FROM THE OFFICE OF PUBLIC AFFAIRS

When you were here three months ago, the economy was growing strongly and inflation was low. The cloud on the horizon was the emerging financial problems in Southeast Asia. Now, three months later, the Asian situation shows signs of stabilizing and the U. S. economic situation has if anything improved even further. Growth moved above 4 percent in the fourth quarter and inflation stayed near 1-1/2 percent.

Most recent measures of domestic economic performance have been extremely positive. Perhaps the only exceptions worth noting are some features of the last quarterly reading on the employment cost index and a dip in the Conference Board index of consumer confidence in January, offset by stronger readings recently from other such surveys.

The general picture is one of a strong domestic expansion supported by vigorous job growth and sharply rising incomes. The unemployment rate stayed below 5 percent in the second half of last year, but cost pressures are still well contained with some key measures of inflation showing the lowest readings in more than three decades. This combination of strong growth and low inflation after more than six years of cyclical expansion is remarkable, indeed.

Important features of the current situation were summarized last week in two key data releases: the employment cost index for the three months ending in December and the advance estimate of Gross Domestic Product for the fourth quarter of last year.

The employment cost index covering wages and salaries plus fringe benefits of civilian workers rose by 3.3 percent during the twelve months of 1997, up from increases of 2.9 percent during 1996 and 2.7 percent during 1995. The 1997 increase and the results for the latest three months were somewhat above market expectation.

The latest results were boosted statistically by higher commissions in the financial industry associated mainly with the recent surge in mortgage refinancing activity. This was the only industry to experience a bigger wage and salary increase in the fourth quarter than in the third. Developments in this area seem unlikely to be much of an inflationary force going forward.

Attention is often directed to the potential cost-increasing impact of rising levels of employment rather than to the tangible income-enhancing effects. Converted to real terms, the private wage and salary component of the employment cost index rose by more than 2 percent during 1997 -- the largest such twelve-month increase in nearly fifteen years.

There is little indication, however, that the employment cost index is revealing any significant increase in inflationary pressure. Rising real wages reflect lower rates of inflation and above-average gains in productivity last year. While full productivity data are not yet available for the fourth quarter, approximate estimates can be made. Productivity growth apparently tapered down from a very rapid pace in the third quarter, but ran well above trend for the year as a whole. This held down growth in unit labor costs despite the rising levels of compensation that are an inevitable, and highly desirable, feature of a prosperous economy.

The other key statistical report last week was the advance estimate of fourth-quarter GDP. Growth rose to a 4.3 percent annual rate in the fourth quarter, up from 3.1 percent in the third quarter, bringing the increase during the four quarters of 1997 to 3.9 percent. Inflation remained at relatively low levels with the GDP chain-weight price index rising at a 1.5 percent annual rate in the fourth quarter and 1.8 percent during the four quarters of the year. Strong growth and low inflation were the dominant features of the report.

In addition, there were some special features of the fourth-quarter results which require comment.

Given the Asian difficulties, some early signs of deterioration in the net export component of the GDP accounts might have been expected. That still lies in the future since net exports improved on a seasonally adjusted basis, adding about 1 percentage point to real growth in the fourth quarter. This repeats once again a pattern that has been common in recent years, apparently related to difficulties of seasonal adjustment. On the basis of past experience, some worsening of the net export position early this year would be expected for purely statistical reasons alone.

It should be noted that there was some moderation in the pace of domestic final demand in the fourth quarter, masked by the increase in net exports and by an increase in the rate of inventory investment. Consumer expenditures grew more slowly than in the third quarter, with most of the growth coming from spending on services rather than commodities. In addition, business fixed investment spending actually fell back a little in the fourth quarter, following double-digit rates of increase in the two previous quarters. As a result, final demand slowed down somewhat from the third-quarter pace. The economy closed the year on a strong note, but does not seem to have accelerated much, if at all, from the pace earlier in the year, despite the 4.3 percent growth number for the fourth quarter.

It is an unfortunate fact that even our most recent statistical readings are backward-looking. Yet, in domestic economic terms, the dominant question currently is the impact of Asian developments. Financial market signals flashed rapidly down the electronic highway, as many of you know from firsthand experience. Effects on what we are prone to term real activity are still relatively moderate and not always even clearly discernible in the flow of statistical information. And, with interest rates moving to lower levels, some of the early effects on real activity appear to have been positive, rather than negative.

At this stage, reliance has to be placed on econometric estimation of the probable Asian impact on the U. S. economy. There is no shortage of such estimates although their direct comparability is occasionally questionable with some focussing on primary impact effects and others allowing for subsequent repercussions. All told, a lot of private-sector forecasts point to a negative impact on U. S. growth of perhaps « percentage point this year.

These estimates are valuable. They help to separate fact from fancy and shift the discussion into a quantitative framework. They have one serious shortcoming. Even if we accepted a specific estimate and regarded it as accurate out to several decimal points, what would we subtract it from? An Asian impact could fall heavily on the U. S. economy in one set of economic circumstances and hardly be noticed in another. Given a continuation of the stabilizing policies already put in place internationally and the strength of the U. S. economy domestically, U. S. economic growth seems likely to slow from its recent pace but not to fall much below its trend rate of growth in potential.

This may be a case where strength in numbers provides some support. The Blue Chip consensus estimate of growth by some 50 economists at major banks, corporations and academic research organizations for the four quarters of 1998 has been remarkably stable near 2-1/4 percent since late last summer. Presumably this reflects their collective allowance for a negative impact from Asian adjustments offset by continued signs over the period of greater-than-expected strength in the U. S. economy.

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