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Office of the Press Secretary

For Immediate Release February 4, 1999
                         1999 ECONOMIC REPORT
                           OF THE PRESIDENT

                           February 4, 1999
                     Council of Economic Advisers

Chapter 1: Meeting Challenges and Building for the Future

Chapter 1 provides the customary overview of the entire report, details the President's economic agenda, and describes accomplishments of the past year. The chapter notes that our Nation is currently enjoying the longest peacetime expansion on record and describes important challenges for the next century, including preserving fiscal discipline and meeting the international challenge. The chapter also discusses the challenge of embracing change while promoting fairness.

      Comparing three long expansions.  The current expansion is only
     the third on record that has lasted at least 7 years.  Compared
     with the long expansions of the 1960s and the 1980s, inflation has
     remained tame even as the unemployment rate has reached low levels.
     In addition, productivity growth has remained strong (relative to
     the post-1973 trend) rather than slowing down as is often the case
     in the mature stage of expansions.  Finally, more than a third of
     the increase in real GDP has come from fixed investment - a
     substantially higher fraction than in the other two long expansions
     - while the contribution of government spending has been 

      Preserving fiscal discipline.  Reducing the Federal budget deficit
     has been a centerpiece of this Administration's economic policy and
     the budget balance has improved steadily since 1993.  The chapter
     describes the longer term demographic challenge arising from the
     aging of the U.S. population and the President's plan to use much
     of the projected budget surpluses to help save Social Security and
     strengthen Medicare, while preserving the fiscal discipline that
     has been so hard won over the past 6 years.

      Meeting the International challenge.  The chapter describes how
     the United States has led the international community's efforts to
     promote world economic growth, to stabilize international financial
     conditions, and to implement reforms to reduce the vulnerability of
     the international financial system to future crises.

      Embracing change while promoting fairness.  Difficult choices must
     be made when confronting change that confers broadly distributed
     gains while imposing smaller but more concentrated costs.
     Increases in our standard of living over the longer term require
     that we embrace change, but considerations of fairness require that
     we ensure that no part of our society bears disproportionate
     losses.  The general principle that it is desirable to address the
     disruption caused by positive change rather than block the change
     itself is illustrated with a discussion of three areas of current
     policy concern:  agriculture, corporate mergers, and international

Chapter 2: Macroeconomic Policy and Performance

Chapter 2 reviews macroeconomic developments over the past year, and describes the Administration's economic forecast and the near-term outlook for the economy. This year it also analyzes financial market volatility in 1998, the strength of business investment in this expansion, and the macroeconomic implications of the Y2K computer problem.

      Another strong year.  By a number of different measures, the U.S. 
     economy performed very well last year.  Robust growth in business
     investment and household spending, combined with vital
     contributions from fiscal and monetary policy, fueled strong growth
     and created 2.9 million jobs.  The unemployment rate of 4.5 percent
     was the lowest since 1969; the 1.6 percent rise in the consumer
     price index was the second smallest increase since 1964, and other
     measures of inflation were even more muted.  The turmoil in foreign
     economies showed up in the sharp decline in net exports, but the
     economic expansion maintained considerable momentum.

      Financial markets.  Markets finished the year solidly up by most 
     measures, after a worldwide flight to quality and liquidity in the
     late summer and early fall temporarily reduced some businesses'
     access to capital and raised the cost of borrowing for others.  The
     near collapse of the hedge fund Long-Term Capital Management raised
     questions about the proper regulatory stance toward hedge funds and
     other institutions that actively trade securities and derivative
     instruments - institutions that are currently relatively lightly

      Robust business investment.  Rapid output growth, strong corporate
     profits, plunging computer prices, and increased national saving
     due to improving Federal Government balances have all contributed
     to strong growth in investment during this expansion.  Equipment
     investment has contributed more than twice as large a share of GDP
     growth during this expansion as during previous postwar expansions.

      Y2K.  The chapter concludes that even if Y2K disruptions turn out 
     to be on the serious side, they will most likely show up primarily
     as inconveniences and losses in some particular sectors not in
     substantial macroeconomic terms.

