The United States enjoyed continued strong growth with declining inflation in 1998, extending the current expansion while continuing to build up the budget surplus.

Real GDP growth remained at 3.9% in 1998 as a whole, marking the seventh consecutive year of expansion. U.S. growth continued strongly in the first quarter of 1999, when it rose at a 4.3% annual rate.

In 1998, the largest contribution to income growth again came from the largest component, personal consumption expenditures, which rose 4.9%. This increase in household spending reflects rising incomes, rising stock-market values, and high levels of consumer confidence. During the year, measures of consumer sentiment reached record territory. After a drop brought on by a worldwide flight to safety and liquidity in the third quarter, the S&P 500 stock market index closed out 1998 at levels more than 25% higher than the beginning of the year. In the first half of 1999, the S&P 500 index rose another 12%.

Continued strength in investment also helped drive growth. Total investment rose 9.3% in 1998, led by large increases in private equipment purchases, which rose at a 16.5% clip over the year. Residential investment, which increased at a rate of 10.3%, responded to strong real income growth, rising stock-market wealth, and low mortgage rates. Over the current expansion as a whole, business fixed investment has accounted for an unprecedentedly large share in GDP, and it has held the rate of industrial capacity utilization below its long-run average.

The impact of this surge of private spending was partially muted, however, by a significant erosion in net exports linked to weak demand abroad. Strong domestic demand maintained double-digit growth in real imports, while real exports grew only 1.5%. Government consumption spending has also been restrained, posting only a 1% increase last year.

By every measure, inflation continued to remain remarkably subdued in 1998. The consumer price index (CPI) rose 1.6%, 0.7% less than its year-earlier rate. The GDP price deflator, a wider measure, showed a similar deceleration in prices from 1.9% to just 1.0% last year. In contrast, the so-called "core" CPI, which excludes the more volatile food and energy components, showed little deceleration in consumer prices over the previous year. The remarkable drop in oil prices last year, brought on by a collapse in world demand, no doubt played a beneficial role in limiting U.S. inflation. Aside from the influences of tobacco price hikes and prescription drug price inflation, core producer prices remained very stable last year. Prices of non-petroleum imports fell 3.5% in 1998, the third consecutive year of decline.

Non-agricultural jobs increased by about 2.8 million in 1998, and the unemployment rate averaged 4.5%, its lowest level since 1969. Service-producing industries expanded their payrolls by almost 3%, while manufacturing jobs declined steadily throughout the year and finished 1998 down 1%, probably due in part to the drop in net exports. Surprisingly, the historically low unemployment rate, which is heading even lower in 1999, has coincided with remarkably low and stable inflation, even though trend unit labor costs have shown slight acceleration. Real wages (measured by the employment cost index deflated by the CPI) rose 1.9% in 1998.

The current account deficit grew to US$221 billion in 1998, or 2.6% of GDP (1997: 1.8%). The balance on goods and services was US$164 billion, as a merchandise trade deficit of US$247 billion was partially offset by a services surplus of US$83 billion. In the first quarter of 1999, the current account deficit was US$274 billion (seasonally adjusted annual rate), or 3.1% of GDP.

The U.S. capital and financial accounts recorded US$210 billion in net foreign investment into the United States in 1998, compared with a US$286 billion inflow in 1997. (These figures exclude the change in official reserve assets–which rose US$6.8 billion in 1998–as well as the statistical discrepancy.) Net private investment into the U.S. totaled US$238 billion. Portfolio investment (purchases of stocks and bonds) was the largest source of net private investment into the United States (US$161 billion), followed by direct investment (US$61 billion).

The US dollar rose fairly steadily on world markets from 1995 through 1997, following the strong expansion of the U.S. economy. In 1998, the US dollar rose in real terms against a trade-weighted worldwide average of other currencies over the first eight months of the year, then fell towards the end of the year. Overall, the US dollar held virtually steady over the year. Through mid-1999, the US dollar has risen slightly.

