The Region

U.S. Economy in 1990 and 1991: Continued Expansion Likely

A model used by researchers at the Federal Reserve Bank of Minneapolis predicts that strong consumption growth will sustain the expansion in both 1990 and 1991 and that inflation will remain under control.

David Fettig | Managing Editor

Published February 1, 1990  | February 1990 issue

"As the seventh year of economic expansion draws to a close, inflation fears seem to have subsided. But in recent months some signs of rising inflation and slowing growth have emerged. These signs have caused many economists to predict that inflation will be higher and real growth slower in 1990 than they were in 1989. In contrast, a model used by researchers at the Federal Reserve Bank of Minneapolis suggests that those forecasters' predictions are too pessimistic. The model predicts that strong consumption growth will sustain the expansion in both 1990 and 1991 and that inflation will remain under control."

David Runkle, Minneapolis Fed economist, from the Fall 1989 Quarterly Review, published by the bank's Research Department.

The nation's seven-year economic expansion, the longest in peacetime, will likely continue for another two years, according to David E. Runkle, economist in the Minneapolis Fed's Research Department.

In a recent paper published in the bank's Quarterly Review, Runkle downplays signs of rising inflation and slowing growth and maintains that strong consumer demand will carry the expansion through 1991. Runkle's findings stem from the bank's economic model—a model that has made accurate forecasts throughout the current expansion, he says.

"The model predicts that there is a smaller chance of a recession now than it predicted in 1984, after long-term interest rates rose 200 basis points, and in late 1987, after the October stock market crash," Runkle writes in the Quarterly Review. "In both of those cases, short-term weakness in the economy was reversed and the recovery continued. The model predicts that this reversal will happen again and that the expansion will continue through 1991."

The model's somewhat optimistic forecast flies in the face of more gloomy predictions from other business forecasters, who expect higher inflation and lower real growth in 1990 than in 1989.

"The main reason for this pessimism seems to be a belief that the recent low inflation in the third quarter of 1989 was an aberration whereas the current weakness in consumer spending will continue into 1990," Runkle says.

But the Minneapolis Fed model doesn't agree. The model expects the current weakness in growth to be reversed early this year and predicts that real gross national product (GNP) will increase by 3.4 percent from the fourth quarter of 1989 until the fourth quarter of 1990, and 3.8 percent the following year.

Also, the model predicts that real consumer spending will increase by 4 percent this year—almost twice the predicted rate of a national survey of business forecasters.

The model's optimism is reinforced by recent data that confirm consumers' ability to spend, according to Runkle.

Real disposable income has increased by 4 percent since the fourth quarter of 1988-its sixth fastest growth rate during the past two decades. Real disposable income per capita is at record levels and real net worth per household is also at a record high.

"These data show that people have income to spend and money in the bank—hardly indicators of slow consumption growth."

Runkle also cites the economy's resiliency in recent years as reason to be optimistic. Some forecasters point to the current economy's reduced durable-goods consumption, its reduction in manufacturing employment, and the decline in the real value of new orders as evidence of a slowing economy. But Runkle says the seven-year expansion has weathered similar events in the past.

"Evidence from the current expansion also suggests that neither a decline in manufacturing employment nor a drop in the real value of new orders for manufactured goods need result in slow growth," according to Runkle. "For instance, both manufacturing employment and new orders declined in every quarter of 1985, yet real GNP grew by 3.6 percent in that year."

In his Quarterly Review paper, Runkle presents evidence supporting the Minneapolis Fed model's predictions but concludes by acknowledging that no economic forecasts are completely certain. One feature of the bank's model is that it is able to quantify the amount of uncertainty in its own forecast, and the model estimates that the probability of a recession in 1990 and 1991 is 30 percent.

"Thus, even though the model predicts moderate growth and moderate inflation, it shows that there is still a modest chance of a recession," Runkle writes.

Yes, and 70 percent chance of continued expansion.