U.S. ECONOMIC FORECAST

Real Gross Domestic Product

The Ways and Means Committee staff predicts that the national economy, measured by real U.S. Gross Domestic Product (GDP), will grow by 2.6 percent during 1998, following 3.8 percent growth in 1997 (see Table 18) as the economic crisis in Southeast Asia makes its effects felt in the U.S. As discussed below, the Asian crisis is expected to have a significant impact on two of the four major components of GDP.

Consumption

Overall consumer spending is predicted to slow, growing by 3.0 percent in 1998, less than the 3.3 percent growth rate of 1997 (see Table 18). Durable goods consumption is expected to grow at 3.7 percent in 1998, down from a robust 5.7 percent in 1997. The slowdown in durable goods consumption should not be interpreted as a lack of consumer confidence in the economy. Consumers have been extremely euphoric about the economy as witnessed by the robust readings of the Consumer Confidence Index, which reached a three-decade high in February. Rather, demand for durable and non-durable goods is expected to soften due to a slowdown in personal income growth.

Investment

The Committee staff is estimating investment growth of 6.4 percent for 1998, following much stronger growth of 11.1 percent in 1997. A cooling-off period in investment is anticipated after double-digit growth rates in the first two quarters of 1997. The anticipated slowdown in investment is attributable to an expected decline in inventories, with retail sales expected to weaken relative to the recent period.

Net Exports

The Committee staff predicts export growth of 7.3 percent for 1998, following growth of 12.5 percent during 1997 (see Table 18). Import growth is also expected to slow down in 1998, but by less than exports. Imports are expected to grow 10.5 percent in 1998, following 13.9 percent growth in 1997, implying continued deterioration in the U.S. trade balance. As Figure 14 shows, the current expansion is characterized by robust export and import growth as compared to the previous expansion, indicative of the ever-increasing presence of the U.S. in international trade. While a strong dollar, and the recent collapse of many Southeast Asian currencies, have made exports to Asia precarious, stronger than previously anticipated growth in Europe and Canada will sustain U.S. exports. As already mentioned, the trade gap is set to achieve one more record imbalance reflecting the appetite for cheap overseas products made cheaper by the appreciating dollar.
 

 

Government Spending

Real government spending for 1997 grew by 1.0 percent, with a 1.4 percent decline in federal government spending partially offsetting an increase in spending by state and local governments of 2.4 percent. For 1998, the Committee staff anticipates a 0.3 percent decline in federal government spending, while state and local government spending are expected to grow by 2.1 percent, resulting in 1.2 percent growth for the government sector overall.

Employment

National employment is expected to grow by 1.9 percent in 1998, following 2.3 percent growth for 1997. The services sector is expected to lead with the most job gains in 1998 and grow at a 3.0 percent rate, following 3.5 percent growth for 1997 (see Table 19). Growth in retail trade employment is expected to be weaker at 1.8 percent in 1998, following 2.4 percent growth in 1997. The transportation, communication, and utility sector is forecast to experience growth of 2.4 percent in 1998, down from a 2.6 percent increase in 1997. The construction industry is expected to experience a growth rate of 2.7 percent in 1998, down from 4.3 percent growth in 1997, due to the overall decline in income growth. Manufacturing employment is predicted to grow 0.1  percent for 1998, down from a 0.4 percent increase for 1997. Government sector employment is expected to grow by 1.1 percent in both 1997 and 1998.

Personal Income and Wages

Personal income grew by 5.8 percent in 1997, with its largest component, wages and salaries, growing by 6.7 percent. The Committee staff anticipates this performance will be followed by growth of 5.3 percent and 6.1 percent, respectively, for 1998. During the current recovery, personal income and wages and salaries have grown only modestly by historical standards. Wages and salaries have grown at an average annual rate of 5.0 percent during the current expansion, far below the 7.2 percent average for the period since 1977 (see Table 18).

Inflation

The Ways and Means Committee staff forecast for inflation, as measured by growth in the U.S. Consumer Price Index, is 2.2 percent for 1998 following 2.3 percent in 1997. Inflationary pressures continued to remain in check during 1997. Strong productivity growth, international and domestic competition, as well as a resolute central bank, have helped keep both inflationary pressures and inflationary expectations at bay. Increases are expected within the services components of the consumer price index (CPI), as producers in that sector are more able to pass wage increases on to the consumers, due to its relative insulation from international competition.

Interest Rates

During 1997 the average short-term interest rate, as measured by the yield on three-month treasury bills, stood at 5.1 percent. The average long-term rate, as measured by the yield on ten-year government bonds, stood at 6.4 percent. For 1998, the short-term rate is predicted to remain flat at 5.1 percent and the long-term rate to decline to 6.1 percent. The Committee staff is not expecting the Federal Reserve to increase short-term interest rates during 1998, due to the above low inflation outlook.

