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Real Gross Domestic Product continues to
expand at a robust rate. From first quarter 2003 to first quarter 2004,
real GDP expanded by a very healthy 4.9 percent. Moreover, on an
annualized basis real GDP increased by 4.2 percent during the first three
months of 2004. Similarly, industrial production is thought to have
increased by at a 3.3 percent rate in the year over comparison. This of
course is another indication to analysts that the economy has achieved a
degree of sustainable forward momentum.
Household spending, which accounts for
two-thirds of all expenditures in the economy, has continued to be a source of
strength for the economic expansion. Low interest rates, refinancing of
mortgages, and tax rate reductions have all helped to fuel consumer spending.
Moreover, capital spending by business firms is finally starting to rise which
adds to the economy's momentum. Government spending has also
contributed a great deal of fiscal stimulus to the economy.
Additionally, over the past couple of years the dollar has depreciated about
15 percent against other major trading currencies. This should help to
increase net exports and add further stimulus to the expansion. Monetary
policy has been very accommodative over the past number of years. While
recently rising, interest rates from a historical standpoint remain at
favorable levels. For example, the federal funds rate now stands at one
percent. This key borrowing rate is well below the range that is
considered to be neutral. Most economists believe that a federal funds
rate of approximately three and half percent would represent a neutral
monetary policy stance on the part of the Federal Reserve. A federal
funds rate below this level encourages the expansion of the economy, and rates
above this level are thought to suppress economic activity.
Besides the figures on GDP growth, there
is other evidence to suggest that the current expansion has taken hold and is
sustainable. Employment numbers for the nation suggest that in March
about 310,000 jobs were added to the country's payrolls. During
January thru March about 510,000 jobs were added to the country's payroll.
It also appears that the growth in jobs is broad based and occurred across
most sectors of the economy. Even manufacturing employment has shown
some tentative signs of life. However, one must remember that the
manufacturing sector was hit hard by the last recession and was the main
reason that the current recovery was called the jobless recovery. At the
time of this report manufacturing payrolls are about three million jobs below
the pre-recession figure. This represents a 17 percent decline over the
last four years.
Federal Reserve Board chairman Alan
Greenspan, in recent testimony given to the Joint Economic Committee of the
U.S. Senate, believes that the economic recovery is on firm ground. For
reasons already alluded to, the focus of Federal Reserve policy will gradually
move toward maintaining price level stability and less concern will be
directed to the sustainable nature of the current expansion. Greenspan
indicated that productivity gains enjoyed over the last several years are not
likely to be sustainable. Thus, it is likely that business firms will
have to increase payrolls sometime in the future because further productivity
gains from existing workers are not likely to meet demand. In
Greenspan's opinion, business firms will have two choices: absorb higher
labor costs by cutting profit margins, or raise prices.
Given the slack that still exists in the
economy and foreign competition it is unlikely that labor cost increases can
be passed on now in the form of higher prices, so inflation will not become an
immediate problem. In addition, recent sharp increases in several price
indices are most likely short-term in nature, and the result of volatility in
the energy and food sectors. However, in the longer term the potential
for persistent price level instability is becoming a much greater threat to
the nation's prosperity because aggregate demand in the economy appears to
be so very strong. This is evidenced by rising commodity prices in
steel, copper, and lumber. Thus, there is more than an even chance the
Federal Reserve will tighten credit conditions sometime in the near future in
an attempt to dampen demand and to prevent the economy from over heating.
Therefore, look for the Federal Reserve to embark upon a series or program of
gradually raising interest rates. By using a gradualist approach the
Federal Reserve will attempt to diminish the threat of inflation without
placing the current expansion at risk. It will be most interesting to
see if the Federal Reserve can successfully navigate this course. |
