FROM THE OFFICE OF PUBLIC AFFAIRS

When you were here three months ago, the economy was growing at more than a 3 percent annual rate with inflation as measured in the national income accounts near 1 percent. On the basis of domestic considerations alone, there was little fault to find with economic performance. But events in financial markets here and abroad had moved rapidly and at times unpredictably. Credit-quality spreads had widened sharply and credit availability was interrupted temporarily in some markets. At the time, that financial turmoil inevitably introduced an element of uncertainty into the economic outlook.

Now, three months later, we meet with the domestic economy growing even more strongly than before, inflation remaining low and domestic financial markets functioning smoothly. Some of the original financial problems still remain and new ones always seem to be emerging internationally, but the immediate threat to the current economic expansion clearly has subsided. Indeed, the economy picked up speed late last year.

Last week the Commerce Department reported another "growth surprise", this time for Gross Domestic Product in the fourth quarter. Positive surprises have been the rule rather than the exception in recent years with economic growth regularly exceeding consensus expectation.

That surely was the case in the fourth quarter with growth estimated at a 5.6 percent annual rate, compared to the 2-1/2 percent average growth rate projected at the beginning of the quarter by the Blue Chip consensus of 50 economists at major financial institutions, business corporations and academic research organizations. The big fourth quarter raised real growth for the four quarters of 1998 to 4.1 percent. This was the third successive year of real growth around 4 percent in what has now become the longest U.S. peacetime economic expansion.

The composition of fourth quarter real growth was remarkably well balanced. Inventories grew a little more slowly than in the third quarter and inventory-sales ratios remained at low and what seem to be healthy levels. Business capital spending picked up again to a double-digit pace, after a third-quarter pause which some took as an early sign of weakness in that area. Consumer spending continued a strong pace of advance in the fourth quarter, residential construction pushed to higher levels and consumer confidence remained strong.

It is not likely that 5 percent real growth will continue. There were special factors boosting real growth late last year which are unlikely to repeat and which may in some cases reverse. There was a rebound from effects of the General Motors strike. Construction activity benefitted during the fourth quarter from unusually mild weather, as well as from the generally favorable economic and financial environment. Net exports exerted an essentially neutral influence in the fourth quarter as opposed to large negatives earlier in the year. Similar fourth-quarter improvement in the past has been associated with difficulties of seasonal adjustment. Based on that experience, some reversal of the fourth-quarter improvement might well be expected in the trade area. In light of these considerations, a slower pace of real growth in the current quarter seems likely to develop for statistical reasons alone, although without necessarily implying much significant change in the underlying pace of activity.

The other major recent reading on economic performance, also released last week, was the employment cost index. This is the most comprehensive measure of the costs to employers of employee wages, salaries and benefits. Total compensation costs rose at a seasonally-adjusted 0.7 percent in the final three months of the year and by 3.4 percent over the last 12 months. Both results suggested considerably less cost pressure than markets were expecting. Two features of the employment cost report deserve special mention.

Despite some deceleration in nominal compensation growth to around 3-1/2 percent, gains in real compensation have been substantial. Inflation-adjusted private wages and salaries, as measured by the employment cost index, grew by 2-1/4 percent during 1998 following a 2.0 percent increase during 1997. An enabling factor has been consumer price inflation of only about 1-1/2 percent per year, partly due to falling import prices.

Reduced cost pressures coupled with sizable real wage gains also reflect more rapid growth of productivity. Through the first three quarters of this year, nonfarm productivity grew at a 2 percent annual rate but may have grown at a much more rapid rate in the fourth quarter for which the initial estimate of productivity will not be available until next week.

It would have been difficult to have imagined a much more favorable set of economic statistics than has appeared recently. In addition to strong economic growth and low inflation late last year, there are more recent economic readings which suggest that considerable forward momentum is carrying over into this year.

Initial claims for unemployment insurance had been running a little higher than expected earlier this year (about 350,000 after seasonal adjustment). This began to raise some doubts as to the pace of current activity. Downward-revised data released last week paint a different and more encouraging picture. Initial claims have been lowered to a level (near 300,000) that is more consistent with strong growth and tight labor markets.

Doubts as to the continued strength of consumer spending and business capital outlays have caused many economists to write down this year's growth prospects. Early but still inconclusive signs this year have been more favorable. The LJR Redbook survey of retailers shows broad-based strength in sales through the first three weeks of January, the December report on durable goods orders points to strong business equipment spending this quarter and the latest report of the National Association of Purchasing Management suggests the possibility of some firming in manufacturing activity.

Despite this run of favorable economic statistics, it is necessary to recall that only three months ago the outlook appeared much less certain. There are still risks inherent in the current economic and financial environment both here and abroad. Domestically, the economy and its financial markets are always subject to ups and downs. But, the economy looks strong currently with its combination of solid growth and low inflation and seems to be poised for further gains.

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