Economic Reporting Review

February 7, 2000:

Record U.S. Expansion; Interest Rates and the Fed;
Japan's Borrowing

By Dean Baker

The Record Expansion

"Expansion Is Now Nation's Longest" 
John M. Berry 
Washington Post, February 1, 2000, page E1 

"107 Months, and Counting" 
Louis Uchitelle 
New York Times, January 30, 2000, Section 3, page 1 

Both of these articles examine the '90s expansion, as it passes the length of the '60s expansion
to become the longest period of uninterrupted growth in the history of the United States. While
both articles provide valuable analysis of the expansion (particularly the Times article), both
include misleading statements. 

For example, at one point the Post article notes the fact that the United States' large trade
deficit is being financed by large capital inflows from abroad. The article warns that "if the
confidence of foreign investors is shaken by some event, interest rates might have to rise
sharply to keep the needed capital flowing into the United States." 

In fact, there is no reason that interest rates would have to rise at all under such circumstances.
The immediate impact of a loss of investor confidence in the United States would be a fall in the
value of the dollar. If the dollar were allowed to fall freely, then at some point, investors would
become convinced that it will eventually rebound and start holding dollars, even if the interest
rate were no higher than it is at present. 

Furthermore, the decline in the dollar would make imports more expensive and U.S. exports
cheaper to foreigners. This effect would significantly reduce the size of the trade deficit and
therefore lessen the nation's need to attract foreign capital. The Federal Reserve Board may
instead opt to raise interest rates to keep the dollar from falling, but this would be a policy
decision, not a necessary outcome of a loss of investor confidence. 

The Post article also characterizes concern over household debt as being overblown, "since the
bulk of their debt is in the form of fixed-rate home mortgages." Actually, even if mortgage debt
is ignored, other forms of household debt (mostly on cars and credit cards) far exceed previous
records when measured as share of disposable income. The growth in reported debt actually
understates the growth of consumer debt in this cycle, since there has been a boom in car
leasing in the last ten years. (Just under one in three new cars is now leased.) Leasing acts as a
substitute for debt, since it also incurs a financial obligation. 

At one point the Times article asserts that "limits to economic growth and prosperity still exist
at the turn of the century, but they are not the stunted ones of the '70s, '80s and early '90s." It is
not clear whether the economy's growth potential is greater at present than in these prior
periods, or whether it is simply the Federal Reserve Board's policy that has changed. In these
earlier periods, the Federal Reserve Board raised interest rates to clamp down on growth as
soon at it saw the first hints of inflation, or became concerned that the unemployment rate was
falling too low. The Federal Reserve Board has been more restrained in the last few years,
allowing the unemployment rate to fall to 4.0 percent. It is not clear that the economy could not
have expanded considerably more rapidly in the prior quarter century if the Federal Reserve
Board had not raised interest rates enough to restrain growth. 

Later, the Times article refers to a 2.25 percent speed limit on the annual growth rate that the
Federal Reserve Board and other economists believed to exist based on evidence from the
'60s, '70s, and '80s. In fact, there was no evidence that supported any specific speed limit on
the rate at which the economy could grow. Only the unemployment rate, not the growth rate,
mattered in the statistical evidence which provided the basis for the view that the economy's
growth potential was severely limited. 

This view held that the unemployment rate could not fall below 6 percent without experiencing
rising inflation; a 1 percent growth rate at a time when the unemployment rate was 5 percent
was seen as more inflationary than a 4 percent growth rate during a period when unemployment
was above 8 percent. (See Congressional Budget Office, 1994, The Economic and Budget
Outlook: An Update, pp. 59-64; Gordon, R.J., 1982. "Inflation, Flexible Exchange Rates and
the Natural Rate of Unemployment," in M.N. Baily, ed., Workers, Jobs and Inflation, The
Brookings Institution; and Gordon, R.J., 1990; "What Is New-Keynesian Economics?" Journal
of Economic Literature, 9/90, pp. 1115-1171.) 

Both articles include a series of charts comparing the economy's performance across decades.
These charts are somewhat misleading because the measurement techniques used over this time
has changed. Specifically, the methods of measuring GDP and productivity growth since 1978
raise the measured rate of growth by approximately 0.2 percentage points compared with the
measures used in the period prior to 1978. This means that it would be necessary to raise the
annual rate of reported growth in '60s and '70s by approximately 0.2 percentage points to
make these numbers comparable to the numbers reported for the '80s and '90s. Making this
adjustment would significantly increase the extent to which the growth in both categories in
these decades exceeds the growth in the '80s and '90s. The methodology used to measure
inflation in the '90s also would cause the inflation rate to appear lower in that decade than in
prior decades. 

