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The Economy in Perspective
The Big Chill...The Soviet Union was officially
dissolved on December 26, 1991, one clay after
the resignation of Rilikhail Gorbachev. The Cold
War was over. Ever since, the countries that
nlacle up the former U.S.S.R. have been struggling to govern themselves and to fincl their
places in the world.
The United States has reacted to these clevelopnlents on two levels. Military bases are closing and spending for national defense is shrinking. New relationships among the United States
and the emerging nations are expanding,
pronlising greater trade and employment opportunities. These are the more immediate, visible acljustments, but broacler forces are working
beneath the surface.
The manifest threat of nuclear attack by the
Soviet Union brought a high degree of cohesion
to U.S. foreign and clefense policies. The vacuum created by the collapse of the "evil empire"
is prompting questions that are still largely
unanswerecl. Do we have any enemies now,
and what d o they want? What are our obligations to protect other nations, ancl how far
should we go to fulfill them? By what means
can we best achieve our objectives? How much
will these efforts cost? In a dangerous world,
how much risk should w e bear? There are
choices to make, and each comes at a price.
In 1979, the United States initiated a hot war
against another seenlingly inlplacable foe-inflation. President Carter appointed Paul Volclter
to heacl the Federal Reserve, giving hill1 a 11lalldate to eliminate double-digit inflation. This
effort relied on a clernonstral~lytight tnonetary
policy and the public's willingness to suffer
casualties. Inflation hacl become so intolerable
that having a numerical goal was unimportant;
all that ~nattereclwas reducing it. With support
from President Reagan, the Volcker Fed continued using heavy artillery to break inflation's
back, reclucing the core rate fro~n11% to 5% by
1953.
Uncles the leaclership of Alan Greenspan
since 1987, the Fecleral Reserve continued its
war against inflation, which it clescribecl as a
campaign for price stability. Having reducecl inflation's imlminent threat to economic progress,
the Federal Reserve coulcl more gradually
squeeze it from the U.S. economy. Initially, the
Greenspan Fed followecl a course of li~nitedaggression, 111arkedby an occasional preemptive
strike and persistently combative rhetoric. This
strategy finally paid off in 1991. As Boris Yeltsin
faced clown the tanks in the Kremlin, the U.S.

inflation trencl collapsed from 5% to 3%, the
spoils of a seven-year siege. Backing its words
with action, the Greenspan Fed cut inflation to
levels not seen since Sputnik.
Once again, howevel-, broader forces startecl
working beneath the surface. With inflation
lower than it hacl recently been, voices were
heard pronouncing it dead. The econotny's
pace faltered after the Gulf War, and national attention was focusecl on expansion and employment, not inflation. Whenever Fecleral Reserve
to
officials spoke about their corn~llit~nent
achieving price stability, critics saicl the Fed was
fighting the last war. The Soviet Union was imploding, ancl the public was tired of combat.
In a sense, people know exactly what they
want: peace at no price. But on a very practical
level, our nation has no clearer idea about what
it wants from the Federal Reserve than from the
Pentagon or the State Ilepartn~ent.
How does an honorable monetary authority
achieve a responsible peace with inflation? A
workable conlpromise requires that the public
and its central bank understand one another's
aspirations ancl limitations. After all, nations create indepenclent central banks to prevent the
popular wish for easy money from running
amok. An uncluly restrictive monetary policy will
eventually lose popular support, but so will policies of appeasement. Although there is a ~ n p l e
room for misunderstanding and mischief in the
goal-setting process, an honozible monetary authority atte~nptsto be as transparent as possible
about its intent ancl operations. Transparency,
alas, does not always equal precision.
"Price stability" has been described as inflation so low that it cloesn't enter into people's
thinking about economic decisions. So defined,
this lnonetary policy goal cloes not lencl itself to
numerical accountability. Some decry this imprecision as a shortco~l~ing
of the current monetary policy regime and argue that it lessens the
Fed's credibility. Perhaps so. But if the Federal
Reserve's aggressive war against inflation has
enclecl, it has been replaced by its own Cold
War strategy? designed to attain its goal through
less overt means than sustained cornbat. To
keep inflation out of econotnic decisions, the
at persuaFederal Reserve must be successf~~l
sively shaping inflation expectations. Although
a clearly articulatecl theoretical framework
woulcl enhance its actions, this Fecl's inflation
policy is realpolitik. It recognizes that clktente
cloes not mean peace.

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Monetary Policy
Bllllons 01 dollars

420

Billions of dollars

CURRENCY

300 t f ~ l t ' t l l t t f l l l l t l l l l l l l l l I 1 ~ * l ~ l ~ ~ t ~ ~ I l
1994
1995
1996

Billions of dollars

1994

1995

1996

a. Growth rates are percentage rates calculated on a fourth-quarter over fourth-quarter basis
b. Adjusted for sweep accounts.
NOTE: All data are seasonally adjusted. Last plot is est~matedfor January 1997. Dotted lines represent growth ranges and are for reference only
SOURCE: Board of Governors of the Federal Reserve System.

