Next month the nation's extraordinary economic expansion, which began in April 1991, will become the longest in American history, and there's no sign it's about to die of old age.
Yes, it's showing some wrinkles and a wart or two, and, like anyone in the prime of life, it could be struck down in an accident. Still, the odds-on bet is that when 2001 rolls around the economy will have logged another year of solid if somewhat slower growth, and economists will once again be scratching their heads in wonder.
Stephen Slifer, chief U.S. economist at Lehman Brothers Inc. in New York, says he has been telling clients that the American economy could still be going strong not just a year from now but five years from now. The reason? The surge in productivity--the amount of goods and services for each hour worked--that began several years ago.
"There is no question in my mind that it is going to continue for the next five years," Slifer says. Capital is "cheap," he said, adding that to keep labor costs low businesses are investing so much in cost-saving new technology that the economy's efficiency will be boosted and inflation held down.
Since the expansion began in 1991, the U.S. gross domestic product has increased about 37 percent after adjusting for inflation. GDP for the private sector alone has risen even more, about 41 percent.
Part of the growth is due to the constant increase in the size of the U.S. population and work force, but even on a per capita basis inflation-adjusted GDP is now 29 percent higher than when the expansion started. That compares with an increase of less than 27 percent in real per capita GDP in the long expansion of the 1980s. That still falls short of the 36.4 precent increase during the longest-ever expansion, in the 1960s.
Some analysts are cautioning that the economy could be derailed at some point, perhaps as early as this year, by a collapse of the highflying stock market, which could so stun consumers that they suddenly cut back their spending enough to trigger a recession.
Another gloomy scenario is based on a possible change of heart by foreign investors who have been supplying the money to finance the record U.S. trade deficit. If suddenly they put their money elsewhere--perhaps into a country with a reviving economy that offered big growth potential--their pullout could cause the value of the dollar to plummet, adding to inflationary pressures and pushing up interest rates. An abrupt end to foreign capital flows into the United States would probably also slam stock prices, and the combination of all these forces could cause the economy to slump.
The economists citing these risks are not predicting they will be realized, though many analysts expect some sort of market correction during 2000. A moderate decline in stock prices actually would be beneficial for the economy's long-term health, the economists say, because it would dampen consumer spending and slow growth enough to keep inflation under wraps.
After six straight years of growth averaging almost 4 percent, employment gains have begun to slow, partly because there are so few jobless workers that many employers can't find people to fill vacant jobs. That, in turn, means that total household incomes are likely to increase more slowly, discouraging consumers from continuing to step up their spending at the rapid pace of the past few years.
The Federal Reserve is a factor, too. The central bank raised its target for short-term interest rates by three-quarters of a percentage point, to 5.5 percent, last year to take some steam out of the nation's economic boiler. Some Fed-watchers expect another quarter- or half-point increase this year, particularly if spending by consumers and businesses doesn't taper off a bit.
"The U.S. economy will slow next year to a growth rate below its 3.5 percent potential," forecasts John Lipsky, chief economist at Chase Securities. "This benign slowdown will reflect mainly the Federal Reserve's  tightening, moderating real income growth and a waning of the stock market stimulus to household spending."
The key reason Lipsky and many other forecasters remain so optimistic about the U.S. economy is that even after nearly nine years of uninterrupted growth, there is little evidence--outside the stock market--of the sort of excesses that in the past have led to accelerating inflation and recession. This essential balance in the economy is reflected by the low level of core inflation--that is, consumer prices other than for food and energy items.
Some forecasters, such as those at Macroeconomic Advisers in St. Louis, don't expect a downturn but do think the nation's very tight labor markets are going to cause an "upward creep" in core inflation over the next two years.
Over the past half-century, every U.S. recession has been preceded by a run-up of inflation as various elements of the economy got out of balance. Usually it has been a straightforward matter of overheating: households and businesses wanting to buy more goods and services than the economy could readily produce, with tight markets giving producers the power to raise prices without losing their customers.
Historically, those tight markets for goods and services have always been associated with low unemployment rates and rapid wage increases. In the minds of many people--and in the elaborate mathematical models many economists use in forecasting--low joblessness and rising inflation always go hand in hand.
But something clearly is different this time around. Strong growth has pushed the national unemployment rate down to 4.1 percent. The rate has been below 6 percent--which previously was thought to be the threshold below which tight labor markets would cause inflation to rise--for nearly 5 1/2 years. The jobless rate has been below 5 percent for 2 1/2 years, and even below 4.5 percent now for more than a year.
Yet most measures of labor costs, such as average hourly earnings and the employment cost index, which tracks employers' costs for wages, salaries and benefits, are actually going up more slowly now than they were a year ago. And core inflation remains close to 2 percent, the lowest level in about 35 years.
"All measures of core inflation are at [business] cycle lows," says Bruce Steinberg, chief economist at Merrill Lynch & Co. in New York. "Competitive pressures are fierce, even in booming sectors. While higher oil prices will push the consumer price index up during the next few months, we believe core inflation will remain on a sub-2-percent trend."
One unique feature of the current expansion is that while labor markets are extremely tight, the markets for most goods and services are not. For example, the Federal Reserve's index for the share of production capacity actually in use at the nation's factories, mines and utilities is running well below the level that in the past has usually been associated with rising industrial prices.