The Post article includes the assertion that "virtually no one is forecasting the expansion will end
any time soon." Immediately below the article, there is a blurb for a page 3 column by
Newsweek Wall Street editor Allan Sloan, which reads "the boom could go kaboom." 



Social Security and Medicare

"Tuesday's Big Test: How Deep in the Heart of Taxes" 
Richard W. Stevenson 
New York Times, January 30, 2000, Section 4, page 3 

This article discusses public attitudes towards tax cuts. At one point it reports poll results
showing that "respondents regularly say their top priorities are putting Social Security and
Medicare on sound footing for the retirement of the baby boom generation." It is worth noting
that Social Security is already on a very sound footing for the retirement of the baby boom
generation. The Social Security trustees report shows that the program can pay all scheduled
benefits, with no changes whatsoever, through the year 2034. At that point, the oldest of the
baby boomers will be 88 and the youngest will be 70. 

The projections from the non-partisan Congressional Budget Office (CBO) show the program
to be even stronger. (Four of the six trustees for both Social Security and Medicare are
political appointees of the Clinton administration.) CBO shows a cumulative surplus through
2010 (the end of its projections period) that is $500 billion higher than what the Social Security
trustees project. Given the larger surplus projected for the next decade, and carrying through
CBO's assumptions about economic growth, the fund would probably be fully solvent through
at least 2040, at which point the oldest baby boomers will be 94 and the youngest will be 76. 

CBO also projects a much brighter picture for Medicare than do the trustees of the program.
The cumulative surplus projected by CBO for the Medicare trust fund as of 2010 is more than
$250 billion greater than that projected by the trustees. While the Medicare trustees project
that the program will run short of money by 2015, the CBO projections imply that fund should
be fully solvent for at least 20 years into the future. 

It is worth noting that the changes (tax increases or benefit cuts) needed to keep both programs
fully solvent well into the future, under either set of projections, are not large relative to changes
implemented in prior decades. Nor are these costs larger than other major public sector
commitments of recent decades, such as building schools for the baby boomers or the
Reagan-era military build-up. 



Interest Rates and the Federal Reserve

"Economy's Pace Makes Fed Action Seem Likely" 
Robert D. Hershey Jr. 
New York Times, January 29, 2000, page B1 

"Stocks May Be Facing Worst January in Years" 
Jonathan Fuerbringer 
New York Times, January 29, 2000, page B1 

These articles discuss the state of the economy, as indicated by the GDP report for the 4th
quarter of 1999, and the market's reaction to it. Both articles include assertions that the Federal
Reserve Board will "have" to raise interest rates because of evidence of rising inflation. If the
Federal Reserve Board raises interest rates, it will be a policy choice, just as when it chooses
to lower interest rates. It is not forced to make either decision. 

The Hershey article, which is written about the economy, not financial markets, relies
exclusively on economists associated with financial institutions for its sources. 

"2 U.S. Institutions Separated by an Uncommon Bond Policy" 
Gretchen Morgenson 
New York Times, February 1, 2000, page C1 

This article discusses the tightening policy of the Federal Reserve Board and the bond-buying
policy of the U.S. Treasury. The article suggests that these policies appear to be contradictory,
since the Federal Reserve Board is trying to raise interest rates, while the Treasury's policy of
buying back government bonds to retire to the national debt is lowering interest rates. The
article points out that this has led to a situation, which it characterizes as an "oddity," where the
interest rate on two-year government notes is higher than the interest rate on 30-year bonds. 

Although longer-term bonds ordinarily offer higher interest rates, the reverse is normal in a
period when the Federal Reserve Board is trying to slow the economy. When the Fed acted to
slow the economy in 1969, the average yield three-year bonds was 7.02 percent, while the
yield on ten-year bonds (the longest issue in existence at the time) was 6.67 percent. The same
inversion took place in 1980 when the yield on three-year bonds was 11.55 percent,
compared to 11.27 on 30-year bonds. In 1989 the yield on three year bonds averaged 8.55
percent, while the yield on 30-year bonds averaged 8.45 percent (Economic Report of the
President, 1999, table B-73). 

Short-term rates will tend to exceed long-term rates in a period when the Federal Reserve
Board is tightening because the markets do not anticipate that the high short-term rates will
persist. Investors are willing to temporarily hold long-term bonds that provide a lower rate of
interest than shorter-term notes if they believe that these bonds provide an opportunity to lock
in a relatively high rate of interest on their money well into the future. This logic is almost
certainly the main factor behind the current inversion in the yield curve. The impact of the
Treasury's bond buy-backs is small by comparison. 


