Order Code RL30329
CRS Report for Congress
Received through the CRS Web
Current Economic Conditions and
Selected Forecasts
Updated July 30, 2004
Gail Makinen
Economic Policy Consultant
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
Current Economic Conditions and Selected Forecasts
Summary
U.S. real GDP has been positive for 11 consecutive quarters, and the economy
is considered to be in an “expansion” phase. As of the second quarter 2004,
inflation-adjusted growth was more than 9.0% above its previous high near the end
of the 1991-2001 expansion.
Real growth at 3.0% in the second quarter of 2004 was considerably lower than
the 4.5% rate achieved in the first quarter of 2004 (both at annualized quarterly rates).
Both are down from the 7.4% rate achieved in 2003:3Q. Even during the 1990s
expansion, the pace of growth was rarely over 7%.
Yet the rebound in growth has not translated into higher payroll employment,
and many call this a “jobless recovery.” Payroll employment, despite recent
impressive gains, is only 430,000 above the level attained at the end of the recession
(November 2001). The unemployment rate rose to 6.4% in July 2003; it has since
declined. During five of the first six months of 2004 it was 5.6% (in February it was
5.7%). These are well above rates in the second half of the 1990s.
There are however positive elements of the economic picture:
(1) A pick-up in output at the same time as employment is declining means that
productivity (or output per worker) is increasing. As we saw in the 1990s,
productivity growth is the key to raising our standard of living and is not necessarily
associated with weak labor markets over time. We eventually experienced both rapid
productivity and strong employment growth as the recovery broadened and deepened
throughout the decade. In the short run while adjustment is taking place, however,
there is a human toll from the continuing payroll employment losses.
(2) Inflation has accelerated over the first half of 2004, rising at an annual rate of
4.9% vs. 3.3% for the 12 months ended in June (as measured by the CPI).
While most economists did not expect the sizzling third quarter pace to be
sustained, they anticipate that growth will settle down to around 4% over the next
year, still above what is considered to be the long-run potential rate of growth.
However, the unemployment rate is expected to show only a modest change as long
as businesses are able to improve profitability through increased productivity.
Inflation is expected to remain low while considerable slack remains in the economy.
Fiscal and monetary policies have both been eased since 2001 and the easing has
continued into this year. They are having a positive effect on spending. The external
deficit is large and expected to remain so. This report will be updated monthly.
Contents
Current Economic Conditions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Details . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Labor Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Inflation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
The U.S. Foreign Trade Deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
The U.S. Dollar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Posture of Fiscal and Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Economic Forecasts, 2004-2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Special Topics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Accounting for GDP Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Promotion of Economic Growth: The Importance of Saving . . . . . . . . . . . 15
List of Figures
Figure 1. Real Dollar Exchange Rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Figure 2. Yield on Selected Securities and Federal
Funds (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
List of Tables
Table 1. The Growth Rate of Real GDP v. Final Sales, 1991-2003 . . . . . . . . . . . 3
Table 2. Civilian Unemployment Rate, 1991 - 2004 . . . . . . . . . . . . . . . . . . . . . . 5
Table 3. Rate of Change in the GDP Deflators, 1992 - 2003 . . . . . . . . . . . . . . . . 6
Table 4. Rate of Change in the Consumer Price Index (CPI), 1992 - 2003 . . . . . 6
Table 5. Rate of Change in Labor Costs, 1993 - 2004 . . . . . . . . . . . . . . . . . . . . . 8
Table 6. U.S. Foreign Trade Deficit, 1988 - 2003
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Table 7. Alternative Measures of Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Table 8. The Growth Rates of the Monetary Aggregates . . . . . . . . . . . . . . . . . . 11
Table 9. Economic Forecasts 2004 - 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Table 10. Accounting for GDP Growth: 1995 through 2004 . . . . . . . . . . . . . . 15
Table 11. U.S. Saving By Sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Current Economic Conditions and
Selected Forecasts
Current Economic Conditions
Overview
The U.S. economy is once again in an expansionary phase because it has more
than recovered its recession-related losses in real GDP. This situation was formally
recognized on July 17 by the National Bureau of Economic Research (NBER), which
declared that the recession starting in March 2001 had ended in November 2001. As
of the second quarter 2004, U.S. real GDP (measured in 2000 dollars) was 9.2%
above its recession low point in the third quarter 2001, and had grown 9.0% beyond
its previous high near the end of the 1991-2001 expansion. U.S. real growth has now
been positive for 11 consecutive quarters.
According to the most recent GDP report, growth in the second quarter of 2004
was at an annual rate of 3.0%, down from the 4.5% rate during 2004:1Q and the
7.4% rate during 2003:3Q.1 Growth excluding inventories was less buoyant in the
second quarter increasing at an annual rate of 2.8%.2 Contributions to GDP came
mainly from consumption and investment in equipment and software.
Yet, despite the recovery in growth and other positive signs, concerns remain.
The rebound has not yet translated into payroll employment rising above the level
attained at the end of the previous cyclical peak.3 Employment has contracted on
balance and the unemployment rate has risen and remained high relative to the level
1 The estimate of second quarter 2004 GDP growth is from the first (or “advance”) estimate.
2 The accounting framework that governs the calculation of GDP isn’t always straight-
forward. In the GDP accounting rules, inventories subtract from growth if they are drawn
down more in a particular quarter. However, in some circumstances, the drop in inventories
might point to stronger growth ahead. For example, if domestic demand (defined as GDP
other than inventories) accelerates at the same time inventories are drawn down, the
standard interpretation is that growth will probably be higher in the near future. The reason
why a pick-up is anticipated would be at least technical: with demand on the rise,
inventories will not be sufficient after a while and new production will eventually be
required to keep up with demand. New production increases GDP, according to the
accounting framework. A pick-up may also signal underlying acceleration in the economy.
quarter data. A similar signal was evident in the third quarter estimate.
3 The other major employment survey by the Bureau of Labor Statistics (BLS) indicates that
employment has risen since the end of the recession. According to the BLS household
survey, employment has increased by 2.8 million in contrast to a 1.2 million decline in
payroll employment.