      The Administration forecast.  The Administration projects GDP 
     growth over the long term at roughly 2.4 percent per year, a
     figure consistent with the experience so far during this business
     cycle as well as with reasonable growth rates of the economy's
     supply-side components.  A moderation in output growth to 2.0
     percent is projected for the next 3 years, in line with private
     forecasts, but the outcome could be even better, as indeed it has
     been for the past 3 years.

Chapter 3: Benefits of a Strong Labor Market

Chapter 3 examines conditions in the labor market during this expansion and discusses the Administration's education and training initiatives. It finds that the Nation's labor market is performing at record levels: the number of workers employed is at an all-time high, the unemployment rate is at a 30-year low, and real (inflation-adjusted) wages are increasing after years of stagnation.

      Progress for disadvantaged groups.  Groups whose economic status
     has not improved in the past decades are now experiencing progress.
     The real wages of blacks and Hispanics have risen rapidly in the
     past 2-to-3 years, and their unemployment rates are at long-time
     lows; employment among male high school dropouts, single women with
     children, and immigrants, as well as among blacks and Hispanics,
     has increased; and the gap in earnings between immigrant and native
     workers is narrowing.

      A strong employment relationship.  Job displacement - job losses
     due to layoffs, plant closures, and the like - has declined
     substantially since the 1993-95 period, and among those who have
     been displaced, the share that have found new work has increased.
     These reemployed workers still typically earn less on the new job
     than at the job they lost, but these wage losses are at record
     lows.  Moreover, the popular assertion that secure lifetime jobs
     are disappearing appears to be overstated.  This is not to suggest
     that the picture is entirely benign:  some groups have experienced
     declines in job tenure since the 1980s, and the rate of job
     displacement remains relatively high given current labor market

      Reduced welfare use and crime. Besides spreading the benefits of
     economic growth more widely, the robust labor market has generated
     other, less obvious benefits.  It has contributed to a decrease in
     welfare caseloads, allowing States and localities to focus
     increased resources on designing and implementing welfare reform.
     In addition, low unemployment and, especially, the rise in average
     wages may have contributed to a reduction in crime.  Several
     studies have demonstrated an inverse relationship between labor
     market opportunities and criminal behavior:  the better the options
     in legal employment, the less likely are potential criminals to
     commit crimes.

Chapter 4: Work, Retirement, and the Economic Well-Being of the Elderly

Today, more than one out of every eight Americans are over 65. By the time the youngest baby-boomers hit age 65 in 2029, almost 20 percent of Americans will be elderly, according to projections. Chapter 4 assesses the work decisions and economic well-being of the current and the soon-to-be elderly as America anticipates this phenomenal demographic change.

      Labor force participation -- long-term trends are changing.  
     The century-long decline in male labor force participation at
     older ages has leveled off since 1985.  More men aged 55-64 are
     continuing to work, often part time or in a different occupation,
     after retiring. Meanwhile the share of women aged 55-64
     participating in the labor force has increased by almost 10
     percentage points in the past 15 years.

      Pensions and health insurance -- also changing rapidly.  The 
     share of participants in defined-contribution pension plans, such
     as 401(k) plans, is growing and the share in defined-benefit plans
     shrinking.  Employer-provided health insurance coverage for
     retirees has also become less widespread, less generous, and more
     expensive.  These developments have many ramifications, both for
     retirement incentives and for the well-being of retirees.

      Less poverty.  The economic status of the elderly as a group 
     has improved remarkably during the past three decades.  Their
     poverty rate has fallen to less than half what it was in 1970.  In
     that year the elderly were more than twice as likely to live in
     poverty as the nonelderly, but today poverty is less prevalent
     among the elderly than it is among younger persons.

      Disparities in well-being.  Although most elderly groups - 
     men and women; blacks, whites, and Hispanics; older and younger
     elderly; single as well as married persons- have enjoyed economic
     progress, large disparities in well-being prevail among these
     groups.  Just 4.6 percent of elderly married men, but 28.8 percent
     of elderly black women and 17.9 percent of elderly widows, live in
     poverty.  And whereas Social Security benefits account for at least
     80 percent of income for 38 percent of all elderly households, for
     another 9 percent Social Security contributes less than 20 percent
     of their income.  Moreover, among those now approaching retirement
     age, over 10 percent have no financial savings whatsoever, and 30
     percent have less than $1,200, whereas the top 10 percent have at
     least $200,000 in financial assets.  Over half of all blacks and
     Hispanics aged 51-61 have no financial holdings.