Every nzirron rnoney measure e s cept currency fell in January. Currency grew 't.7(H1.
which n.as slightly
slower than its 1996 average rate of
5.7%. linacljustecl total reserves fell
19.4(%.subst:intiaIly more than last
ye:lr's annual percentage loss of
11.4%. 'I'he monetary lmse cleclinecl
5.3% ~lf'tei-rising 3.8% in 1996. 7'he
4.5% clr-op in un~icljustetlM 1 is in
line with last year's 4.7%)clccrease.
Both M1 anel tot:ll reserves were

Ixginning to ~noclerateat the end of
1996, convincing some analysts that
sweep accounts were becoming saturatecl. These accounts, irlitiatecl in
late 1903 as a way for banks to
economize on their reserves,
"sweep" excess housel~olcl checka l ~ l ecleposits, which are resewable,
into money market deposit accounts. which are not. Su.eep accounts :ire I>elieveclto be responsible for the shar-p cleclines in M1 and

- >i11 recent years; howtot. 1 rtscrves
ever, even when these measures are
atljusted for sweeps, they still shocv
anemic groxvth.
The usefulness of available sweep
account c1at:i is limited, hecause clepositories arc not recluiretl to clisclose the size of their pmgums. This
rlleans that sweep account activity
can be estim:itecl orlly by tising the
daily-average effect o f new sweep
programs on the rnonthly avelage
> .

(cotititilrcd 071 12~.xtpugc?)

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Monetary Policy (cont.)
Percent weekly averages
65

RESERVE MARKET RATES

Percent

[ TREASURY BILL YIELDS

Percent

7.0
6.5
6.0
5.5

50
4.5
4.0

3.5
3.0

1994

Dec

Jan.

Feb.

March
Aoril
Contract month

Mav

June

a. Predicted rates are federal funds futures.
SOURCES: Board of Governors of the Federal Reserve System; and the Chicago Board of Trade.

level of other checlial~lecleposits.
The Fecleral Open Market Cornmittee (FOI\IC) reconvened in early
Febrrial~;lncl reporteclly tooli n o action on the federal f~inclsrate. A full
year has passeci since policymaliers
approved a recluction (25 basis
points). Since that time, the economy lias contin~iecl to growT \;at a
mocler;~te price ancl infl:~tion:iry
pressures 1i:lve k c - n kept in check.
Altho~igli tlie funcls rate has re-

mainecl constant, yielcis on shortterm 'I'reasury securities have tapered off in recent months. Current
T-l~illyielcls are 5.0% on the threemonth I ~ i l l ancl 5.2% on the six~nonth.Although short-term yielcls
are l,elow their historical averages,
they are ahout 2% above 1993 levels.
Federal Reserve Chairman Alan
Greenspan :~ppeareclsatisfiecl with
the current state of the economy
when lie testified before tlie Senate
13uclget Co~nmitteein January, but

lie obser\;ecl that if the U.S. labor
~ilarlietcontinc~esin its current state,
workers :Ire liliely to start demancting higher wages. The fecleral funds
futures ~narlcet,which reflects participants' expectations of fi~tureFOMC
actions, seems to concur with the
Chairm:~n.ancl has built a moderate
increase into the funcls rate by late
in the seconcl quarter of 1997.This
is a clistinct change fro111last Decemher. when marlict participants were
(contiu~re~l
on 17extp~~~ye)

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Monetary Policy (cont.)
Percent

Inflat~onrate percent

lBUNEMPLOYMENTAND NFwTloN, 1960-1996

lnilat~onrate

CHANGE IN UNEMPLOYMENTVERSUS INFLATION,
1960-1 9%

-1 0

-05

0.0

1 .O

Change in unemployment, percentage points
Actual mlnus expected inflation percentage po~nts
5
CHANGE IN UNEMPLOYMENT VERSUS UNANTICIPATED

-1 0

-0 5

Inflationrate, percenl

Change ~nunemployment rate percentage po~nts

Unemployment rate, percent

a. Unanticipated inflation is the difference between actual inflation and its expected value, where expected inflation is based on past inflation rates.
SOURCES: U.S. Department of Commerce. Bureau of Economic Analysis; U.S. Department of Labol; Bureau of Labor Statistics; and the Federal Reserve Bank
of Cleveland.

expecting policy Lo remain ne~ltral
until May.
The unemployment Ixte is curwell Ixlon; what rn:iny
rently 5.40/0.
analysts consicler consistent with
low inflation. They contenel that
rising unemployment leads to
lower inflation ancl killing unemployment le:lcls to higher inf1:ltion.
Although this relationship (c:lllecl
the "f'hillips curve") is thought to
b e o n e ol' the rnost re1i:lhle in
11iacroeco11011li~~.
tile c11rre11tprolongeel pcriocl o f lo\v inflation ancl

low^ unenl~ployment raises douhts
a l x x ~ its
t valiclity.
Incleed, in examining the clata,
one might at first I ~ l i e v ethat a slight
pc~sitiverelationship exists. a view
that is confirmed when one plots the
inflation rate against the ch:ulge in
the uncmpIo)11nent rate. Analysts
generally resolve the apparent conflict between the Phillips cuIve :Inel
the cl:ita by focusing on the change
in unemploytnent ancl the cleviation
of inf1:ition from the level espectecl
I,y the market. With this ~noclification, the clata Inore reaclilp reveal a

neg:ltive correlation hetween price
changes ancl unemployment.
Clearly, the relationship betwecn
unemploynient and inflation SIIC)LIICI
be regarclecl with some skepticism.
After all, a negative correlation is
one thing, but a stable relationship
is quite another. Eviclence shows
that simple estimates of the I-'hillips
cur-ve basecl on :ivailable clata may
shift over time. Thus, although the
Phillips curve I-emains :i foc;~lpoint
for policy cliscussions, :I cautious application seems xvarmntecl.

2.0

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Percent
75
YIELD CURVES ON JANUARY 31,1997')

Percent, weekly averages

50 -

453-mo

6-mo.

I-yr

2-yr

3-yr.

5-yr. 7-yr. 10-yr

30-yr.

