Consumer spending will grow at annual an annual rate of 2.5% to 2.7% in the next 18 months, according to our projections at the Federal Home Loan Bank of New York.

That's rather subdued growth when compared with rates in past business cycles. But we project rather subdued inflation, too.

Some 51/2 years of conservative monetary policy and other factors, including a two-quarter recession, have 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. The rate of increase in employment costs for civilian workers reached a recent peak in the third quarter of 1989 and has zigzagged lower ever since.

Separate but related labor contract settlements have been at progressively lower rates of increase.

With labor costs risisng at less that 40% a year and productivity likely to rise more than 1.5%, we are optimistically forecasting that the increases in unit labor costs will range between 1.5% and 2%. The economy has not seen sustained increases of unit labor costs at 2% or below since 1960-65.

Mandate for Change?

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 national elections.

Furthermore, it is widely expected that there will be many changes in Congress. The newly elected legislators will have a mandate to do something different.

Long-term budget projections of the Congressional Budget Office show a core imbalance between revenues and expenditures. Revenues are expected to stabilize at about 19% of gross domestic product; expenditures are projected at 22% or more, rising to about 23% in 10 years.

As a result, yearly budget deficits, with one exception, are projected to remain well above $200 billion 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 economic distortions.

Equally important, in order for the economy to breat out of a slow-growth rut of 2% to 2.5%, there will have to be increases in productivity.

These will require more investment - in infrastructure, private sector capital goods, and education. Changes in the tax code will be required to stimulate saving and investment and discourage consumption.

So the prospect is for a reduction in transfer-payment benefits and other expenditures and for increase in consumption-oriented taxes such as gasoline levies, excises, fees, or value-added taxes. Personal tax rates may have to go up, and new taxes may be levied on upper-in-come recipients of entitlements.

The entire program is likely to be addressed as a whole, and should be.

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 it fiscal affairs.

This would cause a severe surge in intermediate and long-term interest rates.

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 inforce its anti-inflation credentials.

Intermediate and long-term rates are likely to ease a little later in the year. Next year 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.

Mr. Sherman is chief economist of the Federal Home Loan Bank of New York.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.