Corporate Profits and the Stock Market

Corporate profits grew by 8.1 percent in 1997, and are estimated to grow by 5.7 percent in 1998. Corporate profits, which have been strong since the beginning of the national recovery, will continue to grow due to an expanding economy, the rewards of technological investments, as well as the absence of significant wage pressure. However, the exposure to Southeast Asian economies has already begun to erode corporate returns, thus lowering the forecast for 1998 compared to 1997. Strong profit growth should also result as firms reap the benefits of corporate restructuring, driven by the need to lower costs in the face of increased global competition.

Stock prices, as measured by Standard and Poor's Index of 500 common stock prices, grew by 30.1 percent in 1997, and will be followed by slower but still robust growth of 18.1 percent for 1998.19 The average value of the S&P 500 index for February 1998 stood at 1,023.4. Our forecast for all of 1998 is 1,031.0.
19. The stock market is much more volatile than the level of corporate profits which drives it. Therefore, the Committee staff estimates stock market growth by comparing annual averages rather than by comparing the year-end value to the value at the beginning of the year. Any single day’s value reflects the news and rumors which may happen to be in the air that day, making it impossible as well as undesirable to forecast. Annual averages are purged of this daily volatility and are therefore more reflective of the fundamentals driving the market.

Comparison with Other Forecasting Groups

The Ways and Means Committee staff forecast of 2.6 percent overall economic growth is consistent with the Blue Chip Economic Consensus forecast of 2.6 percent for 1998. The Blue Chip Economic Consensus is a compendium of the forecasts of 50 private sector groups. As reported in the February 1998 issue of Blue Chip Economic Indicator, 22 of the 50 forecasters are above the 1998 average while 19 are below. As of February 1998, DRI/McGraw-Hill was predicting real GDP growth of 2.7 percent for 1998. As of February 1998, the WEFA Group was predicting real GDP to grow by 2.7 percent in 1998. As of February 1998, the Federal Office of Management and Budget was predicting growth of 2.4 percent for 1998. The New York State Division of the Budget predicts growth of 2.6 percent for 1998 (see Table 20).
 

Risks to the National Forecast

The Ways and Means Committee staff forecast is based on the assumption of sustained real GDP growth without any significant inflationary pressures, stable interest rates, sustained productivity gains, and a recovery in Europe and Canada. The most substantial risk to this forecast is the economic crisis in Asia. Although there is little doubt that Asia will have a significant impact on the economies of the U.S. and its trading partners, there is much uncertainty as to the magnitude of that impact. Asian purchases of U.S. goods comprise 27 percent of U.S. exports, but they represent one of the fastest growing components.

The Committee staff baseline forecast presumes a decline in overall growth in Asia from 2.6 percent in 1997 to 1.6 percent in 1998.20 However, lower growth than anticipated could affect the Committee staff forecast through three possible channels. First, a weaker Asia means weaker demand for U.S. exports by Asian firms and consumers. Second, a weaker Asian economy threatens the profits of U.S. firms with direct investments in that part of the world. Finally, additional weakness could either cause Asian currencies to devaluate further or drive Asian producers to market their own exports even more aggressively by further lowering prices. This could lead domestic and foreign consumers to substitute cheaper Asian imports for goods produced in the U.S.
20. The Committee staff baseline forecast incorporates data and forecasts for international economic variables made available by DRI/McGraw-Hill.

In order to test the sensitivity of the Committee staff forecast to unanticipated weakness in Asian, we analyzed the impact of a scenario whereby the baseline assumption of 1.6 percent growth is reduced to zero growth. This reduction reduces U.S. export growth from 7.3 percent to 4.4 percent, and real U.S. GDP growth from 2.6 percent to 2.2 percent. Both employment and consumer price growth fall slightly. If additionally, import prices fall by 5.0 percent, U.S. import growth rises from its 10.5 percent baseline to 11.4 percent. Real GDP growth falls an additional 0.1 percent to 2.1 percent.

The Asian crisis could also affect the Committee staff’s baseline forecast for U.S. corporate profit growth of 5.7 percent. U.S. corporations earn 13 percent of their profits from direct (non-financial) foreign investment. Of this, 16.8 percent is derived from investment in Asia. If return on this investment should fall to zero for 1998, then U.S. corporate profits could fall by $18.3 billion, reducing total profit growth from 5.7 percent to 3.3 percent.

As agreements between the International Monetary Fund, the world banking system, and the Asian countries seem near, the scaffolding for a recovery appears to be falling into place. The possibility that the Asian crisis will have less of an impact than anticipated—producing, for example, stronger than anticipated exports—poses an upside risk to our forecast.

A substantial supply shock from a source other than Asia could also have a significant and long lasting impact on U.S. growth. The precarious nature of the Middle East, particularly the situation in Iraq, could provide cause for concern and instability, directly influencing the price of oil and related products, throwing our inflation forecast off balance. Additional fiscal discipline among prospective single currency European Union member countries could exert an adverse impact on Europe’s medium-term growth potential.

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