3-mo

I
6-mo

I
I-yr

I
2yr

I
3-yr

I
5-yr

I
7-yr

I
10-yr

Percent

a. All instruments are constant-maturity series.
b. The coupon yield is a weekly average and the zero-coupon yield is a daily number.
c. The real interest rate and expected inflation rate are calculated from the Survey of Professional Forecasters using the 30-day T-bill rate
SOURCES: Board of Governors of the Federal Reserve System; the Federal Reserve Bank of Philadelphia; and The Wall Street Journal, various issues

3
A

-i:

-.%.
4

Interest rates have movecl up since
last month, ancl the yielcl curve has
steepened. 'rhe yield on 30-year
I~oncls11:~sincreaseel 31 basis points.
(to 6.89(%); the .?-year, 3-month
spreacl stancls at 99 basis points,
a n d the 10-year, .?-month spreacl is
at 144.
The yielcls on zero-coupon I~oncls
continc~eto closely tl.acli the yields
on coupon 1,oncls. This month.
however. the yielcls on 2-, 3-, 5-,
ancl 7-year notes exceecl that of
s:ulne-maturity zeroes. This is sur[>rising. IIecause the shorter clura-

tion of the notes usually leads to a
lower yield. It also serves as a remincler that other factors, such as
nnarliet licluiclity, d o matter.
Nominal interest rates clepend
1,oth on espectecl inflation and on
real (inflation-adjusted) rates; uncertainty :IISO has an effect. Prior to maturity, a bo~lcl'spielct can be adjusteel
for expected inflation, giving an estimate of the real interest rate. In the
l,ottom ch:irt, which slnom~ssuch a
hreaIiclo\~~nfor the 30-clay T-bill
rate. several relationships stand out.
From 1990 to late 1995, expected in-

flation Utes cleclinecl fairly steaclily.
Since then. espectecl inflation 1n:ts
inchecl higher for 14 consecutive
months.
Expected inflation does not account for nnost of the variation in
nominal rates, Inowever, at least
since the micl-1980s. Clnanges in the
~~nderlping
real sate have been more
ilnpc)rt;tnt. Careful obsen~ersnnay
note that tile real rate and espectecl
inflation do not aclcl up to tlne nominal rate: the clifference is the risk
premium that investors clemand for
I2earing uncertainty ahout inflation.

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Inflation and Prices
Perceni of forecasis

80 DISTRIBUTION OF JANUARY BLUE CHIP CPI FORECASTSa

1 8-2 2

23-2 7

2 8-3 2
3.3-3 7
Annual perceni change

]

12-monih percent change

I TRENDS IN THE CPI

3 8-4.2

December Price Statistics
Annualized percent
change, last:
I mo. 6 mo. 12 mo. 5 yr.

1995
avg.

Consumer Prices

All items

3.1

3.0

3.2

2.8

2.6

Less food
and energy

1.4

2.4

2.6 3.0

3.0

MedianC

2.1

2.8

2.9

3.2

Finished goods 6.5

3.7

3.0

1.8

2.1

Less food
and energy

1.7

0.6

1.5

2.6

3.0

-5.6

-0.7

2.9

5.4

Producer Prices

Commodity futures
pricesd

a. Forecast of the Blue Chip panel of economists.
b. Upper and lower bounds for CPI inflation path as implied by the central tendency growth ranges issued by the FOMC and nonvoting Reserve Bank
presidents.
c. Calculated by the Federal Reserve Bank of Cleveland.
d. As measured by the KR-CRB composite futures index, all commodities. Data reprinted with permission of the Commodity Research Bureau, a Knight-Ridder
Business Information Service.
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; the Federal Reserve Bank of Cleveland; the Commodity Research Bureau; and Blue Ch~p
Econorn~cIndicators, January 10. 1997.

Economists' 1907 projections for retail price inflation are narron.ly clistributecl. Xearly 70(!,6ol those pollee1
in Januai-y's Blue Chip s~lr\-eyexpected the Consumer Price Inclex
(CPI) to rise l>et\\-een2.S'Xi ~iancl3.2%
this year. vet-), close to its :ia\.crage
increase for the p a t five ye:irs
(2.8%,).b~iorct1i:tn 60% of tile I3lue
Chip economists cspcctecl tlie CI'I
to rern:~in in this narrotv I.;inge in
1998, ancl less than lo?%sarv inklatlon f:llling l>clo\\ 2 3"i1 or I rslng
above 3 7(!h

After trending beneath the central
retail prices seems centered in only
tencletlcy projection of the Fecleral
:I hanclful o f components, particuOpen I\/I;irket Committee (FOblC)
1:irly fc>ocl ant1 energy items-two
di~ring most of 1996, tile Ct'I's
areas that hacl a moclerating inflitgrowth sate \\;as pushed to the proence on the CI'I for 111ost of tlie past
jection's extreme upper limit (3.2%)
five years. If we exclucle these com13y a surge in consumer prices at
ponents, the CI'I appears to have
year's end. In fact, the CPI's 12heen trending clon.nward over the
month gro\vth rate 112s been trendpast year or so: After reaching al~out
ing i~p\v:iarcl ever since reaching its
3% in micl-1995, its 12-month growth
recent lo\v of ahout 2.6% at tile encl
rate fell to only 2.5(Hj l ~ ythe encl of
of 1995.
1996. This matches 1994's record :IS
Much of the lecent a c c e l e ~ ~ ~ t1i11o n
( c o n t r i l ~ ~ e01
~2/ I~.Y/
f~crigc)

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Inflation and Prices (cont.)
Dollars oer barrel

