FROM THE OFFICE OF PUBLIC AFFAIRS

Thank you. I'm pleased to be here today with institutional investors and money managers from so many countries around the globe.

I'd like to use this opportunity to describe the current U.S. economic landscape as we see it from the perspective of the Treasury Department. In particular, my remarks today will focus on three aspects of the American macroeconomic situation: the current macroeconomic environment in the United States; the effects on the U.S. economy of the global financial crisis; and the outlook for the American economy going forward.

In the eighth year of the current expansion, the fundamentals of the U.S. economy remain exceedingly sound. Thus far, domestic demand has proven sufficiently robust to keep the economy on a solid course of growth, even in the face of economic turmoil abroad. And when we reach the end of the current fiscal year in just over one week, the Federal government will record a budgetary surplus for the first time since 1969. More specifically, a host of indicators suggest that the performance of the American economy remains on sound footing:

The unemployment rate has held steady at 4.5 percent for the past three months, close to the 28-year low of 4.3 percent reached this spring. For college-educated workers, the joblessness rate is a remarkably low 1.8 percent. During the first two-thirds of 1998 alone, nearly two million new jobs have been created, extending the total since the Clinton Administration took office in January 1993 to 16.7 million.

Over the past 12 months, average hourly earnings have increased 2.9 percent in real terms the largest such increases since the early 1970's. Earlier in the expansion, real wages had been stubbornly sluggish, and a common complaint about the U.S. economy was that it was generating an ample number of jobs, but meager gains in real income. Not so over the more recent period.

During 1996 and 1997, real GDP grew nearly 4 percent per year, the fastest annual increases in a decade. In the first quarter of this year, the pace of growth jumped to 5.5 percent at an annual rate, before easing back to 1.6 percent in the second quarter. Throughout 1998, domestic final demand has remained strong. The slowdown during the second quarter was in large part due to a slowdown in inventory investment to a pace that should be more sustainable.

One of the most encouraging features of the current expansion has been the strong performance of private investment. Real business fixed investment grew at a 10 percent annual rate over the five years ending in the second quarter of 1998, the best performance since the mid-1960's. As a share of real GDP, real investment has risen to a post-World War II record in recent years. Given our recent move from fixed-weight national income accounting to chain-weighted, this strength in investment will not be revised away.

As a result of the strong economy, as well as President Clinton's 1993 deficit reduction package and the bipartisan budget package enacted in 1997, we are looking forward to the first budget surplus in 29 years. The Federal budget is expected to drop from a deficit of $290 billion in fiscal year 1992 an all-time high to a surplus in the current fiscal year that is more likely than not to exceed the $39 billion projected by the Administration in May.

The longer-run fiscal outlook is also encouraging, with surpluses forecast as far as the eye can see. I never thought I would see the day when serious market commentators furrowed their brows over the issue of whether there would be sufficient supplies of Treasury securities to support a deep and liquid market.

One long-run challenge that we do face is dealing with the demographic strains on the Social Security system, but as many of you know, President Clinton has made clear his determination to address this issue now, and to reserve the budget surpluses, in their entirety, until we have arrived at a solution. Indeed, as the President noted in his radio address last Saturday, he is prepared to veto any bill the Congress sends him that would threaten to squander the surplus before Social Security reform is in place. The Administration's position on this issue is easy to remember, because it is summed up in the simple phrase that the President first used in his State of the Union Address earlier this year: "Save Social Security First."

Even with all of the forward momentum in the domestic economy, there are few signs so far that inflationary pressures are building to any significant extent. That, in itself, is remarkable, given the length and pace of the expansion and the relatively low level to which the unemployment rate has been driven.

"Core" CPI inflation (excluding food and energy) remains near the low level of the mid-1960s. To be sure, a fraction of the recent favorable readings reflects changes in measurement methodology, but the bulk reflects genuine slowing in the overall trend in inflation.

The core PPI showed no increase in 1997, the first time that has happened since the series began in 1974. The core index has risen only moderately so far in 1998.

The chain-weighted GDP price index increased at less than a 1.0 percent annual rate in the first half of the year, down from 1.7 percent over the four quarters of 1997. This was the first time that inflation by this measure has been below 1 percent since the early 1960's.

The real proof comes not in these backward-looking measures, but in forward-looking indicators, and inflation expectations over the next five years remain remarkably low. The University of Michigan's survey of consumer sentiment finds that inflation expectations have continued to edge down over the past year despite the low level of the unemployment rate. Over the next five years, according to this survey, consumers expect an annual inflation rate of 2.7 percent, the lowest reading in two decades.

