The current expansion of the U.S. economy has persisted
for more than seven consecutive years. This extended period of growth
has followed on the heels of the 1982-1990 expansion, so sustained
growth is becoming almost "commonplace" in the United States. But
this period has been marked by other noteworthy economic events, including
the October 1987 stock market crash, crises in the savings and loan
and banking industries, financial turmoil in Mexico (one of our largest
trading partners), significant downsizing in the domestic defense
industry and persistently large (until recently) federal budget deficits.
In light of all of this, one might wonder how our economy has managed
to do so well.
I do not intend to offer a detailed explanation for this performance
because in many ways the results speak for themselves. In general,
the U.S. economy is sound and resilient, enabling it to weather
shocks that seemingly could be highly disruptive. This observation,
and the performance upon which it is based, has in my view reassuring
implications for the future.
Economic growth slowed significantly in the
second quarter of this year to 1.6 percent at an annual rate, less
than one-third of the first quarter pace and well below 1996-97
experience. In an arithmetic sense, the strike at General Motors,
a reduction in the pace of inventory accumulation and a much-enlarged
foreign trade deficit accounted for the slowing. Given the resiliency
of the economy, this slowing could well be only a temporary setback.
But in light of pronounced weakness in several Asian economies,
including notably Japan, the mushrooming problems in Russia, and
concerns about, if not overt signs of, problems elsewhere, there
is a question about the future of the domestic expansion. Apart
from the international situation, a second source of concern is
the state of domestic labor markets, where a shortage of labor appears
to be inhibiting expansion plans in some regions and industries,
and leading to cost increases as well. In short, "overheating" remains
a potential menace.
How serious are these threats? Forecasting is
always a challenge, even in circumstances more settled than these,
and clearly one cannot be sanguine about the global situation at
the moment. Nevertheless, the historical resilience of the U.S.
economy suggests that it is unlikely to be knocked significantly
off course by currently visible developments.
This conclusion is underpinned by a number of
long-lived, positive trends that have contributed to the expansion
and that remain in place. First, inflation and interest rates are
low and relatively stable. With experience, it is becoming evident
that the economy performs well in a low inflation environment, as
we in the Federal Reserve have long contended. Moreover, the interest
rate-sensitive sectors of the economyhousing activity first
and foremost, and also consumer and business spending on durable
goodshave fared well in these circumstances, as would be expected.
Second, labor productivity has improved demonstrably
in recent years and appears to be on a more favorable trend than
earlier believed. This augurs well both for the economy's long-run
capacity to produce goods and services and for further increases
in employees' real earnings. One of the recent hallmarks of the
expansion has been that economic gains have been distributed widely,
with broad-based improvement in real incomes. And the federal budget
is also on a more favorable trend, with government savings augmenting
private sector savings.
While many things clearly have gone well and
long-term trends are favorable, it is premature to embrace the notion
that a "new era" bereft of business cycle fluctuations and the disruptions
of recession or accelerations of inflation has been attained. To
be direct, resilience is not a synonym for new era, and even with
the experience of the past 15 years, the burden of proof is on those
who find the new paradigm story compelling. Among other things,
there is neither enough experience nor evidence to accept such a
story; under these circumstances, it is prudent to attend to short-run
Indeed, my confidence in the long-run resilience of the economy notwithstanding,
a continuation of sustainable, noninflationary domestic growth is not
foreordained. Recently, many financial markets have been volatile, apparently
responding to rapidly changing assessments of prospects for Asia and Russia.
It may be that weakness abroad and its attendant excess capacity, together
with its implications for profit margins and equity values, will lead
to sustainable supply-demand balance in the United States, relieving concerns
about overheating. But this result is not assured quantitatively and,
of course, there may be developments not yet visible with significant
economic consequences. Policy may ultimately have to adjust in order to
smooth the path of the economy, especially since global performance is
so dependent on what happens in the United States.