Statement by the IMF Staff Representative July 30, 1999

This 1999 Article IV Consultation highlights that the U.S. real GDP grew by 3.9 percent in 1998, reflecting buoyant consumption and investment spending. In the first quarter of 1999, real GDP grew by 4.3 percent (annual rate) before slowing to 2.3 percent in the second quarter. Consumption has been boosted by a sharp fall in personal saving, with the ratio of personal saving to personal disposable income declining to ½ percent in 1998, and turning negative in the first quarter of 1999.

Abstract

This 1999 Article IV Consultation highlights that the U.S. real GDP grew by 3.9 percent in 1998, reflecting buoyant consumption and investment spending. In the first quarter of 1999, real GDP grew by 4.3 percent (annual rate) before slowing to 2.3 percent in the second quarter. Consumption has been boosted by a sharp fall in personal saving, with the ratio of personal saving to personal disposable income declining to ½ percent in 1998, and turning negative in the first quarter of 1999.

1. Since the staff report (SM/99/159, 7/9/99) was issued, the Chairman of the Federal Reserve Board, Mr. Alan Greenspan, presented the biannual report to Congress on the economic situation and monetary policy; the Congressional Budget Office (CBO) provided an updated analysis of the Administration’s budget proposals; and new data releases indicate that real GDP growth slowed in the second quarter of 1999 and that labor costs may have begun to pick up. The thrust of the staff appraisal is unchanged by these developments.

Chairman Greenspan’s testimony

2. In his congressional testimony on the Federal Reserve’s Semiannual Report on Monetary Policy (Humphrey-Hawkins testimony) on July 22, Chairman Greenspan indicated that by late June it had become apparent that much of the financial strain that emerged in the later part of 1998 had eased, the near-term outlook for foreign economies had improved, and U.S. demand was growing at an unsustainable pace. These developments prompted the FOMC to raise interest rates to avoid putting the economic expansion at risk.

3. Mr. Greenspan indicated that, in his view, factors were in place that should help to slow the growth in domestic demand to a pace more in line with potential output growth in the period immediately ahead. Consumption growth would slow if, as seemed likely, the strong equity price appreciation of the past several years did not continue. This would also induce businesses to trim capital outlays, a tendency that would be reinforced by the higher level of market interest rates borrowers now faced. GDP growth was expected by most of the Federal Reserve governors and Bank presidents to slow in 2000 to between 2½ percent and 3 percent.

4. Mr. Greenspan emphasized the major role of increased productivity growth in helping to keep inflationary pressures in check in recent years. He said that the accelerating use of newer technologies, business restructuring, and the synergies of the new technologies had enhanced productive efficiencies. Nevertheless, he cautioned that it was necessary to be modest about the ability to project that more rapid productivity growth would continue in the future.

5. Mr. Greenspan observed that for monetary policy to foster maximum sustainable economic growth, it was useful to preempt forces of imbalance before they threatened economic stability, although at times this may not be possible given the limits on forecasting ability. He emphasized that, whenever it was possible, a preemptive policy should be followed in order to avoid a more severe response at a later date that could destabilize the economy. Consequently, the Federal Reserve would act promptly and forcefully in the event that new data suggested inflationary pressures would be picking up.

6. Mr. Greenspan indicated that equity prices figured importantly in the Federal Reserve’s forecasting process because they influenced aggregate demand. Nevertheless, he reiterated his earlier view that the central bank could not effectively target equity or other asset prices. He said that identifying an asset bubble as it inflated was among the most formidable challenges confronting a central bank, as it would pit the central bank’s judgement against that of millions of investors. In the event of an adjustment in stock prices, it was the job of economic policymakers to mitigate the fallout and to ease the transition to the next expansion.

7. Mr. Greenspan’s remarks appeared to be interpreted by market participants as potentially foreshadowing a further increase in interest rates. Stock prices declined following the Chairman’s remarks and yields on long-term Treasury securities rose modestly.

CBO’s budget outlook

8. The CBO recently released testimony before the Senate Budget Committee on the Administration’s Mid-Session Review of the FY 2000 Budget. The CBO now estimates that under current policies the unified federal budget surplus will be $120 billion in FY 1999 (1.3 percent of GDP), and will reach $266 billion in FY 2004 (2.4 percent of GDP); this is a somewhat higher surplus than that projected by the Administration. Despite the more favorable surpluses under current policies, the CBO estimates that the Administration’s updated proposals as laid out in the Mid-Session Review would reduce the surplus in FY 2004 to $174 billion (1.6 percent of GDP), somewhat less than the surplus projected by the Administration. The CBO’s slightly less favorable medium-term budget projections under the Administration’s policy proposals is the result of their lower estimate of projected savings arising from the Administration’s proposed reforms of Medicare, and a significantly higher estimated cost for the Administration’s proposed addition of a Medicare prescription drug benefit.

Recent economic data

9. Real GDP grew by 2.3 percent (annual rate) in the second quarter of 1999, compared with 4.3 percent in the first quarter. The slowdown in growth was largely the result of a decline in the growth of consumer spending and residential investment. Business investment continued to rise at a relatively rapid rate. The unemployment rate in June edged up by 0.1 percentage point to 4.3 percent, but remains below most estimates of the natural rate.

10. Although inflation has remained subdued, employment costs rose sharply in the second quarter. The core CPI rose by 0.1 percent in June, and at an annual rate of 1.6 percent during the first half of 1999. The core PPI declined by 0.2 percent in June, and by an annual rate of 0.4 percent during the first half of the year. The employment cost index (ECI), on the other hand, rose by 1.1 percent (seasonally adjusted) in the second quarter, following a 0.4 percent rise in the first quarter. Both the benefits component of the index and the wages and salaries component contributed to this rise, with benefit costs growing at their fastest rate since the final quarter of 1997 and wages and salaries rising at a pace not seen during the current expansion.

Bank soundness

11. A table containing the latest summary indicators on the soundness of U.S. banks is attached for the convenience of Directors (Table 1). These indicators do not alter the position discussed in paragraph 43 of the staff report.

Table 1

U.S. Commercial Banks: Selected Performance Indicators 1/

(In percent, unless otherwise noted)

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Source: Board of Governors of the Federal Reserve System, Summary Profile of all Insured Commercial Banks.

Includes all commercial banks insured by the FDIC.

United States: Staff Report for the 1999 Article IV Consultation
Author: International Monetary Fund