12-month percent change

PPI less food and energy

1993

1994

1995

Index, 1982-84 = 100
115

1996

Percent
l 6 ENERGY EXPENDITURES AS A SHARE OF GDP

a. West Texas intermediate.
b. As measured by the KR-CRB composite futures index. Data reprinted with permission of the Commodity Research Bureau, a Knight-Ridder Business
lnformation Service.
c. Ratio of barrels of oil to dollars of real GDP
SOURCES: U.S. Department of Labor, Bureau of Labor Statistics; U.S. Department of Commerce, Bureau of Economic Analysis; the Commodity Research
e Expenditure Report.
Bureau; DRI/McGraw-Hill; and U.S. Energy Information Administration, State Energy P ~ c and

the smallest annii;tl increase in the
inclex for more than 30 years.
Wicle swings in food and energy
prices were also major contributors
to last yeas's ju~llp in proclucer
prices. The I'roclucer Price Index for
fitinishecl goocls (1'1'1) increaseel 3%
o v e r the 12 months encling in I>ecernber, a l ~ o u ta percentage point
higlier than in 1995 and the
strongest rise in six years. Nonetheless, after adjusting for changes in
food ancl energy prices, the 11' 1' ~ 2 s

a substantial two percentage points

l o n e r in 1996 than in 1995, ancl
ne:trly one percentage point below
its five-year average increase.
The 1996 rise in energy prices
l>rolie a string of generally moclerate
increases for this important commodity dating back to the Gulf \Var.
Several factors, inclucling severe winter weather in Europe, contribi~tedto
the price siirge and accelerateel the
clo~vnwarcltrend in U.S. crucle oil
stoclis t1i:lt began in 1990. Comrnoci-

ity marliet palticipants apparently clo
not expect these effects to linger
very long. A reading of oil futures
si~ggeststhat oil prices could come
clown by the enel of spring.
Moreover; improvecl energy efficiency appears to have reclucecl the
role of oil in the economy. Expenclitures on petroleuru accoi~nteclfor
less than 4% of GDI' in 1993nearly full percentage point less
than in 1970.

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Percent of forecasts

45 IDISTRIBUTION OF ECONOMISTS'REAL GDP FORECASTS

Real GDP and Components, 1996:IVQ
(Advance estimate)
Change,
billions
of 1992 $

Real GDP
Consumer spendlng
Durables
Nondurables
Services
Business f~xedinvestment
Equipment
Structures
Res~dentialinvestment
Government spending
National defense
Net exports
Exports
Imports
Change In business
~nventor~es

Percent change, last:
Quarter

Four
quarters

80.3
38.8
8.1
6.0
24.6
8.0
-2.5
9.9
-0.9
2.2
-1.4
36.7
47.7
11.0

4.7
3.3
5.4
1.7
3.8
4.2
-1.7
22.7
-1.3
0.7
-1.8

3.4
2.7
5.5
1.8
2.5
9.1
9.4
8.4
4.0
2.3
1.5

25.5
4.7

7.6
8.6

-2.6

Annual percent change

Percent

Billions of 1992 chain-weighted dollars

NOTE: All data are in chain-weighted 1992 dollars, seasonally adjusted annual rate.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; and Blue Chip Economic Indicators, January 10, 1997.

I n l i k ~n l c ~ t ~olit
b . like ci lio~z.According to advance estimates. real
GDP grew \:ill exceptionally kist 4.7%
in 1906:11TQ.\vith :::tins in exports
and personal consulnption expendit u r e s leading the way. Inventory accumulation slo\vecl slightly.
Last c1u:lrter's gro\vtli rate compares
with 2.1% in 1996:IIIQ, 4.7% in
1096:IIQ. ancl 2.0041 in 1996:IQ. The
fourth-quarter figure. hon.ever, is
su1,ject to revision as more cornplete clata hecome a\.ailat~le.

In tlie sixth year of the current
business expansion, outpiit grew
2.5(%. up f r o ~ n2.0% in 1995 and
\\jell a l ~ o v elast winter's pessimistic
projections of 2.0%. Future prospects also seem good. On average.
economists participating in the January Blue Chip s u r \ ~ e j ~
which
,
prececled the laelease of the most recent
GIII-' nurnl~ers,forec:~st real economic growth of 2.3% in 1997 and
2.1% in 1998.
'The recent GDP release highlights
the gro\\;ing importance of tracle to

the U.S. economy. Exports anel imports together no\\^ ecl~lalapproxinlately 26% of GDI), up from 9% in
the early 1960s. Last cluarter's export
gi1i11~
acco~lnteclfor 59% ($47.7 billion) of the rise in total output. Although the data are incomplete, this
sharp increase in exports seems to
have come primarily from shipments
of computers, aircraft, serniconcluctors, ancl telecommunications eclui11rnent. Imports increasecl $11 billion,
( C ~ I I I I ' I Z L I0~11~ I)?ex/pagd

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Economic Activig (cont.)
Index, March 1973=100

Ratio index, 1973=100
I110

95 [TRADE-WEIGHTED DOLLAR AND RELATIVE ECONOMIC

Percent
Percent change from corresponding month oi previous year
8
89
[INDUSTRIAL PRODUCTIONAND CAPACITY UTILIZATION*

Percent change from corresponding month of previous year
7

Percent rising
65

35
1990

1991

a.
b.
c.
d.

