanditslikelyfuturecourse, appearstohaveperformedaboutasexpected:If and that is what I’ll do this morning. realGDPgrowsatabouta1¼percentannualrate Thetitleoftoday’sprogram,“TheAmerican inthefourthquarter,andCPIinflationisabout EconomyandMiddleEastSituation,”presents 2¼percentatanannualrateforthequarter,as considerablechallenges.I’lltalkaboutthe projectedintheDecember10issueoftheBlue “AmericanEconomy”—actually,theU.S.economy ChipEconomicIndicators,theneconomicgrowth partofthetopic.Thatistheeasypart,andI’ll in2002willbe2.9percent,inflationwillbe2.2 leavethetoughMiddleEastissuestoothers. percent,andtheunemploymentratewillproba- Beforeproceeding,Iwanttoemphasizethat blyaverageabout5.9percent.Intheforecasting theviewsIexpressherearemineanddonot business,lastyear’sprojectionsaretantamount necessarilyreflectofficialpositionsoftheFederal tohittingabull’s-eye. ReserveSystem.Ithankmycolleaguesatthe Iftheeconomyisperformingaboutasforecast, FederalReserveBankofSt.Louis,especially whyaresomanysoglumthesedays?Partofthe storyisthatforecasterswererightfortheannual KevinKliesen,fortheirassistanceandcomments, averagebutwrongonthepatternovertheyear. butIretainfullresponsibilityforerrors. Atthistimelastyear,policymakersandbusiness Mybasicmessagetodayisthat,whilethe leadersalikewerestrugglingwiththeeconomic economyisstillworkingthroughsomeadverse uncertaintiesassociatedwiththefalloutfrom developmentsthataffectedoureconomicperformthehorrificeventsofSeptember11.Thegeneral anceoverthepastcoupleofyears,ithasdisplayed expectationwasthattheeconomywouldcontract anextraordinaryresiliency.Theeconomyisfundainthefourthquarteroflastyearandthateconomic mentallysound;ourunderlyingeconomicstrength growthinthefirstquarterofthisyearwouldbe hascarriedusthroughsomedifficulttimes. onlyatouchabovezero.Then,theconsensus viewwas,asthe9/11shockworeoffandasthe expansionistpoliciesputinplacebytheFed REVIEW OF 2002 andCongresstookhold,theeconomywouldbe Atthistimelastyear,theconsensusview growingatabouta4percentpacebythethird amongforecasterswasthattheeconomy,asmeas- andfourthquartersofthisyear. uredbyrealgrossdomesticproduct(GDP),would Actualeventshaveplayedoutabitdifferently. growbyabout2¾percentin2002andthatthe Aftergrowingata2.7percentannualrateinthe consumerpriceindex(CPI)wouldincreasea fourthquarterof2001,realGDPsurgedtoa5 shadeover2percent.Withbelow-trendeconomic percentgrowthrateinthefirstquarterof2002. growthexpectedtoprevailformostoftheyear, Thosetwoprettystrongquarterswerecertainlya theunemploymentratewasprojectedtorisefrom surpriseinthewakeof9/11.Theeconomythen 1

ECONOMICGROWTH slowedappreciablyduringthesecondquarter,to plants,equipment,andsoftware.Thisrecovery a1.3percentrate,andacceleratedagainduring hasbeenunusualbecausethesesourcesofstrength thethirdquarter,toa4percentrate.Smoothing havebeenmuchweakerthanusual,resultingin throughthisvolatilityshowsthatrealGDPhas belowaveragegrowth. grownatabitlessthan3.5percentatanannual The2002recoveryhasalsobeenunlikethe rateoverthefirstthreequartersofthisyear— typicalrecoveryinthatequitypriceshaveconwhichisprettyclosetotheeconomy’spotential tinuedtobeweak,whichmaybepartofthereason rateofgrowth.Thesoftpatchinthefourthquar- thatdemandgrowthhasbeenmodest.Allelse terfinishesthisyearonadownnote,andthatis equal,risingstockpricesincreaseconsumer partofthestoryofwhysomanyaresoglum. wealth,leadingconsumerstoincreasetheirpur- Consumerspendinghasaccountedforabout chasesbymorethantheirincomegrowth.For two-thirdsofrealGDPgrowthoverthefirstthree business,risingstockpricesspurequityissue, quartersofthisyear.Muchofthisstrengthreflects whichisusedtofinanceinvestmentinplantand elevatedsalesratesofnewlightvehicles,the equipment.Whenequitypricesfall,theopposite slowerpaceofsalesinOctoberandNovember effectsoccur.Ultimately,stockpricesriseorfall