The U.S. economy has been more robust throughout the 1990s than previously thought, and growth was very strong this summer with no increase in the unusually low inflation rate, the Commerce Department reported yesterday.
For the July-September period, the gross domestic product grew at a 4.8 percent annual rate after adjustment for inflation, up from a 1.9 percent rate in the second quarter. Meanwhile, the GDP price index for goods and services bought by Americans rose at only a 1.6 percent rate, down from 1.9 percent in the previous three months.
The report was reassuring news that the economy can continue its strong expansion without producing inflation.
"The U.S. economy blazes into the millennium at cyber speed," said Bruce Steinberg, chief economist for Merrill Lynch & Co. in New York.
Federal Reserve Chairman Alan Greenspan said in a speech last night that the figures made it clear that productivity gains have sharply accelerated, allowing the economy and American living standards to grow more rapidly than in the previous two decades. [Story, Page E1.]
Greenspan also noted that rising long-term interest rates may be helping to contain rapid increases in consumer demand that could otherwise touch off inflation.
A separate report from the Labor Department underscored the lack of inflationary pressures. The employment cost index, a closely watched number that tracks changes in employers' costs for wages, salaries and benefits, rose 0.8 percent in the third quarter and 3.1 percent over the past year. Both figures are in line with or below the rate at which the index has been rising for several years despite continued strong growth and the lowest jobless rate in nearly three decades.
The two reports triggered sharp rallies in both the stock and bond markets. The Dow Jones industrial average rose 227.64 points, or 2.2 percent, to close at 10,622.53. Yields on 30-year U.S. Treasury bonds fell to 6.25 percent, from 6.33 percent late Wednesday, while the price on the bonds, which goes up when yields fall, rose $10.31 per $1,000 in face value.
White House economist Martin Baily noted that the GDP report incorporated several changes in how the Commerce Department calculates the total value of goods and services produced in the United States. The changes highlight more rapid growth than had previously been reported, which Baily attributes in part to strong productivity gains. "These numbers do shift you a little bit more to thinking that we are seeing . . . more signs of the emergence of a new economy," he said.
For example, GDP growth for 1998 was revised to 4.3 percent, up from the previously reported 3.9 percent. The economic growth rate for the 1992-1998 period was revised upward 0.4 percentage points, to 3.6 percent a year from 3.2 percent.
Steinberg of Merrill Lynch said that because of these changes, particularly the treatment of software purchases by business and government as a capital investment rather than a current expense, forecasters need to raise their estimates of how fast the economy can grow on a sustainable basis by the same 0.4 percentage points.
"Based on the new GDP accounting, we will raise our 2000 forecast to around 3.75 percent from our prior estimate of 3.3 percent," Steinberg said.
The Merrill Lynch economist also said the upward revisions in inflation-adjusted GDP mean that past estimates of labor productivity will be revised upward next month by the Labor Department. With productivity increasing rapidly, he predicted that the cost of labor for each unit of production by businesses rose at a very low 1 percent rate in the third quarter. "Inflation simply does not develop out of that situation," he said.
The third-quarter growth rate of 4.8 percent is well above what Greenspan and most other Fed officials have said they would like to see if inflation is to remain low. Their concern is that U.S. labor markets are so tight that such strong growth will make them tighter and eventually prompt employers to raise wages in an inflationary fashion in order to keep and attract workers.
On the other hand, the number of hours worked in the July-September period increased at only a 2.2 percent rate, according to Labor Department figures released earlier this month. That probably means that more than half the third-quarter increase in GDP was the result of rising productivity rather than more employees working longer hours, which would mean there was little if any additional inflationary pressure from tight labor markets, analysts said. Productivity is the ultimate source of improvement in the standard of living.
"That good gain in productivity raises the Fed's noninflationary 'speed limit' for overall economic growth," said Maury Harris, chief economist at PaineWebber Inc. in New York. Harris said the 4.8 percent growth rate was "still too strong for the Fed's liking, but the 'big picture' wage and price data are so mild that we still believe" that Fed policymakers will not raise short-term interest rates when they meet next month. Instead, Harris said, the officials will continue to lean toward raising them in the future, as they did at their last meeting, on Oct. 5.
Ian Shepherdson, chief U.S. economist for High Frequency Economics Ltd. in Valhalla, N.Y., agreed, citing the 0.8 percent increase in the Labor Department's employment cost index, which was slightly below what analysts had expected.
"This is a seriously helpful report to those, including us, who think the Fed will not raise rates next month. . . . There is no sign whatever in these numbers, which Mr. Greenspan is generally thought to trust more than the hourly earnings numbers, that wage pressures are picking up. . . . In short, good news all around."
Some analysts said they think the Fed will raise rates for the third time this year, while others said it is a tossup.
The strong third-quarter GDP advance notwithstanding, analysts said there were some indications that growth may be slowing. With interest rates for home mortgages considerably higher than they were early in the year, spending on new-home construction fell at a 6.3 percent rate. Investment in new business structures also fell at a 5 percent rate, the third consecutive decline of that magnitude.
Consumer spending rose at a 4.3 percent pace, but that was down from 5.1 percent in the second quarter and 6.5 percent in the first three months of the year.
On the other hand, business investment in new equipment and software shot up at a 21.7 percent rate, though many analysts regard such spending as anti-inflationary because it increases the economy's capacity to produce goods and services.
Baily noted that the upward revisions in economic growth for 1997 and 1998 were driven by much more than the change in the treatment of software purchases.
"We have uncovered more GDP and more income, and that's evidence that productivity may be accelerating," he said. The increases in business investment that are bolstering productivity are partly the result of the government's "fiscal discipline," which has swung the federal budget from large deficits to large and growing surpluses and left more funds available to finance private investment, he said.
Undersecretary of Commerce Robert Shapiro went a step further. "My hope is that what we are seeing is the return to the long-term trend for productivity that we got off of in the 1970s," he said. "We have had a long period of depressed productivity that no one has fully understood. Many economists were concerned that this was just the way a mature economy performed. But now we have some real evidence that we have restored a higher trend growth in productivity and a higher trend growth rate for the economy."