December data, except for 1997, which covers only January.
1996 and 1997 data are based on The Economist poll of forecasters.
Chain-weighted data in 1992 dollars, seasonally adjusted annual rate.
Seasonally adjusted.
SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; International Monetary Fund,
International FinancialStatistics; the National Assoc~ationof Purchasing Management; and The Economist, January 18-24, 1997.

substantially off the pace that prevailed e;ulier this yc:lr.
Despite the Sourtli-cluartw imS
net expc~rt
provements. ~ L I ovel.;llI
position \vorsenecl in 1996. This foll o w s a tre~ldtow:~rcl growing trade
deficits that l ~ e g a nin 1990. I h r i n g
the currcnt l~usinessespansion, U.S.
output growtl~has esceeclecl that of
most of our m:ljos t~lclingpartners.
In atitlition, tile cloll:lr's eschange
rate incles-:~tijustecI for inklati011
clifferentials anlong countries-has

;lppreciiatetl 10.4% since 1990. These
relative growth and exchange rate
patterns seem lilcely to persist
througho~~t
1997, suggesting that our
net expclrt position will not improve
hefore 1998.
Appmxin~atelyhalf of the 1996:lYQ
rise in real GDP stem~necl from
stronger consumer spending, much
of it for lionautomotive durable
goods. Real disposable personal income rose 2.8% in Decemt~esfrom
12 months earlier, anct real personal

consumption expentiituses increased
2.2%). Although consumer debt 1,~sclens have gone L I in
~ recent years,
the current level is actually 11elo~v
that of 1989.
Industrial procl~~ctionincreaseel
,,
:t.3(%on a year-over-year basis in
Ilecemher, and capacity utilization
rose to S3.5?41.The National Association of I'urchasing lvk1nagcment's incles inclicates that 52% of man:tgers
are r e p o ~ - t i growth
~ ~ g in their firr-ns.

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Labor Markets
Change thousands o i bvorkersn
600 [AVERAGE MONTHLY NONFARM EMPLOYMENTGROWTH

Labor Market Conditionsa
Average monthly change
(thousands of employees)
Year

1996
IVQ Nov.

Dec.

1997
Jan.

Payroll employment 218
Goods-producing
17
Manufacturing
-8
Construction
25
Service-producing 202
102
Services
Business services 30
Retail trade
50

234 181
34 35
12
8
23 27
200 146
91 71
18 -7
76 54

261
40
14
28
221
100
36
73

271
32
18
14
239
167
70
19

Average for period (percent)

Civilian unemployment
rate
5.4 5.3
5.3
5.3 5.4
Employment/
population ratio
63.2 63.4 63.4 63.4 63.6
Labor force
participation rate 66.8 66.9 66.9 67.0 67.2
1990 1991 1992 1993 1991 1995 1996

IVQ Nov Dec. Jan

1996

1997

Percent

Percent change, year over year

1 INFLATIONAND EARNINGS

a. Seasonally adjusted.
b. Vertical line indicates break in data series due to survey redesign.
SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

Nonfarm payrolls gre\v 13). 271.000
in January, continuing the fourth
q u : ~ t e r ' s string o f vigoroils increases. 7'he g:lin was l>roacl-/>aseel,
with every major sector of the
economy adding to its pxyrolls. Services contini~eclto espancl as :L ~ I C tion o f total eiiiploynlent. \vhilc
rnanuklcti~ring acl\.ancecl :I solitl
2.1% o n a n ~ ~ n n u aI~asis.
l
Strong
growth in t2usiness sel-vices \\;as led
by contini~eclespa~lsionol'the n:~tion's tempolxry help agencies.

Although overall employment
rose. the jobless rate increaseel
slightly for the month, from 5.3% to
5.4%, a statistically insignific;lnt
ch311ge. The source of this app:lrcnt
conflict can l ~ tracecl
e
to the increasing number of people looking for
\\.orli w h o previously were neither
cmployecl nor searching for a jol,.
While an influx of people into the
1:117or marliet is expcctecl \\-hen employment prospects are goocl, the

current I~usiness expansion has
yielded p:lrtic~~larlylarge inflo~vs.
Both the e ~ ~ i p l o y ~ i ~ e ~ ~ t - t ~ ) - ~ ) o ~ ~ i ~ l : ~ t i o
n t i o :lncl the lal~orforce particip:ltion Ixte stancl at recorcl higlis.
A\.erage \\.eelily earnings increasecl moclerately in 1996. 1111 3.2%
over 1995's lei-el :111d only slightly
above the 1996 inflation w e . The
Janiiary nilmhers clicl not I~reakwit11
this pattern, 21s aver:lge hourly p:ly
rose only 1 cent, to $12.06.

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Employment Cost Index
Four-quarter percent change
7

1
1986

1988

1990

1992

1994

1996

ECI Wage and Salary Growth

ECI Wage and Salary Growth by Industry, 1 9 9 6 ~

by Occupation and Region, 1996

Average annual
percent change, last:

Occupation
Professional specialty/
technical
Executive
Administrativesupport
Serviceoccupations
Blue-collar occupations
Region
Northeast
South
Midwest
West

1 yr.

3 yr.

6 yr.

3.57
3.77
3.12
3.40
3.04

3.04
3.44
3.14
3.14
3.01

3.42
3.45
3.50
3.25
3.1 6

3.32
3.76
3.32
3.10

2.96
3.16
3.20
3.11

3.24
3.28
3.45
3.34

1 yr.

3 yr.

6 yr.