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reached in the late 1990s, even as growth picked up. Since its peak in March 2001,
payroll employment has fallen by around 1.2 million people. An encouraging sign
is that employment has grown by 1.5 million since August 2003. It is still too soon
to know if this marks a major turning point. The unemployment rate has been a near
constant 5.6% since December 2003, which is well above the 3.8% low of the 1990s
expansion.
Measured inflation appears to be rising. The broadest measure of inflation for
the economy, the GDP price index, rose from a 1.1% rate in 2003:2Q to 3.2% during
2004:2Q (annualized rates). The Consumer Price Index (CPI) followed a similar
path. It’s annualized rate of growth accelerated from 0.7% during 2003:4Q to 4.7%
during 2004:2Q. The CPI, however, has been heavily influenced by sharp
movements in the price of food and energy. Excluding both, the CPI accelerated
over the same period from an annual rate of 0.9% to 3.0%.
The most recent data are difficult to interpret. The key questions are: To what
extent does the recent improvement in several key indicators point to the long-
awaited strengthening of the economy ? How will this translate in the labor markets?
Will employment pick up strongly with a lag, as it did in the 1990s ? To what extent
will a drag on growth continue from adjustment in the business sector, particularly
in the telecommunications industries, but also in transportation-related industries
affected by security concerns?
Monetary Policy
Beginning in January 2001, Federal Reserve policy has shifted to one of ease.
Since then, the Federal Open Market Committee (FOMC) of the Federal Reserve
System has lowered the federal funds target rate in 13 steps by a cumulative 550
basis points (5.50 percentage points), from 6.5% to, most recently, 1.0% on June 25,
2003 its lowest level since April 1961. The June FOMC decision was related to
continuing growth disappointment and the need to add further support to economic
activity from monetary policy. However, over the past year inflationary pressures
have moved upward. To forestall additional upward pressures, the Fed, on June 30,
2004, moved the federal funds target upward to 1.25%.
Details
GDP. To understand the most recent macroeconomic developments, it may be
important to understand aspects of the previous business cycle. The growth rate of
GDP since 1991 is shown in Table 1. Its most notable feature is that after a weak
start, the growth rate of GDP averaged more than 4% per year during the second half
of the recent expansion. GDP growth began to slacken during the second half of
2000 and actually contracted during 2000:3Q, 2001:1Q, and 2001:3Q. This pattern
was reversed beginning with 2001:4Q when GDP grew positively, at an annual rate
of 1.6%. Since that time, it has experienced positive growth in each subsequent
quarter. In 2003, real GDP grew at an annualized rate of 1.9% in the first quarter,
4.1% in the second, 7.4% in the third quarter, and 4.2% in the fourth quarter. During
the first two quarters of 2004, GDP grew, respectively, 4.5% and 3.0%.
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Productivity gains have been an important part of the current expansion.4 Most
economists refer to recent trends as reflecting a “productivity-led” recovery. In 2002,
productivity rose by 5.0%; and quarterly growth during 2003 and the first quarter of
2004 has been, respectively, 3.4%, 6.2%, 9.5%, 2.5%, and 3.8% on a quarter-quarter
annualized basis. To put these numbers into perspective, the underlying productivity
trend from 1973 to 1995 was for 1.4% annual growth; and the “step-up” in
productivity from 1995 to 2000 was to a 2.5% annual rate of productivity growth. In
the previous expansion, strong productivity gains were not part of the initial recovery
phase after March 1991 and did not show up in the aggregate data until 1995.
The second jobless recovery? Many people are referring to the present expansion as a
“jobless recovery” and parallels have been made to the “jobless recovery” after the
1990-1991 recession. How do the two compare?
—
Payroll employment gains in the present cycle are far smaller than in 1991-1992.
Payroll employment was 430,000 higher in June 2004 than at the end of the recession
in November 2001 (31 months ago). By this point in the previous recovery, payroll
employment had increased by 3.096 million.
—
Furthermore, between the start of the recession and now (from March 2001 to June
2004), payroll employment has declined by 1.206 million. At the same point in the
1991 expansion (39 months out), employment had increased by 1.865 million.
Table 1. The Growth Rate of Real GDP v. Final Sales, 1991-2003
(percent)
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
GDP
-0.2
3.3
2.7
4.0
2.5
3.7
4.5
4.2
4.5
3.7
0.8
1.9
3.0
Year -Year
4thQ - 4thQ
1.1
4.1
2.5
4.1
2.0
4.4
4.3
4.5
4.7
2.2
0.2
2.3
4.4
Final Sales
-0.2
3.0
2.6
3.4
3.0
3.7
4.0
4.2
4.5
3.8
1.6
1.4
3.1
Year - Year
4thQ - 4thQ
0.2
4.2
2.6
3.2
2.9
3.9
4.0
4.7
4.2
2.9
1.5
1.2
4.5
Source: U.S. Department of Commerce.
Labor Markets. The civilian unemployment rate fell from its cyclical high in
June 1992 (7.8%) to a low of 3.8% in April 2000, as shown in Table 2. At 3.8%, the
unemployment rate was at a 30-year low. With a weakening of growth and a
contraction followed initially by a modest recovery, the unemployment rate reversed
course and rose, reaching a high of 6.3% in June 2003. Since then it has declined,
and for the past six months has varied between 5.6% and 5.7%.
4 Productivity is measured by output per hour of all persons. In the current situation, change
in both the numerator and denominator of this ratio have been contributing to higher
productivity: output (the numerator) has been rising and hours (denominator) have been
declining.
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Employment remains below its pre-recession peak, however. Measured from
the end of the recession in November 2001, payroll employment has risen by
approximately 430,000. This is unprecedented in any postwar business cycle. Even
in the previous business cycle in the early 1990's (which was also referred to initially
as a “jobless” recovery”), employment had turned substantially upward by this point.
(See Box, above.)
