FROM THE OFFICE OF PUBLIC AFFAIRS

The economy appears to have returned close totrend in the second quarter, after a temporary burst of growthearlier in the year. The exact numbers are not firm at thisstage. First quarter real growth is carried on the bookscurrently at nearly a 6 percent seasonally adjusted annualrate, while market estimates for the second quarter are closer to2 percent.

These numbers arerounded off for the sake of our discussion this morning and mayeven look somewhat different by the end of the week. The firstofficial Gross Domestic Product estimate for the second quarterwill not be available until Thursday. To complicate mattersfurther, annual benchmark revisions to the GDP accounts for thelast three years will also be released on Thursday. Hopefully,these benchmark revisions will add to our understanding of recentdevelopments. But here is what we know, or think we know, aboutthe second quarter on the basis of the information that iscurrently available.

One way to approach the estimation of the secondquarter is from the side of production. Aggregate workhours -- acrude proxy for real GDP -- are known from the monthly employmentsurveys. Workhours grew at roughly a 2 percent annual rate in thesecond quarter. In principle, some allowance might also be madefor rising productivity. An alternative approach forsecond-quarter GDP estimation is to add up, as best one can, themajor expenditure components. Some pieces are still missing sothe results are necessarily approximate. But, once again, realgrowth in the second quarter near 2 percent, perhaps a littlemore, seems to be implied by this method as well.

The difficulty is in deciding how much of thedecline from the 6 percent first quarter to the 2 percent secondquarter is statistical and how much is real.

A plausible statistical case can be made that the combination of an unseasonably warm winter and an unseasonably cool spring accounts for much of the first-quarter speedup and the second-quarter slowdown. Seasonal swings in construction and consumer durable spending, for example, are sizable and the seasonal adjustment factors are correspondingly large. Any small deviations when the weather patterns depart from normal, as they did this year, are bound to be magnified. In addition, we express seasonally adjusted real growth at an annual rate which means that any such deviations in a single quarter are automatically multiplied by four.

 

It is easier to make statistical adjustments to data after the fact than to be sure what the implications are for economic performance in the future. About all that we really know with certainty is that 6 percent growth in the first quarter and 2 percent in the second quarter averages out to 4 percent real growth in the first half of the year. But that is not a great deal of help since this does not feel like a 4 percent economy at the present time.

 

Looking forward to the second half of the year,already underway but for which we have little data, it seemsprobable that the economy will move closer to trend -- closer to2 percent growth than the first half’s 4 percent. In broadterms, that describes the private forecasting consensus path.There seems to be a fair degree of continuity in the recentstatistical record pointing in that direction. Most of the recentnumbers suggest ongoing forward momentum but do not convey muchsense of acceleration from the second-quarter pace. Consumerspending firmed a little in June and weekly data from privatesources suggest that a healthy pace of spending at chain anddepartment stores continued into July. But there are few signs ofany sharp rise in consumer spending. This Friday’semployment and unemployment results for July will provide thefirst comprehensive reading on third-quarter activity and maygive us better insight into what is happening.

The other major dimension of recent economicperformance has been inflation. Here is where the welcomesurprises have occurred. With increased inflationary pressuresnotable by their absence, the outlook for the economy is verypromising.

The slower pace of inflation has been most striking in the commodity area at the wholesale level. Producer prices for finished goods have fallen every month this year and were down at about a 3-1/2 percent seasonally adjusted annual rate in the first half. This is partly an energy story but core producer prices for finished goods (the total index excluding food and energy) were virtually flat in the first half of the year. In addition, there are few signs of any increase in inflationary pressures at earlier stages of the production pipeline.

 

Consumer price inflation has also run below projection. Through the first half of the year, the consumer price index was up at only a 1.4 percent annual rate, less than one-half of last year’s rate of inflation. This, too, reflects declines in energy prices. The closely-watched core consumer price index, which excludes food and energy, increased at a 2.4 percent annual rate in the first half of the year, a little below last year’s rate. Services constitute a little over one-half of the consumer price index. Commodities included in the consumer price index actually fell in price during the first half of the year and rose at less than a 1 percent annual rate if the food and energy commodity components are excluded.

 

Good inflation performance can probably beexpected to continue along a path of moderate growth. Certainly,there was little in this morning’s employment cost indexresults which suggests that rising cost pressures are currentlymuch of a problem.

Over the twelve months ending in June, nominal compensation for civilian workers (wages and salaries plus benefits) grew 2.8 percent, in line with market expectation. This represents a slight decline from the 2.9 percent increase in the previous 12-month span ending in March.

 

Both the wage and salary and the benefit component of the index were in line with recent experience. Wages and salaries were up 3.2 percent in the latest 12 months, compared to 3.3 percent in March. Benefits rose 2.0 percent, the same as in the previous period.

 

With commodity prices flat or falling, demandinflation is virtually non-existent. Overheating seems almost anarchaic term. From the cost side, pressures are surprisinglymodest and offset in part by rising productivity. But it is wellto recall that the economy is operating near potential and atrates of unemployment that are low by historical standards.Developments will still need to be followed very closely.

That is a summary of how we see the domesticeconomic situation at the present time.