FROM THE OFFICE OF PUBLIC AFFAIRS

When you were here three months ago, the dominant feature of the economic situation was strong real growth combined with low rates of inflation. Now, three months later, that is still the case. But there has been a change. Growth now seems to be coming down from a peak rate of over 8 percent late last year on the basis of newly-revised Gross Domestic Product data, while inflation has been edging up from its recent lows. These developments have been gradual, and hardly unexpected, but their timing and eventual resolution is not easy to judge. This is a period in which the behavior of current statistical readings, particularly those with forward-looking properties, takes on unusual importance.

Last week's advance report on second-quarter Gross Domestic Product contained the usual quota of surprises. Not the least of these was a headline real growth number of 5.2 percent annual rate, compared to a downward-revised 4.8 percent rate in the first quarter. But, beneath the surface, there were signs that a slower pace of real growth might be emerging. Real personal consumption expenditures (two-thirds of Gross Domestic Product) grew at a 3 percent annual rate in the second quarter, down from more than 7-1/2 percent in the first quarter. Outlays on durable goods, particularly motor vehicles, fell in the second quarter for the first time in three years, admittedly from a very high level.

Partly as a result of the slower pace of consumer spending, an increased rate of inventory accumulation added a full percentage point to real growth in the second quarter. To the extent that this accumulation was involuntary, it could serve as a drag on production during the second half of the year. It should be noted, however, that aggregate inventory-sales ratios remain very low and survey data do not suggest that inventory holdings are currently regarded as excessive.

Second-quarter real growth was boosted about 1 percentage point and first-quarter real growth was cut by about the same amount by quarterly swings in federal spending, as recorded in the national income accounts, which are likely to net to a small positive for the year as a whole. With allowance for these and other special influences, it seems fair to say that there was some slowdown in the growth of underlying aggregate demand during the second quarter, despite the recorded rise in real growth from 4.8 to 5.2 percent. From a favorable point of view, much of the second-quarter strength was in productivity-enhancing private investment categories. For example, there was a 31 percent annual rate of growth in "information processing equipment and software" which accounted for about one-third of the total growth in second-quarter Gross Domestic Product.

Inflation remained relatively moderate in the second-quarter Gross Domestic Product report, although up somewhat from last year. The Gross Domestic Product chain price index rose at a 2.5 percent annual rate in the second quarter, down from a 3.3 percent rate in the first quarter when the Federal pay raise was a special influence. The 2.9 percent annual rate increase of Gross Domestic Product inflation in the first half of this year compares with a 1.6 percent increase during 1999. A roughly similar pattern is shown in the core Consumer Price Index which rose at a 2.6 percent annual rate in the first half of this year, up from 1.9 percent during 1999.

The employment cost index (wages plus benefits) rose by a seasonally adjusted 1.0 percent in the three months ending in June, a shade below market estimates. Over the twelve months ending in June, total compensation costs for civilian workers rose by 4.4 percent, up considerably from 3.2 percent in the same period one year ago and the biggest gain in nearly a decade. Mounting cost pressure from the benefits component is a major factor along with wage and salary growth in tight labor markets.

However, this does not necessarily imply much, if any, increased inflationary pressure as long as productivity growth continues its recent strong performance. Official productivity estimates for the second quarter are not available yet, but rough estimates on the basis of the second-quarter Gross Domestic Product results point to another strong gain in productivity, probably over 4 percent at an annual rate. This should hold any rise in unit labor costs to modest proportions, consistent with recently observed inflation rates.

Weekly and monthly statistical indicators present a mixed picture and do not yet fully resolve the uncertainties in the current situation.

• The index of leading indicators dipped by 0.1 percent in May and has been down or about flat for the last four months. Based upon past relationships, this points to sustained expansion but not at the rapid pace seen earlier. Preliminary indications suggest a flat index or perhaps a slight rise in June.

• Initial claims for unemployment insurance are volatile and difficult to read at this time of the year because of the auto industry's annual summer downtime. The four-week average of initial claims has turned up sharply since dipping to a 26-year low at mid-April and continued claims have risen to levels not seen since last fall. These are potential signs of softening but difficult to reconcile with consumers' very optimistic perception of employment opportunities.

• The Conference Board index of consumer confidence rebounded in July and is close to its record high reached in May. Consumers' assessment of the current employment situation is now extremely favorable, with the share who believe jobs are "hard to get" at an all-time low. Press reports suggest that the University of Michigan index of consumer sentiment also remained at a high level in July.

• Orders for durable goods increased by 10 percent in June, driven by large increases in aircraft orders, both civilian and military. Excluding the volatile transportation category, orders were up a more modest 0.8 percent. Order backlogs indicate underlying strength in demand for capital goods.

• Existing home sales increased for the second consecutive month in June to a relatively high 5.23 million unit seasonally adjusted annual rate. Mortgage interest rates declined somewhat and may have given sales a temporary boost. Housing starts and permits, on the other hand, have begun to show some weakness.

The difficulty currently is in knowing whether the economy is likely to slow down even further, or whether it is likely to regain whatever forward momentum it may have lost. This uncertainty can probably only be resolved with the passage of time and further readings on the key economic variables. But at the present time and on the basis of the information currently available, the most likely outcome would seem to be the continuation of fairly strong growth, close to the economy's potential, possibly coupled with some mild increase in inflationary pressure.

That is a summary of recent economic developments and the near term economic outlook.