To analyze labor market conditions, it is important to understand that
employment is a net concept that reflects considerable “churning” in the labor
markets, measured as the flows of gross job gains and gross job losses. At any given
time, the U.S. economy is creating and destroying jobs — although this is usually not
readily apparent from the aggregate net figure.5 In this sense, the U.S. is considered
the most “dynamic” labor market in the world.
In the present situation, jobs have continued to be created, but job creation has
not been sufficient to offset the loss in jobs elsewhere. This description raises further
questions about the underlying components (i.e., the gross flows): do net job losses
reflect that (1) gross job losses have been so large that they have offset “normal”
gross job gains; (2) while gross job losses have been small, they have nevertheless
been larger than weak gross job gains; or (3) weakness in both components has been
driving the new number, as gross job losses have been large and gross job gains
small?
The argument has been made that gross job creation has been weaker in this
recovery than in the early 1990s recovery.6 This argument appears to have been
confirmed by the new data series on Business Employment Dynamics released by the
Bureau of Labor Statistics. In the current expansion, gross job losses appear to have
returned to pre-recession levels, but gross job gains have not recovered at all. More
specifically, as of December 2002 (the latest data available), gross job creation has
continued to decelerate since the recession and is taking place at only 1995 levels.
On balance, this has translated into a net decrease in employment.7 Intuitively, the
5 For example, according to the Bureau of Labor Statistics (BLS), while net employment
was only 0.1% lower in Dec. 2002 than in Sept. 2002 (quarterly rate), this small change
reflected considerable churning in the labor market: 7.2% of the jobs in Dec. were newly
created since Sept., while 7.3% of the jobs in Sept. no longer existed in Dec. because they
had disappeared. BLS comments: “These gross job gains and job losses statistics
demonstrate that a sizable number of jobs appear and disappear in the relatively short time
frame of one quarter.” See Bureau of Labor Statistics, New Quarterly Data on Business
Employment Dynamics from BLS, Sept. 30, 2003, pp. 2-3.
6 See Erica L. Groshen and Simon Potter, “Has Structural Change Contributed to a Jobless
Recovery ?” Current Issues in Economics and Finance, Federal Reserve Bank of New York,
vol.1, no. 8, Aug. 2003, available at [http://www.newyorkfed.org].
7 Bureau of Labor Statistics, New Quarterly Data on Business Employment Dynamics from
BLS, Sept. 30, 2003. The new BLS series is useful for investigation of trends in gross jobs
flows — an area in which there has been little data because of the difficulties in following
jobs over time. There are some limitations to the series. The data starts at Sept. 1992, after
the recession (July 1990 - March 1991). As a consequence, a full comparison to the recent
recession and early recovery phase is not possible. In addition, the new BLS series is not
(continued...)
CRS-5
weakness on the gross job creation side is appealing: following a contraction, labor
markets typically improve with a lag after growth picks up because employers are
reluctant to hire until they see that an economic recovery is firmly in place.
However, some economists argue that recent trends reflect structural changes in the
economy.8
Divergence in payroll and household surveys ? An interesting and perhaps important
feature of the present economic recovery is the divergence between the two main
measures of employment. It is well known that the payroll survey remains far below
prerecession levels despite the rise in GDP growth so far in this expansion and an
improvement in employment since August. Less well-known is the fact that the other
main measure of employment (the household survey of the Bureau of Labor Statistics)
indicates that employment has increased by 2.8 million since the expansion began. Even
with a rise in the payroll survey since August, the gap between the two surveys has
widened by about 2.4 million (June). Does the difference between the two measures of
employment reflect statistical problems ? Experts do not know. Some economists also
note that self-employment trends are more accurately captured by the household survey
(the payroll survey does not measure self-employment) and that household employment
trends have often been reliable forward indicators of coming improvement in payroll
employment in the aftermath of a recession.
Table 2. Civilian Unemployment Rate, 1991 - 2004
(%, seasonally adjusted)
J
F
M
A
M
J
J
A
S
O
N
D
1991
6.4
6.6
6.8
6.7
6.9
6.9
6.8
6.9
6.9
7.0
7.0
7.3
1992
7.3
7.4
7.4
7.4
7.6
7.8
7.7
7.6
7.6
7.3
7.4
7.4
1993
7.3
7.1
7.0
7.1
7.1
7.0
6.9
6.8
6.7
6.8
6.6
6.5
1994
6.6
6.6
6.5
6.4
6.1
6.1
6.1
6.0
5.9
5.8
5.6
5.5
1995
5.6
5.4
5.4
5.8
5.6
5.6
5.7
5.7
5.6
5.5
5.6
5.6
1996
5.6
5.5
5.5
5.6
5.6
5.3
5.5
5.1
5.2
5.2
5.4
5.4
1997
5.3
5.2
5.2
5.1
4.9
5.0
4.9
4.8
4.9
4.7
4.6
4.7
1998
4.6
4.6
4.7
4.3
4.4
4.5
4.5
4.5
4.6
4.5
4.4
4.4
1999
4.3
4.4
4.2
4.3
4.2
4.3
4.3
4.2
4.2
4.1
4.1
4.0
2000
4.0
4.1
4.0
3.8
4.1
4.0
4.1
4.1
4.0
3.9
4.0
3.9
2001
4.1
4.2
4.2
4.4
4.4
4.6
4.6
4.9
5.0
5.4
5.6
5.8
2002
5.6
5.6
5.7
5.9
5.8
5.8
5.8
5.8
5.7
5.8
5.9
6.0
2003
5.8
5.9
5.8
6.0
6.1
6.3
6.2
6.1
6.1
6.0
5.9
5.7
2004
5.6
5.6
5.7
5.6
5.6
5.6
Source: Department of Labor.
7 (...continued)
collected from the same survey as the payroll employment data and so they are not precisely
comparable.