Manufacturing
Construction

3.30
2.90

3.15
2.91

3.48
2.75

Transportation and
public utilities

2.67

3.35

3.57

Wholesale and
retail trade

3.84

3.35

3.38

3.21
3.57
4.67
2.34
3.40

2.75
3.04
4.15
2.39
3.56

2.77
3.42
3.52
3.30
3.57

FIRE^
Services
Business
Health
Educational

a. Private industry workers.
b. Finance. Insurance,and real estate.
SOURCE: U.S. Deparlment of Labor, Bureau of Labor Statistics

T h e Emplo)/ment Cost Incles (ECI) is
t h e best rneasure of compensation
(wages ;uncl l~enef'its)gro\i:th available to labor analysts. Like the Consumer Price Incles (CI'I), it relies on
a fisecl Ixtsliet o l items-in
this
case, occilpations. This pre\ients
shifts in the occupational cornposition of the \vorliforce from appearing as LGuge gains. as they clo in average hourly earnings c1:tt:u. Recause
the ECI inclucles overtilne payments

as a fixed i~lcrelnentto wages, shortterm increases in overtilne will not
alter the incles.
A long period of low unemploynlent sates has lecl many analysts to
seek eviclence of "excessive" \\age
increases. but wage growth has remainecl moderate; it has I x e n further offset by slower growth in henefit costs over the last two years. For
most groups of workers (occilpations, industries, or regions), 1996

wage growth was con~para1,leto tile
rates of the ~ ~ 1several
st
years.
Although the ECI ancl the CPI
have shown similar gro\i~thpatterns
in recent years, the clirection of
causality is ~lnclear.Firms coulcl Ile
;~cljustingwages to lteep pace with
inflation or acljusting prices to lteep
1111 with wage growth. Both exp1:lnations are consistent li~iththe correlation hetween the CI'I and the ECI.

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Employment Trends
Percent
""

Percent

EMPLOYED PERSONS AS A SHARE

EMPLOYED PERSONS AS A SHARE OF
POPULATION, AGE 16-19 VERSUS 20-24

16-19

351940

1950

1960

1970

1980

1990

Perceni

Percent

SOURCE: U.S. Department of Labor, Bureau of Labor Statistics.

Despite perioclic fluctu;ltions in the
pace of U.S. economic activity, the
percentage of \\-orking-age Arnericans w h o are ernployeel has risen
steadily since the early 1970s ancl
now stancls at a recorcl 63.4%. Because er-nployment changes play an
important role in cletermining overall economic growth, it is usefill to
explore the source of the employment rate increase to see \vlletlier
this trericl may continue.
The rise in the employment-top o p ~ ~ l a t i o ratio
n
since the e:lrly
1970s reflects a subst:~ntialincre:ise

in wctmen's employment rates, a
trellcl which began much earlier. The
overall employment ratio rose, clespite a sul>stantial clecline in the employment rates for inen ancl people
55 and over. (Early-retirement programs, initiated in the 1970s, contsibutecl to this decline.) Teenagers'
employment rate was roughly unclizunged over the perioci.
It I'ollo\vs that the c1ram:ltic increase in overall employment rates
was clriven by an even Inore elmmatic rise in the ernploylnent sates
of psime-age miorkers (25 to 54).

Gro\vth ~vit11i11this group resulted
exclusively from the increase in
\\.omen's employxnent.
It is u~llikelythat the employment
of prime-age women will keep rising at the same rate over the next
clecacle. If substantial growth in the
overall employme~ltpercent:lges is
into continue, it will liltely recl~~ire
creases in the employment mtes o f
men ancl people over 54.However.
a more liliely scenario is that growth
in the percentage of Americans \\rho
are employeel will s l o ~ vgreatly in
the coming years.

I
0

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Structural Changes in US.Fiscal Policy
Percent of GDP

Percent 01 GDP
"

Percent of GDP
12

I STATE AND LOCALTAXES AND EXPENDITURES

Index, 40-year-old male = 1

Index, 40-vear-old male = 1

SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis and Bureau of the Census; and University of Michigan, Survey Research Center.

s.
A

-4

Feclelal spencling has cot~sistently
outpaceel fec1er;ll revenues since the
1970s. Although the opposite is true
for the sum of st;lte :~ncllocal budgets, the total national clel2t (both
nominal ancl inflation-adjustecl) has
m~~shroomecl
over the last 25 ye:trs.
Many analysts vie~vthe higher
level of esplicit clel~tas 2111 indication
of ho\\- fils the 1,urclen o f paying for
current government spencling has
b e e n shifted onto future genemtions. Some suggest that the level of
explicit ciebt :tlone i~nclerestirnates
t h e extent of such 1,urclen-shifting,
citing the government's implicit So-

cia1 Security and Medicare liaf>ilities
:tlso snakes Social Security, i\leclic;ue,
to current generations, which f ~ ~ t ~ i r Meclicaicl,
e
ancl \velfare tztnsfers.
generations of workers will have to
A glance at the components of aggregate taxes ancl tmnsfers is suffipay. Ho\vever, the paylnent burclen
on fi~turegenerations has itlcreasecl
cient to convince anyone of the sigin a thircl \?ray---through struct~lral 11ific:lnt structural changes in postwar
changes in fiscal policy.
[J.S. fiscal policy. As a share of GI)I',
The government has man), fiscal
lal>orinconle taxes xncl pa)7roll taxes
instn~mentsat its disposal. It obtains
(which also fall on \vorltel.s) have
revenue through taxes on labor ant1
trenclecl upwarel. Because ).ounger
capital income, payroll tases. ancl ingenerations \\'.ark more than retirees,
clirect (sales and escise) taxes,
their taxes have incre:~sedsnore. 011
the other hand, taxes or1 capital inamong others. Apart from spending
to purchase goods and services for
come have declinecl over this period,
reducing the t:lses of older generaits own operation and to provicle
puhlic goocls like national defense, it
(cot2titzzred orz tze.xip~/ge)

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Structural Changes in US.Fiscal Policy (cont.)
Index 65-year-old male = 1