Why has the recent inflation experience been so favorable? Many observers of labor markets believe that the Nonaccelerating Inflation Rate of Unemployment (NAIRU) the theoretical level of unemployment below which the economy generates inflation has fallen in recent years, to around 5-1/2 percent or perhaps even less. A lower NAIRU implies less inflationary pressure for any given level of the actual unemployment rate.

Another factor that has probably played a role in the recent low inflation results has been the healthy pace of productivity growth over the past two years or so. There are even some hints in the data that trend productivity may be inching up, boosted by strong investment spending. Indeed, output per hour as officially measured, using the output side of the national income and product accounts, has risen at a 1.3 percent annual rate since the business cycle peak in the third quarter of 1990 slightly faster than the 1.1 percent trend rate of growth since 1973. And if calculated (as it used to be) using data from the income side of the national accounts, productivity has risen at a 1.5 percent annual rate over that time span. Moreover, the exceptional performance of corporate profits over the last six years in the face of low inflation seems to corroborate the idea of an improvement in productivity growth.

While the fundamentals of the U.S. economy remain strong, we are also now unmistakably beginning to experience the effects of the global financial crisis. Beginning with the devaluation of the Thai baht in July 1997, Asia, Russia, and, more recently, Latin America have come under varying degrees of financial pressure. At the same time, the situation in Japan has deepened in severity. The effect on the U.S. has evolved slowly, and although it is too early to know for sure how serious the impact of the Asian financial crisis will be on the U.S. economy, it is clear that it is having some effect, particularly on our balance of trade. The continued strength of the U.S. economy relative to the rest of the world most notably East Asia has led to significant changes in international trade flows and a significant increase in the U.S. current account deficit.

Thus far, the shift in the balance of trade has mainly been a story about exports. Indeed, total U.S. exports actually declined 2.8 percent at an annual rate in the first quarter of this year, and 7.4 percent at an annual rate in the second a sharp contrast to the 10 percent average annual growth in real exports over the preceding four years. Perhaps the most obvious consequence of this reduced demand for exports has been a noticeable weakening in manufacturing activity since the beginning of the year. Meanwhile, real imports into the United States have not accelerated thus far, rising at a slightly slower pace in the first half than they did in 1997. And going forward, if the turmoil continues to spread, we run the risk of additional impact on the economy. Consumers have already expressed uneasiness in recent surveys about the international economic turmoil, although confidence levels are clearly still high enough to support continued solid growth in consumer spending.

Over the past year, the decline in net exports has taken about 1-1/2 percentage points off of the growth of real GDP in the United States. Some of that effect is a normal occurrence during an expansionary phase of the business cycle and reflects the strong growth in the U.S. economy. But a significant portion is attributable to the decline in exports to East Asia. And going forward, if the turmoil continues to spread, we run the risk of additional impact on our economy.

Evidence of the impact of the global financial crisis on the U.S. economy as well as other economies throughout the world underscores the importance of Congress approving full funding for the International Monetary Fund. Failure to do so puts American prosperity at risk. As we face what could be the world's greatest economic challenge in half a century one in which the nations of the world are looking to the United States for leadership disengaging from the increasingly interdependent global arena simply ought not be an option. As President Clinton said last week: "History teaches us that at a time of worldwide difficulty, it would be folly to retreat into a protectionist shell."

Let me conclude by commenting briefly on the near term economic outlook for the United States. The sharp downward adjustments taking place in many foreign economies and the appreciation of the dollar in recent years are leading to expectations for moderated growth rates in the U.S. economy. Such a tempering in growth, however, does not on its face pose a major threat to the longevity of the current expansion and has, in fact, been expected for some time now. But let me be clear: Although the precise impact of the global financial crisis on the U.S. economy is at this point uncertain, the latest evidence available to us makes a strong case that the current expansion will continue.

In the meantime, we expect to stay on the responsible path of strict fiscal discipline charted by this Administration almost six years ago. According to the Office of Management and Budget's Mid-Session Review, the budgetary outlook is bright. OMB forecasts that the surplus will grow over the next four years to $148 billion by 2002. By 2008, OMB forecasts a surplus of just over $340 billion. Such surpluses would likely lead to higher savings and investment and continued low interest rates. Moreover, provided we can maintain the kind of fiscal discipline that we've been able to muster over the past few years, there is every prospect of continued sound fiscal policy for many, many more years.

The current strength of the U.S. economy is in large part the result of a combination of sound policies: deficit reduction, open markets, and investing in our people. Our commitment to these sound policies benefits both our domestic economy and the global economy. With the fundamentals of the U.S. economy strong and with an outlook for continued strength in the domestic economy the United States is in a position both to continue to generate solid economic growth at home and to play a leading role by working with industrialized and emerging nations, as well as the international financial institutions, to encourage responsible reforms and measures to stem the tide of the contagion effect in economies around the world.