More highlights (Administration proposals):

      Long-term care.  In 1994, an estimated 2.1 million elderly 
     Americans living in the community needed assistance with 3 or more
     activities of daily living.   About 65 percent of elderly persons
     living in the community and needing long term care assistance rely
     exclusively on unpaid sources, most often family and friends.  The
     Administration has proposed 4 initiatives to help relieve the
     burdens of family members with long-term care needs:  a tax credit
     of up to $1,000 for persons in need of long-term care or their
     family members who care for them; "one-stop shops" to assist
     families caring for elderly relatives with training, counseling,
     and arranging respite care; a national campaign to educate families
     about Medicare's limited long-term care coverage; and long-term
     care insurance for Federal employees at nonsubsidized but favorable
     group rates, thus making the Federal Government a model employer.

      Universal Savings Accounts.  The President has promised to 
     reserve 12 percent of the projected unified budget surpluses over
     the next 15 years - averaging about $35 billion a year - to
     establish Universal Savings Accounts (USAs).  Under the proposed
     plan, the government would provide a flat tax credit for Americans
     to put into their USA accounts and additional tax credits to match
     a portion of each extra dollar that an individual voluntarily puts
     into his or her USA account.  This plan would provide more help for
     low income workers.  USA accounts will build on the current private
     sector pension system to enable working Americans to build wealth
     to meet their retirement needs.

Summary of Chapter 5: Regulation and Innovation

Because innovation - the development and adoption of new technology - is essential to U.S. economic performance over time, regulation that interferes with innovation, however justifiable on other grounds, comes at a cost. Chapter 5 examines Administration efforts in three areas to ensure that regulation not only does not interfere with innovation, but indeed fosters beneficial technological change and adapts itself to such change as well.

      Competition policy.  Antitrust policy in recent years has 
     broadened its conventional focus on the price and output benefits
     of competition to incorporate consideration of the long-run
     benefits of innovation.   New technologies often have significant
     consequences for markets and consumers, while market and industry
     characteristics can affect the incentive and ability to innovate.
     The antitrust authorities have met the resulting challenges through
     careful enforcement decisions.  In evaluating mergers, they look
     not only at conventional effects on prices and competition but
     also, increasingly, at evidence of a merger's likely effects on
     research and development, as the FTC did in a recent biotechnology
     merger.  Antitrust policy has also addressed the relationship
     between competition and innovation in "network industries."
     Enforcement actions in the credit card and software industries as
     well as consent decrees in the telecommunications sector have
     highlighted the challenges enforcement agencies face - and their
     ability to meet those challenges- of balancing long-run
     encouragement of innovation with short-run concerns about 

      The environment.  Environmental regulation can reduce pollution 
     and increase the net value of economic activity (the value of goods
     and services produced after deducting all costs of production,
     including the social costs of environmental damage).  The design of
     environmental regulation can also have a significant impact on
     innovation, and the ultimate costs of efforts to address important
     environmental concerns, such as climate change, will depend
     importantly on the pace at which such innovation occurs. The use of
     incentive-based regulation, such as the recently introduced
     tradable permits system to reduce nitrogen oxides emissions, not
     only achieves environmental goals at lowest possible cost given
     existing technology, but also gives firms proper incentive to
     search for more environmentally friendly technology.

      Electric power restructuring.  The electric power industry is in 
     the midst of technological and profound regulatory change.  The
     Administration's Comprehensive Electricity Competition Plan
     provides an excellent example of how an enlightened regulatory
     approach can remove barriers to private innovation, resulting in
     both economic and environmental benefits.

Chapter 6: Capital Flows in the Global Economy

What began in the summer of 1997 as a regional currency crisis in Southeast Asia spread in 1998 to Russia, Brazil, and elsewhere. Coming as it did after years of increasing worldwide financial integration, the crisis shook the faith of some in globalization. Chapter 6 describes these issues and the policy steps that ensued.

      Global integration and financial crises.  Enhanced financial 
     integration has allowed investors to tap the benefits of
     international diversification, while enabling borrowers to draw on
     a broad pool of world savings to finance investment and growth.
     But these trends have also been associated with recurrent financial
     crises, three in this decade: the European Monetary System crisis
     in 1992-93, the Mexican peso crisis of 1994-95, and now the 1997-98
     Asian crisis.