notwithstanding.Thetwoothersourcesof becauseprofitsriseorfall.Thisyear’spoorstock strengththisyearhavebeenfromaslowerdraw- marketperformanceisreadilyexplainedbythis downofbusinessinventoriesandgovernment year’sdimprofitperformance:Asreportedbythe grossinvestmentandconsumptionexpenditures. BureauofEconomicAnalysis,after-taxeconomic Thelatter,obviously,reflectstheinitialresponse profitsaredownabout13percentoverthefirst to9/11eventsandtheassociatedwaronterrorism. threequartersof2002. TheexpectedslowerrateofGDPgrowthin Anotherreasonfortheweakbusinessinvestthecurrentquarterreflectsaprojecteddeclinein mentin2002mayberelatedtotheextraordinary automotiveoutputthatcouldreduceGDPgrowth ratesofcapitalinvestmentseenduringthelatter bymorethan1percentagepoint.Thechoppiness partofthe1991-2001businessexpansion;the causedbytheupsanddownsofautoproduction capitalstockinanumberofindustriesgotahead andinventoryinvestmentisnotamatteroffunda- ofdemand.Butmostfundamentally,themodest mentalconcern.Indeed,someofthechoppiness recoveryreflectsthemodestnatureoftherecession maywelldisappearinthefutureasrevisionsto of2001.Thefactthattheeconomyneversankvery seasonalfactorstendtosmoothshort-run farmeansthattherewasn’tmuchofabounceback fluctuations. inthecardsanyway.Mostnoteworthyinthis Puttingasidetheextraordinary9/11tragedy, regardisthesteadystrengthofhousingdemand. ifthatispossible,whatdowemakeofthecurrent Housingconstructionusuallydeclinessubstanrecoveryfromtherecessionof2001?TheNBER tiallyduringarecession,andthenbouncesback BusinessCycleDatingCommitteehasnotyet duringtherecoveryphaseofthecycle.Thistime, announcedofficiallythattherecessionisover housingwasstrongthroughtherecessionand but,assumingthattherecoverybeganlatelast continuedonahighplateauduringtherecovery. yearorearlythisyear,2002willhavebeenone Housinggrowthwasmodestbecausetheindustry oftheslowesteconomicrecoveriesinthepost- operatedatahighlevelallalong. WorldWarIIperiod.Duringthefirstfourquarters Nevertheless,theyeardoesseemtobeending oftheaveragepost-WorldWarIIrecovery,real onadisappointingdownnote,andthatispartof GDPincreasedbyalittlelessthan7½percent. thereasonmanyareglum.Perhapsamoreimpor- Inatypicalrecovery,thekeydriversofgrowth tantsourceofgloomisthatemploymentgrowth arenewprivatehomeconstruction(residential hasbeenessentiallyzero.Buttheflipsideofthe fixedinvestment);householdexpenditureson employmentstoryistheremarkablesurgein durablegoods,likemotorvehicles,furnitureand productivitygrowth.Thistopicissointeresting homefurnishings;andbusinessspendingon thatitdeservessomeelaboration. 2

GrowthProspectsfortheU.S.Economy PRODUCTIVITY SURPRISE centproductivitygrowtharehuge.Theproblem isnotthatproductivitygrowthistoohighbut Oneofthemostnoteworthyfeaturesofthis thatGDPgrowthistoolowtocreatesatisfactory recoveryistheweakdemandforlabor.Infact, employmentgrowth. thelabormarketperformancethisyearbearsan Intheshort-run,firmshavebeenabletosubeeriesimilaritytotheso-called“joblessrecovery” stitutecapitalforlaborbecauseofthetremendous afterthe1990-91recession.Inthefirstyearof ratesofcapitalinvestmenttheymadeduringthe bothrecoveries,growthofnonfarmpayrollsfrom 1990sandtheapplicationofimprovedbusiness thecyclicaltroughwasnegativeandtheunempracticesthatarecomingclosertorealizingthe ploymentratewasmodestlyhigher. fullpotentialoftheenlargedcapitalstock.What Atonelevel,thereluctanceoffirmstovigorreallymattersisnotthataPCreplacesatypewriter ouslycompeteforlaborintoday’seconomy butthatthePCmakespossiblechangesinbusireflectsthemodestgrowthofoutputandaggregate nesspracticethatsqueezemoreoutputfromeach demand.Yetatanotherlevel,firmsmaybereluchouroflaborinput.Thisveryspeechisasimple tanttoboostemploymentduringthisrecovery example:BasedonanoutlineIsentbyemail, becausetheyhavefoundwaystomeetdemand