8 Groshen and Potter, op. cit.
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Inflation. The U.S. inflation performance has been remarkable over the past
10 years. The inflation rate decelerated throughout most of the expansion in the
1990s, as Tables 3 and 4 illustrate. Toward the end of the expansion in 2000, the
inflation rate accelerated, but the pick up was not noticeably different from earlier
years of the cycle.
During the 1991- 2001 expansion, the inflation rate increased more slowly on
average than at any time since the early 1960s. At the same time, growth was
stronger and the unemployment rate lower than experience would have predicted.
Inflationary pressures slowed further with the recession. Moreover, the deceleration
in inflation over the 1990s occurred even as the pace of growth accelerated. In the
postwar experience, this combination of developments is unusual. The rates of
growth and inflation have not typically moved in the opposite direction, particularly
when the unemployment rate was sustained at a relatively low level close to 4.0% in
what was generally considered to be an economy at or above full employment.
Table 3. Rate of Change in the GDP Deflators, 1992 - 2003
(%, 4Q-4Q)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Implicit Price
Deflator
2.2
2.3
2.2
2.0
1.9
1.5
1.1
1.6
2.2
2.5
1.5
1.7
Chain Type
Price Index
2.2
2.3
2.2
2.0
1.9
1.5
1.1
1.6
2.2
2.5
1.5
1.7
Source: U.S. Department of Commerce.
With the start of the recession in March 2001, inflation decelerated, excluding
energy prices. The increase in consumer prices (the Consumer Price Index or CPI)
slowed on a year-year basis from 2.8% in 2001 to 1.6% in 2002. The rate of increase
in the GDP deflator, the broadest measures of inflation in the economy, decelerated
from 2.2% in 2000 to 1.5% in 2002, on a fourth quarter-fourth quarter basis.
Table 4. Rate of Change in the Consumer Price Index (CPI),
1992 - 2003
(percent)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Dec. over Dec.
2.9
2.7
2.7
2.5
3.3
1.7
1.6
2.7
3.4
1.6
2.4
1.9
Excluding food and
3.3
3.3
2.6
3.0
2.6
2.2
2.4
1.9
2.6
2.7
1.9
1.1
energy
Year Over Year
3.0
3.0
2.6
2.8
3.0
2.3
1.6
2.2
3.4
2.8
1.6
2.3
Excluding food and
3.7
3.3
2.8
3.0
2.7
2.4
2.3
2.1
2.4
2.6
2.4
1.4
energy
Source: Department of Labor.
CRS-7
The exception to the deceleration story is the CPI measured on a December -
December basis. It rose by 2.4% during 2002 and 1.9% during 2003, versus an
increase of 1.6% in 2001. Despite this acceleration, the rate of increase remained
below the pace during most of the 1990s expansion and the price of all items
excluding food and energy decelerated.
The rate of inflation measured by the CPI showed great variability over 2003.
On an annualized basis the rate for the four quarters of the year were 5.2%, -0.7%,
3.1%, and 0%. This volatility reflects, in large measure, the behavior of energy
prices. “Core inflation” (i.e., inflation excluding food and energy prices) showed
little movement over the four quarters, rising, respectively, 0.8%, 1.0%, 1.5%, and
1.1%. A similar pattern has occurred in the first six months of 2004. The overall
index rose at an annual rate of 4.9% whereas the index less food and energy rose only
2.6%.
With the favorable inflation performance of the economy, economists think that
several forces keeping a lid on inflation may be at work:
! In the short run, the acceleration in productivity improvement is
regarded by some economists as an important factor in the
slowdown in inflationary pressure at the same time growth picked up
during the 1991-2001 expansion. Since 1995, nonfarm business
productivity has increased on average by 2.6% annually. In 2002
and 2003, productivity rose respectively 4.3% and 5.6% (fourth
quarter over fourth quarter). To put recent developments into
perspective, the average annual rate of increase since 1995 is double
the average annual rate from 1973 to 1995 (2.6% versus 1.3%). In
concrete terms, this important change means that the same amount
of labor will produce higher output. Over time, a change of this
nature will mean substantially stronger growth in per-capita income
and a higher standard of living.
! Unit labor costs have been decelerating or falling over the past two
years, as shown in Table 5. With more output produced for each
hour worked without a comparable rise in labor costs, firms have
their employee cost per unit of output reduced. Recent trends reflect
the pick-up in productivity growth and slowdown in basic labor
costs during the recession plus continuing labor market weakness in
the recovery-expansion phase to-date. Employee cost trends are also
measured in the Employment Cost Index (ECI). The ECI for private
industry accelerated from 1995 through most of 2001 and the first
half of 2002, but began to decelerate in the course of 2002 as a
result of weakened labor market pressures. Its rise in 2003 and the
first quarter of 2004, however, may reflect the fact that the increase
in productivity is being reflected in employee compensation.
! Technological advances have led to declining prices for many goods
that use certain information technology components as inputs.
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Table 5. Rate of Change in Labor Costs, 1993 - 2004
(in percentages)
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Unit Labor Costs
1.5
1.1
1.5
0.7
1.1
2.4
1.4
4.9
0.1
-2.5
-1.2
1.1
Employment Cost Index
3.6
2.6
2.6
3.1
3.4
3.5
3.4
4.4
4.2
3.2
4.2
3.9
Source: U.S. Department of Labor.
Note: Unit labor costs are for nonfarm business, 4th quarter-4th quarter. For 2004, it is the annualized rate for the first
quarter. The Employment Cost Index is for private industry, December - December: for 2004 it is on a March-March
basis.
The U.S. Foreign Trade Deficit. The U.S. foreign trade deficit (net imports), as
shown in Table 6, recorded a continued and dramatic fall from 1988 through 1992.9 In these
years, the trade deficit declined as export growth exceeded import growth. During 1993 the
trade deficit began to grow as a fraction of GDP and is now running at a rate in excess of its
previous high in 1987. The increase in the U.S. foreign trade deficit during 1992 ! 2004
reminds us that the United States still receives a substantial net inflow of capital from abroad.
