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U.S. Economic Commentary and Forecasts: Three Perspectives

The underlying structure of the economy has proved sound, and the combination of assertive countercyclical economic policies and rapid private adjustments has generated a healthy and rather typical rebound that is expected to gather steam in 2002. Real GDP growth is projected to exceed its sustainable trend, raising real interest rates, and nominal GDP growth is projected to accelerate well-above growth in productive capacity, potentially rekindling inflation pressures. The Fed will need to raise short-term interest rates this year. Failure to do so on a timely basis risks exacerbating future swings in interest rates and nominal aggregate demand, generating more erratic economic performance.

Real GDP is projected to grow about 4.0 to 4.5 percent from 2001Q4 to 2002Q4, a sharp reacceleration from its anemic 0.5 percent growth in 2001. This reflects only a modest acceleration of consumer spending growth, a typical cyclical rebuilding of inventories and moderate pick up in business investment in 2002H2, firm residential construction, a sizable increase in government purchases and a modest deterioration in the trade deficit.

Led initially by the boom in zero percent financed auto sales, ex-auto retail sales and consumption of services have accelerated. Consumer spending is expected to continue to grow, which will restore business confidence and spur increases in production, inventories, and investment. The recovery will be sustained by growing demand, and will not be a short inventory adjustment, as skeptics contend.

As real rates rise with the recovering economy, the Fed must raise its funds rate target to drain excess liquidity. Typically, the Federal Reserve's transition from an easing to a tightening posture is currently receiving close market scrutiny, with accompanying gyrations in the yield curve. Failure to tighten and reverse its crisis-related easing eventually would generate excess demand and inflation, a recent concern in the bond markets. Moreover, with policy aggressively accommodative, prompt but steady reversal is preferable to a delayed but subsequently very sharp tightening. The latter would generate undesired wide swings in monetary policy, interest rates and demand that would harm economic performance. This scenario must be avoided.

Economic and Financial Forecast for 2002

Qtr	RFF	Treasury yields				3 mo Libor
		2-year	5-year	10-year	30-year
2002Q1(actual)	1.7	3.2	4.5	5.1	5.6	1.9
2002QII	1.75	3.6	4.8	5.3	5.8	1.9
2002QIII	1.9	4.0	5.0	5.5	5.9	2.1
2002QIV	2.9	4.5	5.3	5.8	6.1	3.0
2002 (average)	2.1	3.8	4.9	5.4	5.8	2.2

Qtr	GDP	CPI	Jobless	GDP components
				PCE	NFI	DD
2002Q1(actual)	5.8	1.4	5.6	3.5	-5.7	3.7
2002QII	3.3	3.5	5.9	3.1	-0.5	2.7
2002QIII	4.0	2.9	5.7	3.5	3.5	3.6
2002QIV	4.7	3.0	5.6	3.3	6.8	3.5
2002 (average)	3.0	1.8	5.7	3.5	-5.5	2.8
2002 (Q4/Q4)	4.5	2.7	5.7	3.4	0.9	3.4

Notes

Interest and unemployment rates are averages; GDP, CPI, PCE, NFI, DD are annualized growth rates. Average annual growth and Q4-to-Q4 growth rates will differ significantly amid large quarterly growth swings.

Glossary

RFF = federal funds rate; Jobless = unemployment rate; PCE = consumer spending; NFI = nonresidential fixed investment; DD = final sales to domestic purchasers

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