KevinKliesendrafteditandIputitintomyown throughimprovedproductionprocesses.Pro- styleworkingonacomputerattheSt.LouisFed ductivitygrowth—thegrowthofoutputperhour branchinLouisville,withtheassistanceofcomoflaborinput—hasthisyearbeenconsiderably mentsBobRaschesentmebyfax. higherthanwhatisnormal. Recentresearchbyexpertsinthisfieldsug- Tobemorespecific,thegrowthoflaborpro- geststhatareasonableestimateoflong-term ductivityoverthefirstyearofthelastfourrecov- U.S.laborproductivitygrowthgoingforwardis eries(excludingtheshort1980-81recovery) between2and3percent.1Ifso,thenproductivity averagedabout4¼percent.Assumingthatthe growthwillbesignificantlyhigherthanitwas 2001recessionendedsometimeduringthelast from1973to1995,whenU.S.productivitygrowth quarterof2001,growthoflaborproductivityover averagedabout1.4percentperyear. thefirstthreequartersof2002hasbeennearly1 Ofcourse,thereisalwaysthepossibilitythat percentagepointfaster.Acrudeback-of-theenve- somepartoftherecentsurgeinproductivity lopecalculationshowsthatthisextra1percent- growthwillberevisedaway.Forpolicymakers, agepointoflaborproductivitygrowthoverthe oneofthedifficultiesindiscerningthetrendrate firstthreequartersof2002haseffectivelybeen ofproductivitygrowthstemsfromrevisionstothe substitutedforanetjobcreationofalittlemore data,whichcansometimesbequitesubstantial. than2millionworkers,whichwouldhave Forexample,the1998and1999annualrevisions occurredhadtheaveragejobgrowthofthepast indicatedthatproductivitygrowthwasnoticeably fourrecoveriesheld.Infact,2millionmaybe fasterthanoriginallythought.Conversely,the toolow,sincetheaveragejobgrowthincludes 2001and2002revisionssignificantlylowered the1990-91joblessrecovery. estimatesofproductivitygrowth.Duringthese InnowaydoImeantoimplythatthisextra periods,revisionstooutputgrowthwerethe 1percentagepointofproductivitygrowthduring drivingfactor,ashourswerehardlyrevised. the2002recoveryhasbeenbadfortheeconomy. SomepreliminaryresearchattheSt.Louis Strongproductivitygrowthentailsfarmoreben- Fedshowsthat,since1985,therehasbeenlittle efitsthancosts.Indeedthelong-termbenefitsof, correlationbetweentheinitialproductivityfigures say,3percentproductivitygrowthversus2per- releasedbytheBureauofLaborStatisticsand 1 Jorgenson,DaleW.;Ho,MunS.andStiroh,KevinJ.“ProjectingProductivityGrowth:LessonsfromtheU.S.GrowthResurgence;”and Oliner,StephenD.andSichel,DanielE.“InformationTechnologyandProductivity:WhereAreWeNowandWhereAreWeGoing?”Bothin FederalReserveBankofAtlantaEconomicReview,Thirdquarter,2002. 3

ECONOMICGROWTH finalfiguresthatincorporateannualrevisions. forecastofthefuturearemanyleapsoffaith.In Forexample,iftheinitialpublishedproductivity mymindtwostandout.First,anyforecastthatis growthrateis2percent,anapproximate95per- generatedfromamacroeconometricmodelprecentconfidenceintervalforthefinalrevisedfigure sumesthateconomicoutcomesaretiedtogether is0to4percent,ahugerange.Forthisreason, inacertainfashion.Amodel’sstructurereflects I’mhesitanttoputtoomuchemphasisonthis boththetheoreticalbiasesoftheforecasterand year’sstrongproductivitynumbers.Knowing thehistoricalregularitiesinthedata.Clearly,the thishistory,Idon’twanttogooutonapolicy theorycanbewrongorincomplete,andtheinterlimb,oranyotherlimb,basedontheearlyesti- pretationofthedataflawed. matesofproductivitygrowth. Thesecondkeyassumption,orleapoffaith, Thatsaid,thisyear’snumbersareconsistent thatforecastershavetomakeconcernsthelikely withanevolvingupwardtrendinlaborproduc- pathofeconomicvariablesinthemodel.Key tivitygrowth,andtheyareconsistentwithanec- assumptionsinthisregardarethepathofoil dotalinformationfromtalkingwithbusiness prices,theFed’sinterestratetarget,taxrates, leaders.Idon’twanttogetboggeddowninthe depreciationratesoncapitalgoods,foreign details,buttheexpertssuggestthatalargeper- exchangeratesand—sigh—thecourseofthe centageofthisaccelerationisITrelated—both stockmarket.Clearly,aforecastdependsona quantitativelyandqualitatively.Fromaquanti- numberoffactorsthatmaychangeunexpectedly— tativestandpoint,therewasasurgeinbusiness 9/11isaperfectexampleofanimportantbut capitalspendingoverthepastseveralyears:Real inherentlyunforecastableevent.Withthatin investmentinequipmentandsoftwareasashare mind,letmewalkyouthroughascenariothat ofrealGDPeffectivelydoubledto6percentfrom seemscredibleknowingwhatweknownow. 