Table 6. U.S. Foreign Trade Deficit, 1988 - 2003
(as a percent of GDP)
1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
1.8
1.2
0.8
0.2
0.2
0.7
1.0
0.9
1.0
1.2
2.2
3.1
3.9
4.0
4.7
4.9
Source: Department of Commerce.
Note: During the first half of 2004, the trade deficit was 5.1% of GDP.
The U.S. Dollar. Figure 1 records the movement in the foreign exchange
value of the dollar measured against a trade-weighted index of the currencies of many
U.S. trade partners over the past 15 years. After hitting a low in the second quarter
1995, the dollar rose in real or inflation-adjusted terms (that is, it appreciated) by
9 The foreign trade deficit figure analyzed above is different from the headline trade deficit
reported in the press and another trade deficit ratio often used by economists, although they
are all related and can be reconciled. In this report, the “trade deficit” refers to exports and
imports from the U.S. national accounts, which are the basis for the GDP figures. The
underlying data for the figures cited above are released quarterly and annually and are on
an inflation-adjusted basis (“real”). In contrast, foreign trade figures frequently quoted in
the press are different because they released monthly rather than quarterly, not adjusted for
inflation and are defined slightly differently otherwise. These figures are usually not
compared to GDP. To make matters even more confusing, economists often refer by
convention to the quarterly trade figures known as the current account. The current account
position includes components not in the figures above and is not adjusted for inflation. For
2002, 2003, and the first quarter of 2004 the current account deficit was, respectively,
approximately 4.8%, 4.6%, and 4.7% of nominal GDP.
CRS-9
over 34% to its peak in February 2002. From then until February 2004, it has
depreciated on balance by around 14% on an inflation-adjusted basis, with some ups
and downs. As of February, the dollar is now around its December 1998 level and
remains well above its 1995 low (13%) even after the depreciation.
Figure 1. Real Dollar Exchange Rate
115
110
105
100
95
90
85
801990
1992
1994
1996
1998
2000
2002
2004
Source: The Board of Governors of The Federal Reserve System.
The dollar has shown more movement against the major world currencies than
the broad trade-weighted index described above suggests.10 From its high in
February 2002 until March 2004, the dollar has depreciated by nearly 12% against
an index consisting of the major currencies that circulate, adjusted for inflation. The
fall in the exchange value of the dollar has been most noticeable against the British
pound, the Canadian dollar, and the Euro.
Posture of Fiscal and Monetary Policy
The course of GDP growth can respond significantly to changes in fiscal and
monetary policy.
Fiscal Policy
The posture of fiscal policy depends on how it is measured. A generally
accepted method is to examine the ratio of the structural or full employment budget
deficit to full employment GDP. When that is done, as shown in Table 7, fiscal
policy has been expansionary since 2002 as a full employment surplus in 2001 fell
10 In Figure 1, the dollar is measured against an index of the currencies of many of the major
trade partners of the United States weighted according to the proportion of trade. This is
referred to as the “broad dollar index.” The Board of Governors also publishes the exchange
rate of the dollar with the currencies of smaller groups of countries or individual countries.
CRS-10
from 1.1% to a deficit of 2.8% of potential GNP in 2003. An alternative, although
inferior measure, is the ratio of the actual budget deficit to actual GDP. When
examined, fiscal policy was also expansionary with the surplus of 2.4% in 2000
giving way to a deficit of 3.5% in 2003, a net shift of nearly 6% of GDP.
In their annual joint statement, the Secretary of the Treasury and the Director of
the Office of Management and Budget announced that the total fiscal deficit for
FY2003, which ended on September 30, was $374 billion.11 This deficit is more
than twice the recorded fiscal deficit in FY2002 and around 3.5% of GDP.
Monetary Policy
Traditionally, the posture of monetary policy has been judged either by the
growth of the monetary aggregates or by movements in interest rates.12 The three
monetary aggregates, as shown in Table 8, have not responded uniformly to the
easing of monetary policy. The rate of growth of M1 in 2003 exceeded 2002. The
reverse was true for M2 and M3.
Table 7. Alternative Measures of Fiscal Policy
($ in billions per fiscal year)
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Standardized Budget
Deficit
$186
$188
$142
$147
$96
$83
$32
$+12
$+108
$+106
$146
$313
Full Employment GDP 6,402 6,713 7,033 7,381 7,750 8,151
8,545
8,962
9,464
10,038
10,519
11,052
Ratio
0.029 0.028 0.020 0.020 0.012 0.010
0.004
0.001
+0.011
+0.011
0.014
-0.028
Actual Budget Deficit
$290
$255
$203
$164
$107
$22
$+69
$+126
$+236
$+127
$158
$374
Actual GDP
6,222 6,561 6,949 7,323 7,700 8,194
8,655
9,141
9,715
10,032
10,337
10,856
Ratio
0.047 0.039 0.029 0.022 0.014 0.003
+0.008
+0.014
+0.024
+0.013
0.015
0.035
Source: Congressional Budget Office (January 2004).
The positive growth in aggregate reserves over 2001-2003 to-date is in response to
the aggressive easing of monetary policy by the Federal Reserve as it attempts to
accelerate the growth in aggregate demand. The continued rapid growth of the
monetary base reflects in part the growth in reserves. However, it mainly reflects the
growth in paper currency in circulation since about 90% of the base is accounted for
by currency (the great portion of which does not circulate in the United States).
Thus, four of the quantity measures of monetary policy have recorded a rising rate
of growth.
11 Secretary of the Treasury and Director of the Office of Management and Budget, Budget
Results for Fiscal Year 2003, Oct. 20, 2003. See [http://www.treas.gov/press/].
12 For a more comprehensive discussion of monetary policy, see CRS Report RL30354,
Monetary Policy: Current Policy and Conditions, by Gail Makinen and Marc Labonte.