In 1998, the United States became a net recipient of direct investment. U.S. direct investment abroad rose 21% in 1998 to US$133 billion, but foreign direct investment in the U.S. rose nearly 80%, rising from US$109 billion to US$193 billion. Europe remains the largest recipient of to U.S. direct investment abroad and the largest provider of foreign direct investment in the U.S.

In fiscal year 1998, the Federal government ran a surplus for the first time in almost 30 years, capping six years of dramatic budget improvement, and the fiscal year surplus was the largest as a share of GDP since 1957. State and local government finances remained in good shape, and a combined measure of aggregate budget balance grew to 2.6% of GDP, due equally to declining expenditures and increasing revenues. Leaving aside the effect of the world financial crisis in the third quarter, which also worked to raise prices and reduce yields, interest rates on government securities, especially longer-term instruments, ended the year lower on average than in 1997.

Monetary policy began 1998 vigilant for signs of overheating, as the Federal Reserve adopted an asymmetric bias toward tightening as a precaution. In the midst of the world financial crisis in the third quarter, three cuts in the federal funds target rate in quick succession helped restore stability and maintain it through the rest of the year. Once the crisis had subsided, monetary policy returned to an unbiased stance. In June 1999, the Federal Reserve raised the federal funds rate by 25 basis points, but also adopted a symmetric stance on whether the next rate change would be up or down.

The prospects remain good for continued growth with low rates of unemployment and inflation. The economy shows no immediate signs of slowing. Productivity growth, which generally starts to slow during the end of an expansion, remains high. Inflationary pressure has yet to emerge. Inventories remain lean with respect to sales.

As of early July 1999, the consensus of private forecasters now expects growth to slow to a 3.0% annual rate in the final three quarters of 1999. If this private-sector consensus comes to pass, the growth rate for the year as a whole will be 3.9%, the same as the Administration’s projection in its mid-session review. The private-sector consensus expects GDP to decelerate to a 2.5% annual rate of growth for 2000 as a whole. The Administration expects a similar deceleration, to 2.4%.

Both supply- and demand-side considerations argue for some moderation in real GDP growth from its rapid 4% annual pace of the past twelve quarters. The unemployment rate has fallen about 0.4 percentage point per year over this period, indicating that this growth rate is well above its potential. The labor market is very tight as indicated by low unemployment in April and strong increases in real wages. It is doubtful whether a further decline of the unemployment rate could be accommodated without inflationary consequences. Labor force growth has not kept up with demand in the past two years, nor can it be expected to keep up with growth at such a pace in the future. Finally, many components of demand which contributed to the rapid growth of the past few years are not those likely to be sustainable over the long-run, such as business demand for capital goods, and consumer’s demand for durable goods.

The U.S. Administration projects U.S. long-run GDP growth at about 2.5% per year through 2005. This rate is consistent with growth for the 1990 business cycle as a whole and with labor force growth of about 1.2% and labor productivity growth of about 1.3%.

Developments in financial markets during the fall of 1998 prompted the President’s Working Group on Financial Markets to call for constraining excessive leverage by improving transparency, enhancing private sector risk management practices, and developing more risk-sensitive approaches to capital adequacy. Efforts continue to reach agreement between the Administration and Congress on a specific formula for reforming bank regulation.

Reform in electricity and telecommunications continued in 1998, and a wave of mergers spread across numerous industries. Labor market policies focused on expanding education opportunities and worker training initiatives.

The drive to reform the Social Security system took on steam in 1998 and moved to center stage in 1999. Negotiations over specific formulae for restructuring are ongoing.

Unites States: Overall Economic Performance

(1) Capital account balance excludes change in official reserves and the statistical discrepancy

(2) Average 3-Month Treasury Bill market bid yield at constant maturity.

(3) Average exchange rate as reported in IMF, July 1999.

Table 2. Forecasting Summary (% change from previous year)

Note: The IMF forecast is from the World Economic Outlook (IMF, April 1999). The OECD forecast is from the OECD Economic Outlook (OECD, June 1999).