U.S.

Economic Growth Bewilders Experts

By CBSNews.com staff CBSNews.com staff

July 27, 2000 / 10:55 PM EDT / CBS

The U.S. economy, once again perplexing experts, increased by a robust annual rate of 5.2 percent in the spring. A surge in investment by American businesses offset a slowdown in consumer spending.

The Commerce Department said Friday that the increase in the gross domestic product - the broadest measure of economic health - in the just-completed April-through-June quarter surpassed growth in the first quarter, when the economy was growing at a 4.8 percent annual rate.

The acceleration in activity in the second quarter came as a surprise to economists, who had widely forecast that the economy had slowed in the spring under the impact of a series of interest rate increases by the Federal Reserve.

The spring slowdown has now been erased and economic data released this week indicate that the current third quarter is starting at a strong pace as well.

"We essentially have a very strong economy. Business investment is just roaring," said Asha Bangalore, an economist at Northern Trust Co. in Chicago.

She noted that in addition to the strong GDP report, the government released data on Thursday showing that new orders for big-ticket manufactured goods surged by 10 percent in June while Americans' wages and benefits rose over the past 12 months at the fastest pace in nine years.

All of these factors, unless they are mitigated by signs of slowing in the next few weeks, will force the Fed to boost interest rates for a seventh time at its next meeting on Aug. 22 to keep inflation in check, she predicted.

All the economic strength so far has not triggered inflation pressures, however, according to price measures tied to the GDP. A GDP price gauge favored by Fed Chairman Alan Greenspan rose at an annual rate of just 2.3 percent in the second quarter, down from a first quarter rate of 3.5 percent.

Before Friday's release, economists had been estimating that GDP growth slowed to around 3.7 percent in the second quarter, reflecting the view that American consumers were pausing to catch their breath after a big jump in activity in the first quarter.

Consumer spending did slow, rising at an annual rate of just 3 percent in the second quarter, compared to a 7.6 percent surge in the first quarter, which had been the biggest jump in 17 years.

But the consumer slowdown was offset by a jump in private investment, including business spending on equipment and inventories, which rose at a whopping annual rate of 21.2 percent in the second quarter. That compared with a 5.1 percent gain in the first quarter.

This surge reflected heavy spending by businesses on computers, software programs and industrial machinery, which was rising at an annual rate of 21 percent. Businesses also built up inventories more in the second quarter than they had in the first three months of the year.

The strength in the second quarter occurred despite the fact that America's trade deficit widened and acted as more of a drag on growth. The deficit subtacted 1.5 percentage points from growth in the second quarter, compared to a reduction of 0.9 percentage points in the first quarter.

Recent rosy economic report have economy watchers wondering whether the Federal Reserve will raise interest rates at its Aug. 22 meeting.

The Fed hiked interest rates six times from June 1999 to May 2000 but decided against an increase last month, while warning that conditions for inflation remain.

A booming economy can create inflation when demand for products or workers exceeds supply, pushing product prices and workers' wages up, and leading to a general increase in the level of all prices.

What Is Inflation?

Inflation is a rise in the general price level - in other words, the price of all goods and services.

The government measures inflation with the Consumer Price Index, which is a measure of the cost of a basket of goods that an average American might buy.

The causes of inflation are often mysterious.

Sometimes prices of goods go up because of higher demand and wages follow; other times, wages go up first and business owners raise prices to cover the higher wages.

Inflation can have wide-ranging effects.

First, it makes business decisions and investments uncertain. If prices are changing, it's tricky for two firms to enter into a long-term contract. It's also difficult for people to plan for retirement, because they can't be sure how much their money will buy.

Inflation hurts people on fixed-incomes because it means they can buy less. It tends to discourage saving and investment because when inflation hits, people rush to buy things before prices go up further.

Inflation also tends to benefit people who owe money and hurt people who lend it. As prices rise over the life of a loan, the money lent out loses value.

(Source: Federal Reserve Bank of Boston)size>

So the Federal Reserve's June admonishment that, "signs that growth in demand is moving to a sustainable pace are still tentative and preliminary, and the utilization of the pool of available workers remains at an unusually high level."

It's widely believed that the Fed chose not to act in June because no one knew where the economy was heading. Prices were up, but that was blamed in part on higher gasoline prioces.

And while the Commerce Department had reported that the econmy grew by 5.5 percent in the first quarter of this year, down from the sizzling 7.3 percent growth of the last three months of 1999, the economy has recently tended to slow down in winter and rev up again in summer time.

More recent figures show a slight upward trend in wages.

The Labor Department announced Thursday that its June Employment Cost Index of changes in salaries nationwide was up 4.4 percent from last June, up a seasonally adjusted 1.0 percent during the March to June 2000 period. The index had risen 1.4 percent from December 1999 to March.

The Fed works to prevent inflation because it makes it harder for business to make long-term plans and hurts people with fixed incomes.

And while the numbers on growth and wages continue to head up, some studies indicate not everyone is sharing in that boom. The Conference Board, a private economic analysis organization, found last month that nearly 3 percent of people with full-time jobs lived below the poverty line, meaning they made less than $13,003 for a family of three.

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