CRS-11
Table 8. The Growth Rates of the Monetary Aggregates
(annualized rates of change)
Time
Aggregate
Monetary
M1
M2
M3
Period
Reserves
Base
88:12!89:12
0.8%
4.2%
0.8%
5.4%
4.0%
89:12!90:12
3.1
9.5
4.0
3.8
1.6
90:12!91:12
9.0
8.3
8.7
3.0
1.3
91:12!92:12
19.6
10.5
14.3
1.6
0.3
92:12!93:12
11.3
10.5
10.3
1.6
1.4
93:12!94:12
- 1.8
8.2
1.8
0.4
1.7
94:12!95:12
-5.0
3.9
-2.0
4.1
6.0
95:12!96:12
-11.2
4.0
-4.1
4.7
7.3
96:12!97:12
-6.6
6.1
-0.7
5.7
9.1
97:12- 98:12
-3.5
7.0
2.2
8.8
11.0
98:12-99:12
-7.6
15.3
2.3
6.0
8.3
99:12-00:12
-7.3
-1.5
-3.0
6.2
8.6
00:12-01:12
6.7
8.7
8.3
10.5
12.9
01:12-02:12
-2.8
7.2
3.2
6.4
6.5
03:06-04:06
8.4
5.0
4.8
3.7
5.0
Source: Board of Governors of the Federal Reserve System.
The growth in the reserves of depository institutions results to a large degree
from decisions to move the key federal funds’ interest rate (shown in Figure 2), the
principal tool of monetary policy. These moves have been motivated primarily by
a desire to bring the economy to full employment and then keep it growing at a rate
sufficient to maintain full employment. From time to time, other factors may
influence the movement of this rate. For example, the turmoil in both domestic and
international financial markets cause the rate to be reduced 1/4% on September 29,
October 15, and November 17, 1998, at which point it stood at 4.75%. In three equal
moves of 1/4% during June, August, and November 1999, the rate was returned to
its pre-crisis level of 5.5%. On both February 2 and March 21, 2000, in the face of
mounting evidence that the economy was growing at an unsustainable rate, the
federal funds rate was raised an additional 1/4%, and on May 16 it was raised1/2%,
bringing the rate to 6.5%. In six equal cuts of 1/2% (January 3 and 31, March 20,
April 18, May 15 and June 27), and a seventh cut of 1/4% (August 21), the rate was
reduced to 3.50%. In response to the September 11, 2001, terrorist attacks, the rate
was reduced to 3.0% on September 17 and in a further move toward easing, it was
reduced to 2.5% on October 2, to 2.0% on November 6, and to 1.75% on December
11. For most of 2002, the FOMC did not make additional cuts in its federal funds
target rate because it wanted to wait and see how strong economic activity would be
following the dramatic cuts in 2001. Toward the end of the year (November 6,
2002), the target was reduced to 1.25% in the face of a softening in demand growth.
For most of the first half of 2003, assessment of the underlying strength of the
economy was obscured by temporary dampening effects related to the geopolitical
CRS-12
tensions earlier in the year. Nevertheless, the rate was reduced to 1.0% on June 25,
2003. In the face of the strength of the current expansion and its possible effect on
inflation, the target rate was raised to 1.25% on June 30, 2004.
As Figure 2 shows, movements in short-term interest rates mimic closely
movements in the federal funds rate. This is not as true for longer-term rates. Their
rise and fall as well as the magnitude of their shifts is often different from the timing
and magnitude of shifts in the federal funds rate. This is due in part to the fact that
they respond to the longer run outlook for inflation, the financing requirements
necessitated by the budget deficit, both current and prospective, and the international
flow of capital.
Figure 2. Yield on Selected Securities and Federal
Funds (%)
10
9
8
7
6
5
4
3
2
1
0 91 92 93 94 95 96 97 98 99 OO O1 O2 O3 O4
Three Month Federal Funds
Five Year
Long Term
Source: Board of Governors of the Federal Reserve System.
Economic Forecasts, 2004-2005
The forecasts in Table 9 come from three sources. OMB and CBO are well
known. BC stands for the Blue Chip Economic Indicators, a firm that collects the
forecasts from about 50 forecasters in finance, business, and universities. BC Con
represents the consensus or average forecasts of this group. BC T-10 is the average
of the high ten among these forecasts, while BC B-10 is the average of the low ten
forecasts.
CRS-13
The consensus view taken by the forecasts summarized in Table 9 is that GDP
growth should exceed 4% which is near to what is generally considered the rate of
U.S. potential growth. This rate of GDP growth, according to the consensus,
however, will be insufficient to have other than a modest effect on the unemployment
rate. The consensus anticipates that the unemployment rate will begin to come down
only gradually. The inflation rate for the entire economy is expected to remain below
2.0%. Both short-term and long-term interest rates are expected to rise in 2004 above
their 2003 averages.
The chairman of the Board of Governors of the Federal Reserve presented the
economic projections of the Federal Reserve Board and Federal Reserve District
Bank Presidents for 2004 in testimony before the Senate Committee on Banking,
Housing, and Urban Affairs on July 20, 2004, and the House Financial Services
Committee on July 21, 2004. The Federal Reserve projections for 2004 are that from
the fourth quarter 2003 to the fourth quarter 2004, real GDP will grow between 4.5%
and 4.75% and that prices13 will increase about 1.75% to 2.0%. The civilian
unemployment rate is projected to be between 5.25% and 5.5% during the fourth
quarter of the year. For 2005, real GDP, on a fourth quarter over fourth quarter basis,
is projected to grow between 3.5% and 4.0%, prices are expected to rise between
1.5% and 2.0%, and unemployment during the fourth quarter of the year is projected
to average between 5.0% and 5.25%.
Table 9. Economic Forecasts 2004 - 2005
2003
2004
2003a
2004
2005
3a
4a
1a
2a
3
4
Nominal GDPb
OMB
8.8
5.7
7.4
6.3
NA
NA
4.8
5.7
4.9
CBO
8.8
5.7
7.4
6.3
NA
NA
4.8
5.9
5.3
BC T-10
8.8
5.7
7.4
6.3
8.4
8.1
4.8
7.1
6.6
BC Con.
