RELATED ARTICLES "Letter from the President," Annual Report, 1998 (Text or PDF) "Letter from the President," Annual Report, 1997 (Text or PDF)

U.S. Economy
President McTeer's Forecast

Dallas Fed President Bob McTeer discusses the national economy and presents his 1999 economic forecast.

The economy just finished another remarkable year of rapid growth, falling unemployment and declining inflation. Don't say I didn't tell you so. Here's what I said last year:

Our optimism about the American economy was well placed last year [1997]. Real GDP grew almost 4 percent, employment was up 3.2 million, unemployment fell to 4.7 percent and the Consumer Price Index increased only 1.7 percent. The best performance in years in both unemployment and inflation left many less optimistic souls scratching their heads. We, however, expect more of the same in 1998.

How close was I to the mark? Well, real GDP grew over 4 percent last year, employment was up 2.8 million, unemployment fell to 4.3 percent and the Consumer Price Index rose only 1.6 percent. Once again, a stellar performance. Less optimistic souls are still scratching their heads.

Dare I predict more of the same for 1999? Why not? As Tom Wolfe might have me say, let's let the red dog off the leash.

I expect real growth in 1999 to benefit again from technology-driven improvements in productivity, which rose more than 2 percent last year. I also expect the global deflationary environment to combine with strong growth in productivity and real output to hold down inflation. I'm not saying that inflation will remain low despite strong real growth; I'm saying it will remain low in part because of strong real growth. If inflation results from too much money chasing too few goods, more goods will help as much as slower money growth. The bottom line will be real growth in the 3-4 percent range, with inflation remaining below 2 percent.

I don't believe in speed limits on the economy or a stable NAIRU (nonaccelerating inflation rate of unemployment). And I'm certainly not a Phillips curver who believes inflation and unemployment are on a seesaw where one goes down only when the other goes up. I can't support my optimism with sophisticated models, but I do offer as evidence the economy itself. As Yogi Berra has said, "You can observe a lot just by watching." I'm also reminded of an old Richard Pryor line: "Who are you going to believe? Me or your own lying eyes?" For the past three years the economy I've been watching has grown at what most models would consider unsustainable rates while inflation has declined rather than increased.

I think a fourth year like the last three is possible, but we do face some unpleasant employment arithmetic. The past three years have benefited from growth in both productivity (more output per hour worked) and the labor supply (more hours worked). Declining unemployment during those years means we were drawing down the available labor pool. With unemployment at 4.3 percent, with labor-force participation over 67 percent and discouraged workers (people who'd like a job if they thought it possible) at a record low, we may finally run out of slack in the labor market. If so, productivity will have to increase even faster for the recent growth rate to continue. Of course, productivity growth and the number of available workers are related, since much of the consolidation and downsizing undertaken to make companies more efficient frees up labor for other uses.

Congress could help make my optimistic scenario a reality by taking two easy steps to bolster our workforce. My first recommendation is to abolish the earnings test on Social Security benefits to make part-time work more attractive for experienced retirees. My other suggestion is to ease limits on immigration of foreign workers with the education and skills to be productive immediately. We need more good people. While we're at full employment is the time to do it.

The U.S. economy performed well last year despite the Asian financial crisis. In fact, until the Russian default in August, large parts of our economy benefited from the flight of capital to the United States. That changed after the Russian default, however, and our financial markets became unsettled in September and early October, prompting the Fed to ease policy in three small steps. Financial markets returned to near normal, and the overall U.S. economy not only remained robust but picked up strength in the fourth quarter.

—Excerpted from Bob McTeer's 1998 Annual Report Letter.

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