Continuing financial turmoil in Asia has obscured the outlook for the U.S. economy next year.
Many economists had anticipated slower growth in 1998. But they assumed that scenario would unfold after an increase in interest rates by the Federal Reserve on concerns about the inflationary impact of a tight labor market.
Now it appears that the Asian difficulties, centered in South Korea, have simultaneously handcuffed the central bank while acting in its stead as a brake on the U.S. economy. The Fed's open market committee meets Tuesday in Washington, but almost no one believes it will take any action on rates.
The wild card is that the full impact of the still evolving Asian crisis is unknown.
"The effects of the crisis are predicted to take 12 to 24 months to ascertain, sort out, and work through. Given the dynamic nature of the world economy, there are very likely effects we cannot pinpoint now that may percolate up in the near future," said economist Maureen J. Maguire of NationsBanc Montgomery Securities.
Ripples from Asia are currently predicted to widen the U.S. trade deficit next year by $25 billion to $70 billion, which would slice 0.25 to 1 percentage point off growth in gross domestic product.
"With hindsight, the Fed should have continued the tightening it started in March but gave up after only a quarter-point rise in federal funds," said Nicholas S. Perna, chief economist at Fleet Financial Group. "Now, any increase in rates would destabilize a precarious global economic situation.
"What the Fed is hoping for is that the U.S. economy will slow on its own in early 1998 as the Asian situation takes its toll on U.S. exports and the rapid rise in the dollar exchange rate relative to many of the emerging nations boosts imports," he said.
"We think this is a good bet," Mr. Perna said, "and are predicting that the Fed might even have to ease in 1998 in order to the keep the U.S. and global economies rolling."
The consensus forecast of business economists is for economic growth to ease to 2.5% next year and for inflation to decelerate to around the same level.
Many economists still think the nation's current 4.6% unemployment rate, lowest in a generation, is generating wage pressures that will force the Fed to move. But there will be no reprise of the Fed's yearlong tightening campaign of 1994-95.
"If the Fed does need to raise rates, it will not be by very much or for very long," said Stuart G. Hoffman, chief economist at PNC Bank Corp., Pittsburgh.
A quarter-point rise in short-term rates, including the bank prime lending rate, "is still probable in next year's opening quarter," he said. "By yearend 1998, however, we expect the fed funds, bank prime, and Treasury bond rates to be down near 5%, 8%, and 6%, respectively."
Other economists expect a steeper decline in rates because of what they see as the deflationary impact of the Asian crisis. The yield on the Treasury's benchmark 30-year bond dipped below 6% last week.
Edward Yardeni, chief economist at Deutsche Morgan Grenfell, predicted that the 30-year bond yield will fall to 5% next year and to 4% by 2000.
"At 2.3%, the consumer price index core inflation rate is the lowest since the mid 1960s, when the bond yield was 5%," he said. "We expect inflation to fall to 1.5% next year and to 1% by 2000 and the 10-year bond yield to fall to 5% or lower next year, and to 4% or lower in the year 2000."
While they remain in the minority, Mr. Yardeni and a few other economists think global deflationary pressures are real and intensifying, and might eventually push the U.S. inflation rate below zero.
A. Gary Shilling, an economist and money manager, has been forecasting for some time "not just a continuation of the current noninflationary climate in the United States but actual deflation, with prices falling on a widespread and chronic basis."
He thinks all the necessary ingredients are in place for deflation except "a dramatic shift by U.S. consumers away from three decades of borrowing and spending to an extended period of high saving and subdued spending."
Mr. Shilling, a former chief economist at Merrill Lynch & Co., said he thinks rate tightening by the Fed and a sharp price correction in the stock market could supply the shock to convert consumers from spenders to savers.