The Dollar and the Euro

"Europe's Central Bank Raises Interest Rate" 
Anne Swardson 
Washington Post, February 4, 2000, page E3 

This article reports on the decision of the European Central Bank to raise its short-term interest
rate by a quarter of a percentage point. The article notes that the apparent motivation for the
rate hike was to raise the value of the euro. The euro has fallen by more than 15 percent against
the dollar over the last year. The article attributes this decline to the faster growth in the U.S.
economy, asserting that "investors prefer to put their money into a faster-growing economy." 

Actually, there is no direct relationship between an economy's rate of growth and where
investors choose to place their money. The dollar fell by more than 10 percent in the period
from 1977 to 1979, a period in which growth averaged 4.1 percent annually. It fell by close to
30 percent from 1985 to 1988, a period in which growth averaged 3.5 percent. From 1993 to
1995 the dollar fell by close to 10 percent, as growth averaged 3.0 percent. In each of these
cases, the growth rate in the United States was the same or higher than that of its major trading
partners, yet its currency suffered a substantial decline. 

Investors care about getting the highest return on their money. There is no direct relationship
between an economy's growth rate and the return provided to investors. 

This article includes quotes from three sources, all of whom were employed by financial
corporations in Europe. 



Japan

"In a Rare Move, Japan Turns to Direct Loans From Banks" 
Stephanie Strom 
New York Times, January 29, 2000, page A1 

This article reports on the decision by the Japanese government to borrow money through bank
loans instead of by issuing new bonds. The article views this decision as "a striking
demonstration of how precarious Japan's financial situation has become." The article also
asserts that "the government's debts now match the country's GDP." 

It is not clear that Japan's financial situation is especially precarious at all just now, nor that this
move would be a reasonable response if it were. The market interest rate on Japan's long-term
government debt is hovering near 2.0 percent. By comparison, the interest rate of U.S.
government bonds is over 6.0 percent. The relatively low interest rate paid on Japanese bonds
suggests that investors do not feel a great need to be compensated for the risk of default. 

In addition, in spite of the wishes of the Japanese government, the yen has actually been rising
in recent weeks against the dollar. If the markets feared that the Japanese government was
going to have difficulties paying its debt, one would expect that the yen would be falling in
value, not rising. Also, by the standard method of calculating debt used by the OECD
(Employment Outlook, 6/99, Annex Table 35), Japan's net national debt is less than 40
percent of its GDP. 

If Japan were facing a credit crisis, it is not clear how borrowing from banks would help it. The
article implies that this move could allow Japan to deceive investors about the extent of the
country's indebtedness. This would only be possible if market actors were extraordinarily
ill-informed and did not have access to publications like the New York Times. 

The article notes that the interest rate on these bank loans is approximately 0.5 percentage
points higher than the rates on government bonds. The difference will accrue to the banks, who
are the main purchasers of Japanese government bonds. It is possible that the government may
have chosen this route of borrowing as a mechanism to provide assistance to banks that have
not yet fully recovered from the collapse of Japan's stock and real estate market in 1990. 



Outstanding Stories of the Week

"Think Tanks: Corporations' Quiet Weapon" 
Dan Morgan 
Washington Post, January 29, 2000, page A1 

This article reports on how a major Washington think tank, Citizens for a Sound Economy, has
had a practice of writing reports on specific tax or regulatory issues that were of particular
interest to the corporations that underwrote the work. 

"Something Borrowed May Leave Market Blue" 
Gretchen Morgenson 
New York Times, January 30, 2000, Section 3, page 1 

This article examines the extraordinary growth of margin debt in the last few years. It points out
that the large volume of outstanding debt on stock purchases could add to instability if the
market were to enter a downturn. 

"Study Documents Homelessness in American Children Each Year" 
Nina Bernstein 
New York Times, February 1, 2000, page A12 

This article reports on the findings of a new study on homelessness by the Urban Institute. The
study found that 65 percent more people were homeless at some point in 1996 than in 1987. 

[Top] 


Dean Baker is an economist and the co-director of the Center for Economics and Policy
Research (CEPR). His latest book (co-authored with Mark Weisbrot) is Social Security: The
Phony Crisis (University of Chicago Press). ERR is a joint project of FAIR and CEPR. 

ERR is edited by Jim Naureckas. 

Back to CEPR's Economics Reporting Review website.