1995:Q1to2002:Q3. Whenthinkingabouttheoutlook,Iamalways Whilethetremendousincreasesinphysical wellawarethattheonlysensiblestanceformeis volumesofcapitalgoodshavebeenimportant, tobeaninformedconsumerofforecasts.Iam sohasthequalitativeaspectofthesecapitalgoods. notmyselfanexpertforecaster,anddonot—can- Qualitatively,thenewtechnologiesembodiedin not—spendenoughtimeforecastingtoexpectto thesecomputers,servers,telecommunications outperformthosewhomakealivingfromthat equipment,andthelikehasalsoenabledfirms occupation.Iamwellawareoftherangeofforecasts—expertforecastersdisagree.Researchsugtoproducemorewithless.Atsomepoint,though,as geststhatthebestforecastforaconsumerlikeme aggregatedemandgrowthstartstopickupand issomesortofaverageoftherangeofforecasts. firms,respondinginkind,begintoraisethepace Forthesereasons,Iplaceagreatdealof oftheirhiring,thecurrentexceptionallyhigh weightontheso-calledconsensusforecastpubratesofproductivitygrowthwillslowtorates lishedintheBlueChipEconomicIndicators. approximatingtheirlong-termtrend.Thecapital- Eachmonth,about50ofthenation’stopprivate labortradeoffmaybemorepermanentinsome sectorforecastersarepolledontheiroutlookfor industriesthanothers,butintheaggregatethe severalkeyeconomicindicators(e.g.,growthof fasterrateofgrowthoflivingstandardsenabled realGDP,theCPI,industrialproductionandthe byenhancedratesofproductivitygrowthisunamleveloftheunemploymentrate)overthenext biguouslyanetplusfortheeconomy. severalquarters.Theconsensusisjusttheaverage oftheseindividualforecasts.However,andthis isanimportantpoint,Iamalwaysimpressedby OUTLOOK FOR 2003-04 howquicklytheconsensusforecastcanchange. I’llnowturntotheoutlookfortheU.S.econ- Iamnotwillingtobetmyhouse—ormypolicy omyoverthenextyearortwo.Inherentinany position—ontheforecast.Expertsdiffer,andover 4

GrowthProspectsfortheU.S.Economy afewmonths’timetheysometimeschangetheir reasonstobeoptimisticaboutthepaceofcapital forecastssignificantly. spending.Firstandforemost,high-techcapital Withthatintroduction,I’llofferanoverview depreciatesrapidly.Hence,fairlyrapidgrowth oftheconsensusforecastfortheU.S.economy. ofhigh-technologyinvestment—anincreasing First,itseemslikelythatthegrowthofconsump- shareofinvestmentspending—isneededtokeep tion—thatis,spendingbyhouseholdsondurable netinvestmentratesstableorgrowing.Replaceandnondurablegoods,andservices—willremain mentinvestmentisimportantwhenstandard around3percent,whichismodestlyslowerthan practiceis,forexample,todepreciateaPCover thegrowthseenduringthelatterpartofthe1990s threeyears.Second,businessplanningcould (andevenoverthepastfourquarters).Although becomeappreciablylesschallengingoncegeostronggrowthoflaborproductivitywillcontinue politicaluncertaintiesareresolved.Andifthe toundergirdhouseholdincomes,currentsaving uncertaintiesarenotresolved,frommyexperiratesseemabnormallylowinlightofthepending ence,whathappensisthatbusinesseslearnto demographicchallengesassociatedwiththe livewiththeproblemsandgetonwiththeirpurretirementofthebaby-boomgeneration.Ultisuitofnewproductsandnewmarkets.Indeed,if mately,somerebalancingofspendingrelativeto wecanusethestockmarketasabarometer,it incomesseemsnecessary—thoughthisprocess appearsthatsomeuncertaintyhasbeenwhittled