- The Washington Times - Wednesday, December 29, 2004

As 2004 draws to a close, it is clear that the U.S. economy has turned in another strong performance. That is not only true in terms of its absolute rate of growth; it is especially true in terms of its growth rate relative to other advanced economies.

The year-end numbers will not begin surfacing until next month, but it will almost certainly be true that the U.S. average growth rate during 2003 and 2004 will exceed 4 percent per year. Measured on a fourth-quarter-over-fourth-quarter basis, which best describes economic activity during a given year, the 2003 growth rate was 4.4 percent. Through the first three quarters of 2004, the U.S. economy expanded at an annual rate of 4 percent. (No noticeable slowdown has been perceived for the fourth quarter.) By comparison, the Japanese economy expanded by only 2.6 percent during the last four quarters; and its annualized growth rate slowed to a 0.2 percent crawl during the third quarter. Germany grew by a mere 1.3 percent over the past four quarters; and its annualized growth rate for the third quarter decelerated to 0.4 percent. The euro economy overall has grown by only 1.8 percent during the year ending in September.

The U.S. unemployment rate, which reached its cyclical peak of 6.3 percent in June 2003, now stands at 5.4 percent, a level most economists consider to be “full employment.” While job creation has been disturbingly below the pace achieved following earlier recessions, the U.S. economy has nonetheless added more than 2 million nonfarm payroll jobs during the first 11 months of 2004. Meanwhile, the unemployment rate for the euro area (Germany, France, Spain, et al.) stands at 8.9 percent, unchanged from a year ago.

Despite a run-up in energy prices during 2004, inflation still remains relatively subdued, particularly the underlying (or core) rate that excludes the volatile energy and food sectors. While petroleum-based energy costs soared at a 35-percent annual rate during the first 11 months of 2004, overall consumer prices have risen by 3.7 percent. Core consumer prices have risen by 2.3 percent. And while that rate is more than twice the 1.1 percent core inflation rate for 2003, it is worth recalling that at this time last year the Federal Reserve was rightly worried about a debilitating bout of deflation. Concerns about deflation have significantly abated this year.

After falling in 2000, 2001 and 2002, the stock market rose for the second year in a row in 2004. At about 10,800, the Dow Jones industrial average is nearly 2,500 points above its 2002 closing level. Over the same two-year period, the broad-based Standard & Poor’s 500 index has risen nearly 40 percent.

After increasing by an astounding 4.4 percent in both 2002 and 2003, U.S. productivity rose at an impressive annual rate of more than 3 percent during the first three quarters of 2004. In recent years, the short-term costs of this remarkable trend of rising productivity have been reflected in the economy’s slower rate of job creation. Over the long run, however, it is rising productivity that makes it possible for living standards to increase.

Undoubtedly, extremely stimulative monetary and fiscal policies have contributed to the stellar growth rates that the U.S. economy has achieved during the past two years. Having raised short-term interest rates five times since June and having signaled that future increases are likely, the Federal Reserve has demonstrated that it intends to reduce the monetary stimulus it has been providing the economy ever since the beginning of 2001. Progress also needs to be made on the fiscal front. It is unacceptable to run full-employment deficits approaching 4 percent of gross domestic product when those deficits are unrelated to Social Security reform, which will be necessary to address the program’s $10 trillion unfunded liability.

Another major, interrelated structural imbalance in the U.S. economy involves the burgeoning current-account deficit, which is projected to exceed 6 percent of GDP next year. The current-account deficit, which reflects the soaring trade deficit, is the inevitable result of America’s failure to save sufficient funds to finance the investment that is necessary to generate the gains in productivity. Compounding the federal budget deficit, which represents public dissaving, is an atrocious personal saving rate, which has plummeted from an average of more than 9 percent of disposable personal income during the 1970s and 1980s to 5.2 percent in the 1990s to less than 2 percent during the current decade.

With the U.S. economy projected to grow by a solid 3.5 percent in 2005, now is the time to address the structural imbalances inherent in its budget and current-account deficits.

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