Pace of Growth Picks Up in Third Quarter

WASHINGTON — The irrepressible U.S. economy grew at a 4.8% annual rate last summer, its fastest pace of the year, and it did so without triggering a new burst of inflation, the government said Thursday.

Although part of the increase resulted from measurement changes, the growth rate for the July-through-September quarter was still greater than expected and faster than the sluggish 1.9% pace of the previous quarter. The news sent stock and bond prices soaring.

The economy is now on track for a fourth full year of 4%-plus growth, and by next February will have grown for nine straight years, the longest expansion in U.S. history.

Perhaps even more remarkable is that there are still few signs of inflation, despite what most analysts consider the ingredients for it.

The latest evidence came Wednesday when the government reported that Americans’ wages and benefits rose a less-than-expected 0.8% in the three months from July through September and 3.1% in the 12 months ending in September. The 12-month figure was more than a half point lower than in the preceding 12 months, even though the economy continued growing rapidly and companies in some regions reported trouble finding workers.

“There’s a sweet smell of success to these numbers. The good news keeps pouring out of the economy,” said Sung Won Sohn, chief economist with Wells Fargo & Co. in Minneapolis.

Changes in government methods of measuring the gross domestic product, which were used for the first time Thursday, raised the estimate of economic growth in most years during the last four decades. For 1997 and 1998, for example, the new methods pegged growth at 4.5% and 4.3%, substantially above the 3.9% rate that had been assigned to each of those years.

Coming atop Tuesday’s announcement that high-tech giants Microsoft and Intel would be added to the Dow Jones average at the expense of such smokestack stocks as Goodyear Tire & Rubber, the new measuring methods represented a triumph of sorts for New Economy theorists, who believe that technology is revolutionizing the nation’s productive system.

“It does raise a lot of questions about the old macroeconomic rules, which old-school economists like me continue to believe in,” conceded Stephen S. Roach, chief economist with Morgan Stanley Dean Witter & Co. in New York.

According to the new measurement methods, growth has averaged 3.5% a year since 1991, or 0.4 of a point higher than previously thought. Although that still puts the decade’s expansion behind the 1980s boom, when growth averaged 4.1% a year, and the 1960s, when it averaged 4.8%, analysts said the new numbers showed an economy that was stronger and smoother-running than almost anyone predicted even a few years ago.

As eye-catching as the growth figures were, the new inflation numbers attracted considerable attention. The July-through-September quarter’s 0.8% increase in the employment cost index, the government’s broadest measure of wage and benefit trends, was lower than the 1.1% increase in the prior quarter. And it was backed up by a second inflation gauge, the so-called GDP deflator, which showed prices rising 0.9% last quarter, down from 1.4% the previous quarter.

For the entire period from 1990 through 1998, the deflator showed that inflation has averaged a mild 2.3%.

Some analysts said the combination of mild inflation reports reduced chances that the Federal Reserve would raise interest rates for a third time this year when it meets Nov. 16. But even optimists said that the economy’s ability to combine continued strong growth with low inflation is coming to an end.

“We’re at a subtle turning point where we’re moving from the disinflationary phase of the expansion to the inflationary phase,” said Diane C. Swonk, chief economist with Bank One Corp. in Chicago.

But Federal Reserve Chairman Alan Greenspan, addressing the Business Council in Boca Raton, Fla., characteristically did not divulge what the Fed might do.

On one hand, he said, large gains in productivity--output of goods and services per worker--were enabling largely inflation-free economic growth. On the other, he said such gains could not be sustained forever.

“A leveling out or decline in the growth of productivity would have a profound effect on the intermediate outlook, should it occur,” Greenspan said. “The rate of growth of productivity cannot continue to increase indefinitely. At some point it must, at least, plateau.”

The Commerce Department’s upwardly revised economic growth figures will require the government to raise a variety of other economic measures, such as its estimate of how productive American workers are. But analysts warned about reading too much into the increase.

“You can think of the economy as a car driving 70 miles an hour in a 50-mile-an-hour zone. Sooner or later, the cops will give it a ticket or it will hit a wall,” said Edward F. McKelvey, a senior economist with Goldman, Sachs & Co. in New York. “Now imagine you change the measurement system to kilometers. The speed limit goes up to 80, but the car’s still speeding.”

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Presto!

What a difference a few definitions make.

The best news in Thursday’s economic statistics wasn’t third-quarter growth but a switch in how Washington’s bean counters define computer software and government pensions.

Until now, the accountants had treated software as an expense, the high-tech equivalent of the steel that goes into a car. The value of the steel is not counted as part of the nation’s economic output; only value of the car is.

Now the software will be treated like the car. As part of its periodic update of its methods, the Commerce Department redefined software as an investment, something of value in its own right and thus counts toward economic output.

Presto! The economy is bigger and growing faster.

For last year alone, the rejiggering added about $250 billion to estimates of total economic output. Fully two-thirds of that was due to the redefinition of software.

The national savings rate underwent a similar adjustment. The government had thought it was a miserable 0.5% of economic output last year; suddenly it is a more respectable 3.7%.

Commerce traced more than half of that jump to its new definition of government pensions. Previously, and somewhat inexplicably, pensions did not count as savings. Now they do.

Old and New Estimates of GDP (in trillions):

1998 previous: $8.53 trillion*

1998 revised: $8.76 trillion

Latest GDP Growth

Percent change from previous quarter

Third quarter 1999: 4.8% (revised)

* Times estimate

Source: Commerce Department