FROM THE OFFICE OF PUBLIC AFFAIRS

When you were here three months ago, the economy had completed a strong fourth quarter with real growth estimated near 6 percent. Because there had been some boost to the fourth quarter from precautionary inventory building and other transactions in advance of Y2K, a more moderate pace of growth was widely expected to emerge in the first quarter of this year. For example, in early February, shortly after you were here, the Blue Chip consensus of some 50 economists at major businesses, financial institutions and academic research organizations projected about a 3 percent real growth rate for the first quarter, roughly one-half of the fourth quarter rate. The first quarter turned out to be much stronger than expected.

Real growth of 5.4 percent in the first quarter did fall short statistically of the fourth quarter's upward-revised 7.3 percent, but in most key respects the first quarter appears to have been stronger than the fourth. Real personal consumption expenditure, two-thirds of gross domestic product, rose at an 8.3 percent annual rate in the first quarter, up from 5.9 percent in the fourth, and the fastest such quarterly rate since early 1982. Real business fixed investment rose at a 21.2 percent annual rate in the first quarter, up from a 2.9 percent rate in the fourth quarter, while residential investment rose at a 6.7 percent annual rate in the first quarter, up from 1.8 percent in the fourth. As a result, real domestic final demand grew at an 8 percent annual rate in the first quarter despite a sharp drop in federal spending. The 8 percent growth rate in domestic final demand was pulled down to the 5.4 percent headline figure for growth in gross domestic product by negative contributions of approximately equal size from net exports and inventory investment. Each, in its own way, was a reflection of strong domestic demand in the first quarter, rather than any sign of weakening in the pace of economic activity.

With domestic demand growing at such a strong pace, there is naturally some concern that inflationary pressures might begin to increase. The broad gross domestic product inflation measures did show some acceleration in the first quarter, but this was because of higher energy prices and the annual Federal pay raise which is treated as a one-time price increase. Excluding those factors, inflation was tame. The core price index for gross domestic purchases increased at a 1.7 percent annual rate in the first quarter after excluding the Federal pay raise, slower than the 1.9 percent increase in the fourth quarter. The personal consumption expenditure deflator, excluding food and energy, rose at a 1.8 percent rate in the first quarter after rising at a 2.0 percent pace in the fourth quarter.

The employment cost index, released last week, seemed to provide a more serious indication that inflationary pressures are beginning to emerge. The compensation of civilian workers (wages plus benefits) rose 4.3 percent in the twelve months ending in March, up from 3.4 percent in the twelve months ending last December. This latest 12-month increase consisted of a 4.0 percent increase in wages and salaries and a 5.0 percent increase in benefits. It should be noted that these employment cost increases do not translate one-for-one into an inflationary result, instead they are offset in whole or in part by increases in productivity. Official productivity results are not yet available for the first quarter along with their accompanying compensation measures which differ somewhat from those in the employment cost index. Still, it is possible to draw some provisional conclusions. It seems likely that there was another fairly strong gain in productivity in the first quarter, perhaps keeping the productivity gain over the past four quarters close to 3 percent and holding any rise in unit labor costs to relatively modest proportions, consistent with the observed gross domestic product inflation rates near 2 percent.

There has been a remarkable record of rising gains in productivity during this long expansion which has enabled strong growth to be combined with low inflation. In the two previous long economic expansions since World War II, those in the 1960's and in the 1980's, growth in productivity declined more or less steadily after initial cyclical gains, and had virtually disappeared by the late stages of those expansions with clear inflationary consequences. The key to keeping the economy on a sustained low-inflation growth path may well be the continued achievement of strong gains in productivity.

Information currently available suggests that the economy began the second quarter with considerable forward momentum. There is little in the statistical record which points to any sharp change of pace, but many indicators seem to be coming off their recent highs.

• Initial claims for state unemployment insurance benefits rose by 26,000 in the week of April 22, although this was from a 26-year low of 257,000 one week earlier. Both continued claims and the state insured unemployment rate have fallen to new lows and labor markets remain very tight.

• Consumer confidence is at high levels although some measures are slightly off their peaks. According to the Conference Board, consumer confidence was little changed in April after two months of easing from an all-time high in January. Press reports suggest that the University of Michigan index of consumer sentiment firmed somewhat in April, but it too has shaded down from a peak in January.

• Recent readings in retail sales are difficult to interpret because of a late date for Easter this year. There has apparently been some improvement in April, but sales are still reported to be running a little below plan for most retailers.

• The National Association of Purchasing Management index shaded down somewhat in April, suggesting continued growth in manufacturing but some deceleration over the past six months. There were signs of moderation in the rate of increase in prices paid by manufacturers.

It may be worth recalling that in each of the last two years, strong first quarters were followed by second quarters in which growth in real gross domestic product slowed to about 2 percent. Discretionary spending for goods has shown double-digit gains in the first quarter of each of the past three years, suggestive of a seasonal phenomenon perhaps not yet adequately captured in the seasonal adjustment process. Possible factors might include unusually mild winter weather, heavy discounting by merchandisers in the post-holiday sales seasons, increased bonus pay early in the year and earlier tax refunds because of electronic filing. The net effect on the statistical record may have been to pull some activity into the first quarter at the expense of the second. It is not beyond the realm of possibility that something like that could occur again this year. At the present time, though, the dominant feature of the current situation continues to be strong real growth combined with relatively low rates of inflation.

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