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The national
economy turned in an outstanding performance over the past twelve months.
Real Gross Domestic Product expanded by a very robust 5.0 percent since
First Quarter of last year. Industrial production also went up by
an impressive 6.9 percent. All of this economic activity is starting
to have an influence on the rate of inflation. For the record, the
CPI rose by 3.7 percent over the course of the year. In reaction
to the building price pressure, the Federal Reserve has tightened credit
conditions in an attempt to cool the economy and prevent it from overheating.
As a result of the Federal Reserve policy actions, short-term interest
rates have risen from 4.38 percent to 5.78 percent over the past twelve
months.
Most analysts see the economy
expanding in the year 2000. The Federal Reserve expects real GDP
to grow somewhere in the range of 3.25 percent to 4.25 percent during the
year. The major concern though is that inflationary pressure is building
in the economy. Given this year's robust start and continued concerns
regarding inflation, look for the Federal Reserve to raise short-term interest
rates and tighten credit conditions.
Most economists' and the
Federal Reserve's concerns about inflation are based on several key factors.
Rising demand is exerting a tremendous amount of pressure on an already
tight labor market. Moreover, the lagged effects of higher energy
costs will eventually put upward pressure on the price of most all other
goods and services. Another concern is that the price of non-oil
imports will go up for domestic consumers. This will happen because
the value of the U.S. dollar in foreign exchange markets is not as strong
as it was in earlier time periods. Thus, a weaker dollar will cause
the cost of imported goods and services to rise. This will occur
in part because the economies of many other parts of the world are likely
to experience stronger growth in 2000.
Productivity growth up to
this point in time has played a major role in keeping inflationary pressure
in check. In essence, higher wages and benefits can be offset if
there is a commensurate increase in labor productivity. However,
the Federal Reserve is concerned that gains in aggregate supply, which
come from increased productivity, can not indefinitely outpace demand.
Besides the engineering or technical reasons for why this is not likely,
there are additional demand pressures being created by productivity enhancements.
To the extent that firms see productivity enhancing investments as generators
of additional profits, firms will continue to invest in these items.
Witness the huge increase in demand for capital equipment and information
based technologies. This induced demand will add to the growing price
and wage pressure in the economy. In addition, the strong gains in
productivity has lead to greater profits for many firms, which in turn
has helped to propel the financial markets to very high levels. The
growth in the financial markets has created a huge amount of new wealth,
which has fueled additional consumer demand.
With this scenario in place,
inflationary pressures are already starting to show up in CPI figures.
The consensus of most analysts is that the Federal Reserve is most likely
to accelerate its efforts in slowing down the economy. Therefore,
a series of interest rate hikes seems to be the most likely course of action. |