Percent of GDP
IL

ISOCIAL SECURITY AND HWLTH CARE TRANSFERS

Perceniof GDP

Index 40-year-old male = 1
36

1 RELATIVE PROFILES OF MEDICARE AND SOCIAL

lndex 40-year-old-male= 1

IRELATIVE
PROFILES OF WELFARE BENEFITS BY AGE

SOURCES: U.S. Department of Commerce. Bureau of Economic Analysis and Bureau of the Census; Social Security Administration; and Mark McClellan and
Jonathan Skinner, "The Distribution of Medicare Benefits: A Lifetime Perspective," Stanford University, unpublished manuscript. April 1996.

tions, who o\vn most of' the economy's physical capital.
Fu~-thecSocial Security anel health
care tmnsfers have risen ~;tpicllyas a
share of GDI? i~nplyinga clecline in
the net tax burelens of oltler generations, w h o ~nalceup a significant
~najorityof recipients. However; the
increase in these tl-ansfers implies a
s ~ n a l l e rdecline in the net hurclens
of younger ancl unhorn genemtions,
who ~villreceive them in the c1ist:mt
f ~ ~ t u r and
c , then only after malcing
substantial payroll contril,~itions

while worlting. The sh:tre of \velf;u.e
ments may not much affect overall
transfers that accrue mainly to
revenue and spencling numl~ersthat is. annual cleficits Inay remain
young, poor indivicluals-single
mothers a11d the une~nployecl-has
~~nch;lngecl.
It m:ty nevertheless sig;tiso increaseel, but at a IIILIC~I slo\ver
nificantly alter the generational clispace than Social Security ancl health
tril>~itionof net payment hurclens.
care transfers.
I3ecause cliffere~ltgenerations have
clissimilar saving patterns and incliThe government's choice of a parnations to participate in the workticular nix of taxes, spending, anel
force (clepencling on their age),
transfers cleter~ninesthe clistrihution
changes in this clistril,~ttionare likely
of net p:iyment burclens (taxes net
of transfer receipts) alllong current
to affect the nation's overall ecoanel f~1t~ir.e
generations. A str~~ct~ir.;tl nomic performance.
ch:lnge in the mix of these instru-

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Housing Finance
Index, March 16, 1990=1

Percent

*'1

MORTGAGE APPLICATION VOLUME

MORTGAGE RATES

1995

1996

1997

Billions of dollars

[MORTGAGE ORIGINATIONS BY TYPE OF LENDER

J F M A M J J A S O N D J F M A M J

1995

1996

SOURCES: U.S. Department oi Housing and Urban Development; Federal Home Loan Mortgage Corporation; Office oiThrifi Supervision; Mortgage Bankers
Association of America; and Bank Rate Monitor.

After cleclining stezkclily sincc September 1996, 30-year fisecl mostgage rates ha1.e ji~mpecl -40 1):tsis
points from 1)eceml~er's l o ~ v of
7.38%. Fifteen-year fisecl sates have
follo\\;ecl a similar pattern. n~hile
one-year :~clj~istal~le
Utes have risen
some\\-h;lt less. Nonetheless. analysts generally Llgree tl1:kt tl~isrecent
~ ~ p n ' ; ~trencl
rd
n-ill not c o n t i n i ~ e
inclefinitel>- if economic gro\vth
rer~llainsrel:~ti\.elystahle ancl inflation moclelates.

A l t h o ~ ~ gthese
h
rates are still low
compared to those of the last 20
yezkrs, the 1993 refi~lanci~lg
I,oom
the boomlet at the entl of 1995
left many mortgage holclers wit11
even lower rates than those prevailS,
the volume
ing toc1:lp. T ~ L I while
of home-1~urchaseapplications has
continued to grow steaclily, refin~uncingactivity is less p r o n o i ~ n e d .
Nevertheless. mortgage originations
rernainecl strong through the first
11:1lf of 1996.

The recli~ceclrefinzlncing clernancl
;klso helps to explain why the share
of acljust;~l,le-rate mortgage originations is o n c e again moving in
ta~ltlem\vith the spread I,et\veen
fixecl- ancl acljustal>le-ratemortgages.
IVhen long-term rates were at historically l o ~ vlevels in 1993%m:lny
I~orro\verslocliecl in those fa\.oraide ter111s. even thoiigh the spre:lcl
Ixtween fixed anci acljustable rxtes
\\;as i~ni~sii:~lly
\vide.

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Household Debt and Delinquencies
Percent
loo

HOUSEHOLD DEBT BURDENS

Percent

Percent
180

Filings per 100,000 U.S. adults

Percent

1,700 /BANKRUPTCYAND CREDIT CARD CHARGE-OFF FATES

Percent
30 IHOUSEHOLD DEBT/FINANCIAL ASSETS

SOURCES: U.S. Department of Commerce, Bureau of Economic Analysis; Board of Governors of the Federal Reserve System; American Bankruptcy Institute;
and FDIC Statistics Branch.

Over the last few years, the mtio of
householcl clelx to clisposable personal incorile has reachecl historically high levels, raising concerns
about the financial stability of I1.S.
ho~~seholcls.
The recorcl n~imberof
personal I,anl<nlptcyfilings (1996:IIIQ
alone saw more than 290,0001,
along byit11 increases in credit card
charge-offs (\vi~ichreachecl 4.49% of
total cr-eclit care1 debt outstancling in
1996:IIQ). has further heighteneel
this concern.

