U.S. Economic Expansion Longest on Record: Can the "New Economy" Take the Credit?

• Author: Polzin, Paul E.

The U.S. economy is in its ninth year of continuous growth, the longest expansion on record, surpassing that of the Kennedy/Johnson expansion years in the 1960s. The leading economic indicators are still positive, but the Federal Reserve has raised interest rates. Will high growth and low inflation deteriorate into stagnation and recession? Or could conditions even get better?

At this time last year, the nation was worried about the Asian financial crisis and whether it would bring a U.S. recession. This year, things are different; there are few signs of an impending recession.

One way to measure the short-run ebbs and flows in the U.S. economy is with the Recession Barometer; a national forecasting firm, the WEFA Group, developed this index. The Recession Barometer is a composite of many economic indicators, and it measures the likelihood of a recession in the next 12 months. The lower the number on the barometer, the more likely a recession.

Figure 1 shows the Recession Barometer from 1992 through 1999. During that period, the U.S. economy had two close calls with a recession. One was in 1995, and another occurred approximately a year ago.

At present, the barometer is at or near a two-year high, and the chance of a recession is small. In the next 12 months, there is only a 15 percent chance of a recession; last year at this time, there was a 35 percent chance of a recession.

Why is the U.S. Economy Stronger?

Since last year, a number of factors have caused the improved outlook. They are:

* Consumer spending is stronger than anticipated.

* The "Asian Flu" is over. Southeast Asia recovered from the economic crisis faster than expected, which means growth for U.S. exports.

* The Federal Reserve lowered interest rates early last year.

* State and local governments have been spending more than predicted.

The result of this stronger economy is that the Federal Reserve is no longer worried about a recession. They now think inflation is the danger, and they began raising interest rates late last year in an attempt to cool an overheated economy.

The U.S. Economy

The U.S. outlook calls for slightly slower Gross Domestic Product (GDP) growth and a slight inflation increase (Table 1). In 2000, the GDP will increase about 3.2 percent, which is down from 4.0 percent in 1999. Prices will increase by about 2.5 percent per year compared to 2.1 percent in 1999.

Even though a recession in the next 12 months is unlikely, there are some risks for the U.S. economy.

* International risks. Although the Asian Flu is over, some areas such as Brazil, Korea, and China are still experiencing economic problems. If these areas go into recession, it will affect U.S. exports.

* Commodity inflation. Increased worldwide growth resulting from the end of the Asian Flu may lead to increased commodity prices. In contrast, commodity (including energy) prices have been stable or declining in the past few years.

* Stock market crash. This is the one event that is probably big enough to stop the juggernaut U.S. economy. A major stock market crash would have two effects. First, it would kill consumer confidence and greatly affect consumer wealth and purchases. Secondly, a stock market crash would quickly end the tax revenue growth due to capital gains and put a damper on growth of state and local government spending.

Is There a New Economy?

Some say forecasts of 3.2 percent GDP growth and 2.5 percent inflation are too pessimistic. They believe the nation is experiencing a new phenomenon--a "new economy" that will be much more productive.

New economy advocates say the U.S. economy is more productive than ever, and that the nation will have even faster growth with less inflation. Others believe temporary factors and special circumstances are responsible for the improved economy. Following is a look at both sides.

Between 1996 and 1999, the U.S. economy grew faster than 3 percent, and three of those years were in excess of 4 percent. Economists used to think that the long-term potential growth rate was somewhere around 2.5 percent, and that this many years of faster-than-sustainable growth combined with tighter and tighter labor markets should lead to inflation. But according to the numbers, inflation had actually been declining most of this period.

What reconciles these trends of fast growth and no inflation? The answer is increases in labor productivity. During most of the past few decades, labor productivity has been growing by about 1 percent annually. In more recent years, the annual increases have been about 2 percent.

Why has labor productivity increased? The new economy boosters point out that U.S. businesses were on an investment binge during much of the 1990s. A large portion of the investment was in computers and information technology, and these investments are now paying off in increased labor productivity.

The new economy proponents expect faster growth, low inflation, continued growth in business profits, and no crash in the stock market.

While these are convincing arguments, detractors also have credible arguments. They agree that there has been fast growth, low inflation, and increased measured labor productivity. But they believe that these factors don't necessarily make for a new economy. They argue that recent trends have occurred for several reasons, including:

* Measured labor productivity typically increases late in the business cycle, and we are certainly late in the current cycle.

* Inflation is low because energy and commodity prices fell during much of the 1996 to 1999 period but are now starting to rise.

* Health care costs have been contained by HMOs, but we don't know how much longer the HMOs can keep the lid on health care inflation,

In addition, these skeptics point out that the measured productivity increases are not where we expect. The biggest labor productivity increases have been occurring in manufacturing, and we would expect them to occur throughout the computer-using sectors of the economy.

Both of these arguments have merit. Whether these conditions are due to a new and more productive economy or to good luck and some fortuitous circumstances remains to be seen. At any rate, the U. S. economy is strong and a recession in the near future is unlikely.

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