      Origins of the Asian crisis.  After years of breakneck growth,
     Asia might have been heading for a slowdown in any case.  Adverse
     external developments (terms of trade shocks, recession in Japan
     and yen weakness) played a role.  More important were structural
     weaknesses in the crisis countries' financial systems.
     Directed-lending, connected-lending, crony capitalism, and moral
     hazard led financial institutions to borrow too much abroad and to
     lend too much at home for investment projects that were not always
     profitable.  The financing of large current account deficits led to
     a buildup of foreign debt that was largely short-term, in foreign
     currency, and unhedged. Capital account liberalization in an
     environment of lax supervision of the financial system also played
     a role.

      Contagion.  While the crisis was triggered by such fundamental 
     vulnerabilities, investors may have overreacted.  Large capital
     reversals occurred; currencies and asset prices probably fell more
     than justified by fundamentals.  The chapter also discusses the
     channels of contagion across countries, and the role Japan, with
     its own deteriorating economy, played in the crisis.

      The policy response.  The chapter details the U.S. leadership role
     in addressing the crisis and discusses the IMF's approach,
     particularly its emphasis on financing that is conditional on
     countries' adjusting their policies.  A relatively novel feature is
     that the policies on which the IMF programs are conditional are not
     solely macroeconomic, but also structural (dealing for example with
     banking regulation and corporate governance).  The chapter also
     analyzes some of the criticisms that have been lodged against the 

      Implications for the United States.  The crisis has led to an 
     expanding trade deficit, but the chapter refutes the view that this
     deficit has hurt the U.S. economy.  Paradoxically, trade deficits
     are often associated with strong growth, and surpluses with
     recessions.  The increased U.S. deficit has been driven by an
     investment boom.  The crisis has heightened the need to embrace
     economic openness on a global scale; a retreat to protectionism
     would be dangerous.

Chapter 7: The Evolution and Reform of the International Financial


Chapter 7 describes how the recurrence of currency and financial crises in the world economy poses a challenge to policymakers and how the international financial architecture can be reformed so as to strengthen financial systems and make such crises less frequent and less severe in the future.

      Consensus for reform.  Some consensus now exists for reforming the
     global financial system to 1) increase "transparency," namely to
     improve the availability of information; 2) strengthen and reform
     banks and other domestic financial institutions; and 3) improve the
     mechanisms available to resolve crises that do occur.  Three G-22
     working group reports addressed these respective concerns.

      Proposals for reform.  In its October 30 statement, the G7
     committed to a number of reforms consistent with both the
     recommendations of the G22 working groups and other analysis and
     research.  The G7 also stressed the need to widen efforts to
     strengthen the international financial system in the following 

          -    Examining the scope for strengthened prudential 
          regulation in industrial countries.
          -    Further strengthening prudential regulation in emerging
          markets and promoting orderly capital account liberalization.
          Proposals to slow the fraction of capital inflows that take
          the form of short-term bank inflows merit further
          -    Developing new ways to respond to crises, including new
          structures for official finance and new procedures for
          greater private sector involvement in crisis resolution (for
          example, "bailing in" investors).
          -    Assessing proposals for further strengthening of the 
          -    Seeking to minimize the human cost of financial crises 
          and encouraging the adoption of policies that better protect
          the most vulnerable in society.
          -    Consideration of the elements necessary for the 
          maintenance of sustainable exchange rate regimes in emerging

The chapter discusses several key issues associated with these new areas of study.

      The euro.  The European Economic and Monetary Union represents an 
     historic reform of the monetary system.  The chapter outlines the
     history that led up to the January 1999 adoption of a common
     currency.  It outlines criteria for an "optimal currency area" and
     argues that Europe currently has too little labor market
     flexibility and insufficient ability to transfer funds between
     regions.  The prospects for the euro as an international currency
     are also considered.  The introduction of the euro instantly
     created an international currency that potentially rivals the
     dollar.  There may be some small associated costs for the United
     States.  But there is no reason to expect the euro to surpass the
     dollar anytime soon, nor for the costs from the U.S.  viewpoint to
     outweigh the political and economic advantages of a successful EMU.