In previous expansions, tight product markets and tight labor markets went hand in hand, which is one reason the unemployment rate was such a good proxy for the overall state of the economy. But the high level of business investment during most of the 1990s, which has given productivity such a boost, has also added to the nation's production capacity, and through that channel as well, helped keep inflation low.
The increasing openness of the U.S. economy to imports of foreign goods and services has also meant that production capacity available in other parts of the world helps hold down prices in the American market, analysts say.
The productivity surge described by Lehman Brothers' Slifer is also atypical late in a long period of expansion. Usually as expansions near their end, the efficiency of the economy suffers with productivity gains lagging or turning negative. When that happens, production costs rise, profits fall and the pressure to raise prices increases sharply.
That was what happened 30 years ago when the record-breaking expansion of the 1960s dissolved in a witches' brew of soaring inflation, rising taxes and interest rates and international monetary turmoil. President Lyndon B. Johnson, unwilling to curb either his new Great Society programs or the escalating cost of the Vietnam War, let federal spending skyrocket at a time when the U.S. economy was already overheating. That misguided choice helped generate a wave of inflation that destabilized the American economy for more than a decade.
Then, in the late 1980s, as another long expansion was nearing its end, a less virulent inflation caused the Federal Reserve to raise its target for overnight interest rates to almost 10 percent to cool off an overheated economy. But by the middle of 1989, the Fed began to cut rates as economic growth slowed. In that instance, a recession might have been avoided except for the Iraqi invasion of Kuwait and the shock of soaring oil prices on consumer attitudes. Remembering the energy crises of the 1970s, consumers cut back on their spending and pushed the economy over the edge.
Today, consumers aren't so sensitive to oil price increases. For instance, over the past year prices of crude doubled and costs of gasoline and home heating oil rose more than 20 percent. But consumer confidence, buoyed by rising wealth from the stock market, incomes that are increasing faster than prices and plenty of job opportunities, hit a 31-year high last month.
"The inflation performance of the 1990s is unprecedented," says Steinberg. "The 1960s cycle is the only one that lasted as long as the 1990s. By this point in that cycle, the inflation rate was 6 percent. By the time the 1980s cycle ended, the inflation rate was 5 percent." This time around, "core inflation excluding tobacco is up 1.8 percent from a year ago."
With inflation so low, any interest rate increases engineered this year by the Fed to cool off the economy aren't likely to be cumulatively very large because there has been no acceleration of core inflation that policymakers need to wring out of the economy. And that leaves the central bank well positioned to respond to whatever shocks, if any, occur.
In an interview after the last Fed rate increase, in November, William Poole, president of the St. Louis Federal Reserve Bank, said: "I believe monetary policy is pretty much dead center. If we are off, we are not very far off, given the information we now have.
"But the interesting part of the question is the unforecastable events that will come down the road," Poole continued. "We are in the middle of the lane and therefore have some leeway. Crosswinds will not send us over the guardrail."
Pooke added that "I do believe the environment is inherently more stable with low inflation" because that causes markets to respond more slowly to shocks than they otherwise would.
Fed Chairman Alan Greenspan said explicitly last summer that in a low-inflation environment the Fed would respond if a sharp drop in asset prices threatened the nation's economy.
"While bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy," Greenspan told a congressional committee. In Japan this decade and in the United States after the stock market crash of 1929 the real damage was done by "failures of policy" afterward, he said. "And certainly the crash of October 1987 left little lasting imprint on the American economy."
In other testimony later, the Fed chairman added: "Should an asset bubble arise, or even if one is already in train, monetary policy properly calibrated can doubtless mitigate at least part of the impact on the economy [if the bubble bursts]."
Similarly, with the federal government budget solidly in surplus, Treasury Secretary Lawrence H. Summers said in an interview, "we have reloaded the fiscal cannon"--meaning that the budget can perform its role of automatically cushioning shocks to the economy without having to worry about a ballooning deficit.
For instance, if someone becomes unemployed, the added spending on unemployment benefits softens the blow to the individual and the economy. Meanwhile, when that person's income goes down because of the spell of joblessness, so does his income tax liability. The same is true when a business's profits fall.
Summers said the most likely scenario is continued solid growth with low inflation, but as an economist, he would never rule out the possibility of a shock. He added that the government's solid fiscal position should provide reassurance to financial markets should some unexpected event occur.
For all the "fragilities" that may exist in the U.S. and world economies, Rudi Dornbusch of the Massachusetts Institute of Technology says, they don't pose nearly as great a risk as the situation in 1998 when world financial markets seized up in the wake of a default by the Russian government on part of its debt.
Dornbusch calls that episode "as narrow an escape as could be."
"If the Federal Reserve had not rescued financial markets from an assault of all-out pessimism, world recession would have become a real possibility," he said. "But we are beyond that and . . . good growth and substantial calm are now the dominant outlook."
INFLATION AT BAY
Inflation flared up in the two previous long economic expansions, in the late 1960s and the 1980s, but it has yet to materialize during this current robust period.
Dec. '69: 6.2%
Dec. '90: 5.2%
Nov. '99: 2.06%
SOURCE: Bloomberg News