8.8
5.7
7.4
6.3
6.3
6.0
4.8
6.7
5.8
BC B-10
8.8
5.7
7.4
6.3
4.7
4.3
4.8
6.3
5.2
Real GDPb
OMB
7.4
4.2
4.5
3.0
NA
NA
3.1
4.4
3.6
CBO
7.4
4.2
4.5
3.0
NA
NA
3.1
4.8
4.2
BC T-10
7.4
4.2
4.5
3.0
5.1
5.1
3.1
4.8
4.4
BC Con.
7.4
4.2
4.5
3.0
4.2
4.1
3.1
4.5
3.8
BC B-10
7.4
4.2
4.5
3.0
3.5
3.1
3.1
4.3
3.3
13 In its Monetary Report to Congress, the Board of Governors of the Federal Reserve
System features in its projections a measure of inflation known as the Personal Consumption
Expenditure (PCE) chain-type price index. This price index attempts to measure inflation
with regard to consumer spending.
CRS-14
2003
2004
2003a
2004
2005
3a
4a
1a
2a
3
4
Unemploymentc
OMB
6.1
5.9
5.6
5.6
NA
NA
6.0
5.6
5.4
CBO
6.1
5.9
5.6
5.6
NA
NA
6.0
5.8
5.3
BC T-10
6.1
5.9
5.6
5.6
5.6
5.6
6.0
5.6
5.6
BC Con.
6.1
5.9
5.6
5.6
5.5
5.4
6.0
5.5
5.3
BC B-10
6.1
5.9
5.6
5.6
5.4
5.3
6.0
5.5
5.0
GDP Price Index (chain-weighted)b
OMB
1.4
1.6
2.8
3.2
NA
NA
1.7
1.2
1.3
CBO
1.4
1.6
2.8
3.2
NA
NA
1.7
1.1
1.1
BC T-10
1.4
1.6
2.8
3.2
3.7
3.0
1.7
2.4
2.6
BC Con.
1.4
1.6
2.8
3.2
2.1
1.9
1.7
2.1
2.0
BC B-10
1.4
1.6
2.8
3.2
1.2
1.2
1.7
1.9
1.6
CPI-Ub
OMB
2.4
0.7
3.5
4.7
NA
NA
2.3
1.4
1.5
CBO
2.4
0.7
3.5
4.7
NA
NA
2.3
1.6
1.7
BC T-10
2.4
0.7
3.5
4.7
3.4
2.8
2.3
2.8
3.1
BC Con.
2.4
0.7
3.5
4.7
2.5
2.0
2.3
2.6
2.4
BC-10
2.4
0.7
3.5
4.7
1.2
0.9
2.3
2.2
1.7
T-BILL Interest Rate (3 month)c
OMB
1.0
0.9
0.9
1.1
NA
NA
1.0
1.3
2.4
CBO
1.0
0.9
0.9
1.1
NA
NA
1.0
1.3
3.0
BC T-10
1.0
0.9
0.9
1.1
1.8
2.2
1.0
1.5
3.4
BC Con.
1.0
0.9
0.9
1.1
1.5
1.9
1.0
1.3
2.8
BC B-10
1.0
0.9
0.9
1.1
1.2
1.5
1.0
1.1
2.2
10-year Treasury Notec
OMB
4.3
4.3
4.0
4.6
NA
NA
4.0
4.6
5.0
CBO
4.3
4.3
4.0
4.6
NA
NA
4.0
4.6
5.0
BC T-10
4.3
4.3
4.0
4.6
5.1
5.4
4.0
4.9
6.0
BC Con.
4.3
4.3
4.0
4.6
4.8
5.0
4.0
4.7
5.5
BC B-10
4.3
4.3
4.0
4.6
4.6
4.7
4.0
4.5
4.8
Sources: Blue Chip Economic Indicators, July 2004. Congressional Budget Office, January, 2004;
and, the Office of Management and Budget, February 2004.
a. Actual data, subject to revisions. The annual data for nominal GDP, real GDP, the GDP price index
and the CPI are on a year over year basis; and the unemployment and interest rate data are either
quarterly or annual averages.
b. Quarterly rates of change are annualized.
c. Quarterly averages.
CRS-15
Special Topics
Accounting for GDP Growth
Table 10 records contributions to growth in GDP from 1995 to 2004. These
data record two interesting developments. First, investment spending played an
important role in the 1991-2001 expansion. Its contribution to GDP growth was
unusually large during most of that period. And among the categories of investment,
outlays for personal computers were important. This bodes well for the longer run
growth in productivity. Second, purchases by all levels of government played only
a small role in that expansion. The relative contribution of consumption did not
change significantly during this period, although it continued to be the largest single
contributor to GDP growth.
Table 10. Accounting for GDP Growth: 1995 through 2004
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
Real GDP
Growtha
100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Consumption
73.6
63.5
57.4
81.2
81.6
87.2
234.2
118.4
76.0
48.0
Investment
17.7
34.3
41.5
37.7
26.2
26.9
-187.8
-21.0
22.2
52.4
Govt.
4.3
5.2
7.9
8.4
16.3
10.1
80.4
43.1
16.9
11.9
Purchases
Net Exports
4.3
-2.9
-6.8
-27.4
-24.1
-24.1
-26.8
-40.6
-15.2
-12.3
Source: Department of Commerce.
a. Computed using real GDP at 2000 chained dollars on a year over year basis. For 2004, data for half year.
Promotion of Economic Growth: The Importance of Saving
Over the longer run, the economic well-being of a nation depends on the growth
of potential output or GDP per capita. Crucial to this growth is the fraction of a
nation’s resources devoted to capital formation. The ability to add to the capital
stock through investment depends on a nation’s saving rate.
Saving comes from several sources. In the private sector individuals
(households) and businesses are responsible for saving. The former save when all
of their after tax income is not used for consumption. Businesses save through
retained earnings and capital consumption allowances.
The public sector can also be a source of national saving and this occurs when
government revenues are larger than expenditures. Budget surpluses, then, can be
viewed as a source of national saving.