couldplayoutoverseveralyears.Inaddition, awayoflate,asequitymarketshaveralliedmodsomeofthefactorsthathaveboostedconsumpestlysincesettingfive-yearlowsinearlyOctober. tioninrecentyears—rapidgrowthofhousehold Finally,economicactivityshouldcontinuetobe wealth,mortgagerefinancing,andmortgagecashboostedbyanaccommodativestanceofmonetary outsarenotlikelytobethesourceofextraspendpolicy,withsomeassistancefromfiscalpolicy. ingthattheywereafewyearsback.Inshort, consumptiongrowthislikelytobeasolid3 percent,moreorless,buttolagincomegrowth FUNDAMENTALS OF THE slightlyashouseholdsreturnthesavingratioto amorenormallevel. LONG-TERM OUTLOOK Second,whethernear-termrealGDPgrowth GiventheuncertaintiesI’venotedabove,the isfasterorslowerthantheconsensusexpectswill timingofthetransitiontohighergrowthremains dependcruciallyonbusinessoutlaysforcapital unclear,butprobablynottheeventualoutcome. goods.Atpresent,amajorityofforecastersexpect Tobelieveotherwiseimpliesanalternativeview thepaceoffixedinvestmenttobestrongerdurthatsomethingisstructurallyunsoundinour ingthesecondhalfof2003.Thisoutlookisalso economy—eithermuchweakereconomicgrowth consistentwithacoupleofrecentsurveysof islikely,orinflationispoisedtoaccelerate.At firmspublishedbytheFederalReserveBankof thispoint,I’mwillingtoplacemymarkeronthe PhiladelphiaandtheInstituteforSupplyManagesideofthosewhopointtoflexiblemarkets,rapid ment.However,thetimingoftherecoveryinfixed innovation,highproductivitygrowth,andlow investmentisveryuncertain,owingtosomekey factors.Theseincludecurrentlowratesofcapac- inflationasthelinchpinsforareturntosolid ityutilization,duetothehighrateofinvestment economicgrowthoverthemediumterm. inthelate-1990s;relativelyhighvacancyratesin Toooften,though,observersoftheeconomic commercialandindustrialbuildings;aguarded scenegetcaughtupinthehigh-frequencydata outlookforcorporateprofits;uncertaintiesassoci- andneglectlonger-termissues.Thecentralbank’s atedwithapossiblewarwithIraq;andthethreat primaryinputtothemixofconditionsthatprooffutureterroristattacksoccurringonU.S.soil moteshighgrowthinemploymentandoutputis oraffectingU.S.interestsabroad. topursuepoliciesthatmaximizeprospectsfor I’veofferedaformidablelistoffactorshold- lowandstableinflation.Theevidenceisthatthe ingbackinvestmentin2003,buttherearealso FederalReservehasbeensuccessfulinthisregard. 5

ECONOMICGROWTH Currentratesofinflationarelow.Justasimportant, inflationratesexpectedbyfinancialmarkets, consumers,andforecastersgivenocredibilityto theassertionthattheinflationoutlookispoised todeteriorateanytimesoon—eitherontheupside oronthedownside. Thatsaid,thecurrentsituationisnotonein whichmonetarypolicymakerscanaffordtorelax. Monetarypolicyisveryaccommodativeright now.Short-terminterestratesareexceptionally lowandmoneygrowthisstrong.Giventhedownwardpressuresthathaveslowedtheeconomy’s recovery,thisstancehasbeenappropriate.AsI haveemphasizedonseveraloccasions,thispolicy stancehasbeenpossiblebecausetheFed’scredibilityishigh.ThemarketsbelievethattheFed willreversecoursewhennecessarytoprevent inflationfromrising,andI’llcertainlydoeverythingIknowtodotoassurethatoutcome. Havingmadethispoint,Idonotwanttobe readashintingthatI’mcurrentlyontheedgeof pushingforatighterpolicy.Theobjectiveissustainedlowandstableinflation;givenalltheshorttermeconomicnegativesI’vediscussed,theFed needstobealerttodeflationaryaswellasinflationarydangersinthemonthsahead.Ifnecessary, thereisroomtocutthefederalfundsratetarget somemore,andtopursueotherpoliciesifwerun outofroomonthefundsratepolicyinstrument. Ithinkitisunlikelythatwe’llrunintothatproblem,butthinkingthrougheverypossiblecontingencyiswhatcreatesarobustandcompetent monetarypolicy.Inshort,monetarypolicy changesinthefuturewillbedriven,asthey haveinthepast,byarrivalofnewinformation onhowinflationprospectsandgrowthprospects areevolving. 6