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FEDERAL HOME LOAN BANK OF NEW YORK FORECASTS MILD RECOVERY, LOW INFLATION THROUGH 1993

 FEDERAL HOME LOAN BANK OF NEW YORK FORECASTS MILD RECOVERY,
 LOW INFLATION THROUGH 1993
 NEW YORK, April 30 /PRNewswire/ -- In an updated economic forecast, Eugene J. Sherman, chief economist of the Federal Home Loan Bank of New York, anticipates a mild, sustainable economic expansion through 1993, and perhaps beyond, with relatively low inflation. In fact, he believes that the underlying forces of inflation are favorable so that, on balance, the surprises will be toward lower rather than higher inflation rates.
 Eugene J. Sherman issued the following:
 There are two major risks to this benign outlook. The first grows out of the subdued prospective growth rate and delicate balance. Unlike past cyclical upswings which were like juggernauts, the present expansion could be easily pushed off track by one or more relatively mild shocks. Even though real gross domestic product has shown pluses for four consecutive quarters, the expansion does not yet appear to be self-sustaining -- feeding on itself.
 The second risk is political, not economic. The federal budget deficit looms as an ever rising obstacle to long run, sustainable economic growth and will have to be addressed eventually. The growing magnitude of the problem and the urgency of addressing it should induce the new Congress and newly elected administration (of either party) to pass a fundamental fiscal reform program in the post-election environment, phasing down the deficit over several years. In the absence of a serious attack on the deficit for the long run, the U.S. economy in the latter half of 1993 would face risks of sharply rising long term interest rates and a sharply declining dollar, stifling economic growth and worsening an otherwise favorable inflation outlook.
 The private sectors of the economy should do well through 1993. The fastest rates of growth this year should be in expenditures on housing and exports. Those increases in turn should stimulate manufacturing and industrial production in general. In the latter half of 1992 and throughout 1993, we expect accelerating growth in business equipment spending. Throughout the next 18 months consumer spending should grow slowly at around a 2.5 to 2.7 percent annual rate. In the context of past business cycles, that would be rather subdued. But we think low consumer confidence, continuing high debt, slow reductions in the unemployment rate and demographic factors will all serve to restrain such spending. In contrast to the private sector, federal government spending should be a continuous drag on the economy, with actual reductions forecast for the next six quarters. From the second quarter of 1992 through the second quarter of 1993, we expect seasonally adjusted annual rates of increase of GDP each quarter at 2.5 to 3.0 percent. By the second half of 1993, growth rates should slow to between 2.0 and 2.5 percent.
 Five and one-half years of conservative monetary policy and 12 consecutive quarters of real economic growth at 2 percent or less, including a two-quarter recession, have slowed inflation considerably, altered inflation psychology and set the stage for benign inflation rates for the foreseeable future. In fact, labor costs, the stickiest inflation force of all, are showing gradual but continuous slowing. For example, the rate of increase of employment costs for all civilian workers reached a recent peak in the third quarter of 1989 and have been zigzagging lower ever since. Separate but related, labor contract settlements have been at progressively lower rates of increase. The 3 percent wage gain in collective bargaining agreements in the first quarter this year was the first time in 11 quarters that settlements were lower than in the contracts they replaced.
 With labor costs rising at less than 4 percent per annum and productivity likely to rise in the expanding economy above 1.5 percent, we are optimistically forecasting that the increases in unit labor costs over the forecast period will range between 1.5 and 2 percent. The U.S. economy has not seen sustained increases of unit labor costs at 2 percent or below since 1960-65. Also helping to hold inflation rates down will be low commodity prices and available capacity, with new equipment coming on stream in 1993, further adding to productivity.
 The major issue of 1993 is likely to be the federal deficit. The best time for elected officials to overcome political partisanship and timidity is during the year after a major election. Furthermore, it is widely expected that there will be many changes in both Houses. The newly elected legislators will have a mandate to do something different. That might be readily interpreted as addressing the budget problems in a fundamental way. Long term budget projections of the Congressional Budget Office show a core imbalance between revenues and expenditures. Revenues are expected to stabilize at around 19 percent of GDP while expenditures are projected at 22 percent or more, rising into the mid-23 percent range in 10 years. As a result, the yearly budget deficits, with one exception, are projected to remain well above $200 billion a year and to rise to well over $400 billion in 10 years. The resulting borrowing needs, the rising federal interest costs, the diversion of resources from the private sector to government, etc., will create enormous distortions in the economy.
 Equally important, in order for the economy to break out of a slow growth "rut" of 2.0-2.5 percent, there will have to be increases in productivity, since the labor force will grow only about 1 percent a year over the course of the 1990s. Increases in productivity will require more spending on investment -- infrastructure, private sector capital goods and education. That would require changes in the tax code to stimulate saving and investment and discourage consumption.
 So the prospect is for a reduction in transfer payment benefits and other expenditures, and increases in consumption-oriented taxes such as gasoline, excises, fees or, ultimately, value-added taxes. Additionally, personal income tax rates may have to go up and new taxes may be levied on upper-income recipients of entitlements. The entire program is likely to and should be addressed as a whole -- restructuring the tax code to stimulate saving and investment at the expense of consumption while at the same time generating large additional revenues to reduce the deficit. A program of that sweep would have to be phased in over a five- to seven-year period. But the political effort will have to be made in 1993. Failure to address these issues in the post- election environment would raise the risk that investors here and abroad would lose confidence in the willingness and ability of the United States to get a better grip on its fiscal affairs and cause a severe backup of intermediate and long term interest rates. It such were to happen, the associated increase in interest costs would stifle the economy, first in housing and, shortly thereafter, in capital spending.
 Against the backdrop of moderate economic growth and slow inflation we expect very little change in monetary policy and relatively stable short term rates. At most, the Federal Reserve might tighten just a notch or two to reinforce its anti-inflation credentials. Intermediate and long term rates, meanwhile, are likely to ease a little later in the year as it becomes apparent that the recovery is not accelerating beyond a 3 percent rate of increase. Nineteen ninety-three is much more uncertain. If there appears to be progress toward a fiscal package, intermediate and long term rates could fall further while short term rates remain stable. Alternatively, as discussed above, if fiscal policy is neglected, even though inflation is likely to remain subdued, intermediate and long term interest rates could start on an upward spiral. Our projections are based on the optimistic view that 1993 will mark a pivotal year in fiscal policy, with legislation put in place to reduce the deficit and induce investment.
 The Federal Home Loan Bank of New York provides low-cost financing and other banking services to stockholding institutions in support of affordable housing for Americans in New York, New Jersey, Puerto Rico and the U.S. Virgin Islands.
 -0- 4/30/92
 /CONTACT: Eugene J. Sherman of Federal Home Loan Bank of New York, 212-912-4605/ CO: Federal Home Loan Bank of New York ST: New York, New Jersey IN: FIN SU: ECO


AH-SO -- NY081 -- 5103 04/30/92 16:05 EDT
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Date:Apr 30, 1992
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