A better indicator of ho~~seholcls'
true financial health is the proportion of clisposable perso~lalincome
that must be used to service this
cleht. After all, the general cleclinc
in interest rates during the '1990s
has made it much easier for householcls to manage greater clebt levels.
As a fraction of clisposable personal
income, estimated debt-selvice payments have been rising over the 1:ist
few years, but their level is still consistent with that of the late 1980s

ancl is \veil below its 17.6'Yo high of
1989:IVQ.
7'0 understancl householcts' financial r\:\;ell-being, it is also important
to notice that the composition of
householcl cleht has been changing
since the mid-1970s. with home
mortgages acco~lntingfor a larger
share of total householcl liabilities
ancl collsurner cleht becoming relatively less in~portant. In contrast,
tliere has been a relative increase in
(cotztin~redor? 17extpagc)

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Monetary Policy and Global Competition
Yen per U S dollar

I5O [ NOMINAL EXCHANGE RATE

Yen per U S dollar
152

REAL EXCHANGE RATEa

150

148

146

144

142

140

138

1991

Percent change from corresponding quarter oi previous year
7

1992

1993

1994

1995

1996

Percent change from corresponding quarter of previous year

(

" JAPANESE REAL GDP

a. The real exchange rate is calculated using consumer prices for both the U.S. and Japan. The base period is November 1991
SOURCES: Bank of Japan; and the Statistics Bureau of the Japanese Prime Minister's Office.

The clollar's recent sh:irp rise against
the yen has intensifiecl long-held
concerns a l ~ oJapanese
~~t
man~~hcturers' competitive edge in U.S. marItets. Since M:irch 1995, the clollar
has :~ppreciatecla l ~ o u t35% xgainst
the yen, ancl many analysts anticiac1v;lnces this year.
pate ~LII-ther
When one also weighs the persistent inflation clifferentials Ixtween the two c o ~ ~ n t r i ethe
s , competitive implications of the clol1;~r's
rise seem rnore challenging. On a
real i~asis.tlie clollar has :lppreciatecl nearly 13% against tile yen

since 1990. Can policy moves 11i:ilie
:i difference?
Foreign exchange inter\.ention
can sencl ripples through the market. Much like a rock tossed into ):
snift river, however, inten~entionofl
with
fers 110 f ~ ~ n d a m e n t aforce
which to alter a marltet's current.
Because success clepencls on cli~inging traclers' perceptions ancl espectations of events, rather than clirectly
changing fiindamentals, intervention's infl~lenceis at best fleeting.
i\lternatively, the Federal Reserve
co~llcle:ise monetary policy when

tlie 13ank of J:lpan tightenecl its
money supply. This ~ ; o u l dpromote
21 clollar clepreci:ltion at the expense
of higher inflation in the U.S.;Inel
cleflation in Japan. Since exchange
rates often responcl Illore quickly
than prices, our competitive position
might s h o ~ v;I temporary improvement that ~voulcl last only until
prices responded f~illyto monetary
~ I ~ ~ S S L I SUltimately,
~S.
countries cannot imixove their competiti\.e posih
policy.
tion t h r o ~ ~ gmonetar)~

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Monetaly Policy and Economic Growth
Inflation, oercent
100

Short-run Growth of Money and Output

MONEY GROWTH AND INFLATIONa

(Correlation, year-over-year percent change)

M2 lagged
one year

M2 lagged
two years

-0.1 7

-0.1 1

France

0.1 7

0.06

Germany

0.74

-0.13

Italy

0.62

0.42

Japan

0.72

0.51

U.K.

0.1 8

U.S.

0.35

Canada

Correiat~on 0 99

eba

-0.19

0.16

I
30

GO
40
50
M2 growth, percent

100

40
50
GO
Inflation, percent

100

Real GDP growth, percent
10
8

4
2
0

-2
-4
-6

-8
-1 0

40
50
GO
M2 growth, percent

100

a. Average annual percent change.
NOTE: The sample includes 45 countries. All have at least 15 years of available data, and most have 35 years. See GeogeT. McCandless, Jr. and Warren E.
Weber, "Some Monetary Facts," Federal Reserve Bank of Minneapolis, Quarterly Review, Summer 1995, pp. 2-11.
SOURCE: International Monetary Fund, International Financfal Statistics.

Although most economists n.ill concede that nlonetary policy can affect
real economic gro\vth over the
short run. many caution against
attempting to manage i>i~siness
cycles through policy minipulation.
Indeecl, in most large industrial
countries, faster money growth
seems to prececle Lister economic
gro\vth by one year.
E.

--2
-

A causal connection I>et\veen
money ;me1 growth, ho.r\.e\-er, req ~ ~ i rthat
e s information :il)out policyinclucecl price changes bc imperkct.

This m:tp happen if so~lnesectors of
the economy have embeclclecl outdatecl price expectations in Elinding
co~ltmcts,if certain groups have better access to cu~-rentprice information t h ~ mothers, or if people generally have good infor~llational~outthe
wages they earn ancl the prices they
charge, hilt not about other prices.
In the long rim, when information
is complete and contracts can adjust,
faster money growth increases neither
outpilt nor employment. As crosscountry correlations reveal, faster

money gro~vthcontributes only to
inflation. Sollle economists warn
that higher inflation may slo\v
groxvth. If the p~ll>liccluestions the
stability of a currency's purchasing
power, they will expend more time
and energy protecting their financial
\vealth from inflation. Society will
clevote Illore resources to fiillatlcial
services allel to the prompt acljustment of prices. \vhile fewer resources will g o towarcl capital
accumi~lationanci investments that
enhance protluctivity.

Full text of Economic Trends (Federal Reserve Bank of Cleveland) : Economic Trends - February 1997

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