CRS-16
Table 11 shows the sources of saving for the United States during the past 40
years. There are several things to note about these data. First, except for the decade
of the 1990s, the gross private sector savings rate has averaged a remarkably stable
17%-19% of GDP, with most of the saving being done by businesses. More
significantly, however, the private sector saving rate net of depreciation, representing
saving available for additions to capital, declined considerably in the 1990s. The
drop in the household (personal) savings rate has been the major factor in the decline
in the private sector saving rate. Thus, even without a federal budget deficit, the
United States would have had a “saving problem.”
Second, over this 40-year period, the saving done by the public sector, as a
whole, has declined. There is, however, diversity as to the contribution made by the
level of government. The large negative contribution made by the federal
government during the 1980s reflects the widely publicized budget deficit. Even
though state and local governments have been running budget surpluses, they have
not been large enough to offset the federal deficits. This has been reversed beginning
in 1993. The improved budget position of the federal government has been adding
to national saving.
Third, the data show that for 20 of these 40 years, the United States exported a
small fraction of its savings to the rest of the world (i.e., was a net exporter of
capital). This changed during the 1980s when the United States started to import the
savings of the rest of the world.
The United States has been able to sustain its growth and standard of living
since the 1980s because we have been able so far to attract sufficient capital (saving)
from international investors. Without these saving, the United States has a
“financing gap” in view of its domestic saving shortfall relative to its demand for
investment capital. In the absence of sufficient capital, U.S. interest rates will have
to rise in order to restore balance between investment and a now smaller amount of
saving. Higher interest rates will choke off investment and dampen U.S. growth14.
Should efforts to correct the international trade deficit prove fruitful, the net
inflow of foreign saving will diminish or perhaps on net cease (that is, stabilize).
Should this occur without a significant improvement in either the private sector
saving rate or the negative saving rate of the public sector, the rate of new investment
will fall to a very low level in the United States and with it the means for improving
the well-being of future generations of Americans.
A sudden increase in the national saving rate is, however, not without some
possible adverse consequences. In the short run, a sudden increase in the saving rate
means decreased consumption or lower public sector net spending, both of which
depress aggregate demand. Moreover, in either case, the demand for some types of
output would fall to be replaced by an increased demand for other types of output.
As a result, some industries and firms would have to contract while others expand.
14 See also CRS Report RL30534, America’s Growing Current Account Deficit: Its Causes
and What It Means for the Economy, by Marc Labonte and Gale Makinen; and CRS Report
RL31032, The U.S. Trade Deficit: Causes, Consequences, and Cures, by Craig Elwell.
CRS-17
Resources would have to transit from declining to growing industries. These short-
run dislocations should be borne in mind if a higher national saving rate becomes the
object of public policy.
Table 11. U.S. Saving By Sector
(as percent of GDP)
Private Sector
Public Sector
Net Private
Netb
Year
Net of
State
Net of
& Publica Foreign
Pers. Bus. Total
Fed.
Total
Deprec.
&Local
Deprec.
1960-9
5.7
11.4 17.1
9.6
2.2
1.7
4.0
1.3
10.9
-0.6
1970-9
6.8
11.6 18.4
9.8
-0.5
1.8
1.3
-1.2
8.6
-0.2
1980-9
6.7
12.6 19.2
9.0
-2.2
1.4
-0.8
-3.0
6.0
1.5
1990-9
3.8
12.3 16.1
6.4
-1.1
1.3
0.2
-2.0
4.5
1.3
1984
7.8
13.2 21.0
11.0
-3.1
1.7
-1.4
-3.7
7.3
2.2
1985
6.7
13.1 19.8
9.8
-3.0
1.6
-1.4
-3.7
6.1
2.6
1986
6.0
12.1 18.1
8.0
-3.1
1.5
-1.6
-3.8
4.2
3.2
1987
5.3
12.3 17.7
7.6
-1.9
1.3
-0.6
-2.9
4.7
3.2
1988
5.7
12.7 18.5
8.4
-1.5
1.4
-0.1
-2.4
6.0
2.2
1989
5.5
11.9 17.4
7.3
-1.2
1.4
0.2
-2.0
5.3
1.6
1990
5.2
11.6 16.8
7.3
-1.8
1.2
-0.6
-2.8
4.4
1.2
1991
5.4
12.0 17.4
7.6
-2.4
1.0
-1.4
-3.6
4.0
-0.2
1992
5.8
11.8 17.6
8.0
-3.5
1.1
-2.4
-4.7
3.3
0.6
1993
4.3
11.9 16.2
6.8
-2.9
1.1
-1.8
-4.1
2.8
1.1
1994
3.5
12.0 15.5
6.0
-1.9
1.3
-0.6
-2.9
3.1
1.5
1995
3.4
12.7 16.1
6.7
-1.6
1.3
-0.3
-2.5
4.1
1.2
1996 2.9
12.9 15.8
6.2
-0.8
1.4
0.6
-1.5
4.8
1.3
1997
2.6
13.1 15.7
6.1
0.3
1.6
1.9
-0.2
5.9
1.3
1998
3.2
12.0 15.2
5.5
1.4
1.7
3.1
1.0
6.5
2.1
1999
1.7
12.6 14.3
4.5
2.0
1.6
3.6
1.7
6.2
3.0
2000
1.7
11.9 13.6
3.5
2.8
1.6
4.4
2.4
5.9
4.0
2001
1.3
12.4 13.7
3.2
1.4
1.3
2.7
0.7
3.9
3.7
2002
1.7
13.2 14.9
4.7
-1.4
1.1
-0.3
-2.3
2.4
4.4
2003
1.5
13.7 15.2
5.3
-2.9
1.2
-1.7
-3.8
1.5
4.7
Source: U.S. Department of Commerce.
a. Equal to the sum of private sector saving net of depreciation and total public sector saving net of
depreciation.
b. Negative sign indicates the export of saving from the United States. Positive sign indicates the
import of saving from abroad