South-Western College Publishing - Economics  
The Economy Cools
Subject Employment, Unemployment, and Inflation; Productivity and Growth
Topic Stabilization Policy
Key Words Economic Growth, Gross Domestic Product, Inflation
News Story

The Commerce Department reported that U.S. economic growth slowed sharply to a 1.4 percent annual rate in the second quarter. Strong consumer and business spending kept the economy growing, while the combination of the General Motors strike and the Asian crisis reduced economic growth from the 5.5 percent annual rate reported for the first quarter.

For those economists and policy makers who had been worried that the economy was overheating, the slowdown was good news. Janet L. Yellen, a White House economist, predicted that growth for the entire year is likely to be at least 3 percent. Bruce Steinberg, chief economist at Merrill Lynch & Co., said that the economy was in the middle of a soft landing for 1998 and that growth would pick up in 1999. Federal Reserve officials had been hoping for even slower growth because of fears that the nation's low 4.5 percent unemployment rate might stimulate inflation.

Inflation still appears to be in check. The Commerce Department reported that prices rose at a 0.4 percent annual rate in the second quarter following a 0.2 percent decline in the first quarter. The Commerce Department also reported a sharp decline in personal savings. Savings, as a percent of after-tax income fell to an all-time low of 0.6 percent. The dramatic decline in personal savings is not as bad as it sounds. Capital gains and capital gain distributions, for example, are not considered in the calculation of the savings rate. The dramatic increase in the stock market has created a substantial amount of new wealth which consumers are apparently spending.

The economic turmoil in Asia was a drag on the U.S. economy in the second quarter. Japan and other Asian countries cut back their purchases of U.S. goods while exporting more to this country. The combination of reduced exports and increased imports reduced the increase in gross domestic product for the second quarter by 2.5 percentage points. There was a slowdown in production in the second quarter. Some of the slowdown was the result of first quarter inventory accumulation resulting from the General Motors strike and decreased export demand. The drop in production trimmed 2.3 percentage points off GDP growth. (Updated September 1, 1998)
  1. What is a full-employment macroeconomic equilibrium?
  2. What is an inflationary gap?
  3. Why was there concern that a sustained 5.5 percent growth would lead to an inflationary gap?
  4. What is a soft landing?
Source John M. Berry, "Economy Cooled Off in Second Quarter," The Washington Post, August 1, 1998.

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