FROM THE OFFICE OF PUBLIC AFFAIRS October 7, 1998RR-2745 Thank you. It's a pleasure to be here today with a group that includes so
many of our profession's foremost observers of both the U.S. and global economies. I'd like to use this opportunity for three purposes: First, to outline the current domestic
macroeconomic environment in the United States; second, to describe the effects on the U.S.
economy thus far of the global financial crisis; and third, to sketch the outlook for the American
economy going forward. Recent weeks have witnessed a remarkable shift in sentiment among observers of the
U.S. economy, due in no small part to events growing out of the overall global financial crisis.
We must not underestimate the risks that situation poses to our economy; but it would be equally
wrong to allow those events to obscure the remarkable recent performance of the U.S.
macroeconomy. With that in mind, I'd like to offer a little context about where things currently
stand on the domestic front. In the eighth year of the current expansion, the fundamentals of the U.S. economy remain
sound. Thus far, domestic demand has proven sufficiently robust to keep the economy on a
course of solid growth, even in the face of economic turmoil abroad. And when we closed the
books on the fiscal year that ended one week ago, the Federal government recorded a budgetary
surplus for the first time since 1969. As a reminder, it's worth reviewing a number of the most
recent indicators: 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. Indeed, as Chairman
Greenspan noted here this morning, inflation remains low, if not declining. 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. 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.
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 since the 1990 peak. 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 have just recorded the first
budget surplus in 29 years. The Federal budget deficit, which reached an all-time high of
$290 billion in fiscal year 1992, is no more. Thanks to a commitment to fiscal discipline and
the
strong economy, the Federal government ran an estimated $70 billion budget surplus in
fiscal
year 1998. This is no small accomplishment. 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, the President 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." The lesson I take away from all of this is that, if we must enter a period of heightened
global financial turmoil and greater macroeconomic risk, which we clearly are doing, then
we are
starting from a remarkably favorable position. Output and employment are at a high level
and
retain forward momentum. Inflation is under control. A major step toward getting our fiscal
house in order has been taken, with the achievement of the first balanced budget in 29 years.
And a process for shoring up the long-term finances of the Social Security system has been
put in
place. That said, the financial and international environment clearly has grown less
hospitable of
late, and poses decided risks to our economy. Indeed, we concur with the 57 percent of
respondents to the latest NABE Economic Policy Survey who identify fallout from the
international financial crisis as posing the most serious risk to the U.S. economy. 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 what the ultimate scope of that impact will be,
it is
clear if this question had ever been in doubt that the effects on our economy will be
important. Thus far, the most noticeable effect on the domestic real economy has been 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 a significant increase in our current account deficit. Thus
far, the shift in the balance of trade has mainly been a story about exports. Indeed, total U.S.
exports in real terms actually declined 2.8 percent at an annual rate in the first quarter of this
year, and 7.7 percent at an annual rate in the second a sharp contrast to the almost 10
percent
average annual growth in real exports over the preceding four years. Meanwhile, real
imports
into the United States have not accelerated thus far; in fact, they rose at a slightly slower
pace in
the first half than they did in 1997. Overall, the decline in net exports took about 2 percentage points off the growth of
real
GDP in the United States in the first half of this year. And while we expect that effect to
diminish going forward, we agree with the majority of respondents to the NABE Survey
forecast
who expect that our trade deficit will remain a net drag on the macroeconomy for at least the
next
few quarters. Moreover, if the turmoil continues to spread, we run the risk of additional
impact
on our economy. A fascinating aspect of the last year or so is that several aspects of the international
situation acted to buffer the American economy from what could have otherwise been a
more
severe impact. Interest rates have been lower, giving a boost to home building and car
buying.
And import prices and oil price have been lower than they otherwise would have been,
helping to
hold down our overall inflation rate. More recently, however, some aspects of this situation have become less benign. For
example, as Chairman Greenspan discussed with you at some length this morning, yield
spreads
between Treasuries and other securities have widened, in some cases dramatically. This
appears
to reflect both an increased appetite for liquidity, pure and simple, and an increased aversion
to
credit risk. 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 month: "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
widespread 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 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. 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.
The
unemployment rate continues to hover at historically low levels. And corporate balance
sheets
remain generally healthy, with high profit levels relative to interest costs and manageable
debt.
With inflation in both the U.S. and other G-7 countries as a whole low, and in some
cases
declining further in recent months, there is clearly latitude to focus on what President
Clinton has
identified as the number one priority, namely generating sustainable and appropriate growth.
At the same time, 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.
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