Concern has been rising about the health of the U.S. commercial real estate market and any impact it may have on financial markets and institutions. It is too early to judge the full extent of any problems, but commercial real estate financing has been shaken by the financial market tiirmoil associated with recent residential mortgage defaults. The spreads of commercial mortgage-backed securities have widened relative to Treasury securities, and recent reports suggest that prices for many commercial properties are declining. In addition to the direct effects on construction activity, large commercial real estate losses by financial institutions might dampen broad-based economic growth by causing banks to cut back on commercial, industrial, and household lending.One way to gain perspective on the current commercial real estate market is to look back at historical experience. A natural comparison is with the 1980s and early 1990s. In the 1980s, commercial construction boomed, resulting in a massive oversupply of commercial space and creating serious financial problems for many depository institutions and real estate investors. Many analysts believe these problems helped cause a broader credit crunch in the early 1 990s, which reduced the availability of funds to small and middle-sized businesses and slowed overall economic growth.How is the current economic and financial situation in commercial real estate similar to and different from the conditions leading up to the real estate bust in the late 1980s and early 1990s? The first section of this article will describe the earlier episode and identify contributing economic and financial factors. The second section will consider how current commercial real estate fundamentals are similar to and different from the earlier episode. The recent commercial construction boom was not as large as in the 1980s, suggesting excess supplies of commercial space may not grow as large. The third section will examine the curtent size and distribution of financial risks relative to the earlier episode. A major difference from the early 1990s - increased commercial real estate securitization - may expose developers and investors to shocks originating outside the commercial real estate sector. A major similarity is that commercial banks currently have a large direct exposure to commercial real estate loans.I. WHAT HAPPENED IN THE 1980s AND EARLY 1990s?Although commercial real estate has always been cyclical in nature, the 1 980s and early 1 990s stand out as a major episode of overbuilding. For example, booming construction during the early 1 980s eventually caused large increases in office vacancy rates in the late 1980s and early 1990s. The resulting losses on real estate loans in turn caused a surge in failures by banks and savings institutions. After a brief overview of the commercial construction sector, this section describes the causes and extent of the 1 980s building boom and discusses the real and financial consequences of the subsequent real estate bust for broader economic activity.Com mereiai constructionThe commercial construction sector includes a wide range of property types. In this article, this sector is defined as office buildings, retail structures, warehouses, and privately owned healthcare facilities. By this definition, investment in commercial structures accounted for about 1 6 percent of all private investment in structures in 2007 (Chart 1). Construction of multifamily housing (apartments and some townhouses) will also be examined in comparing the 1980s and early 1990s with the present because the financing of multifamily structures is similar to commercial real estate financing. Investment in multifamily residential structures, was about 4 percent of private structures investment in 2007. Because of their similarities, this article will sometimes examine the combined behavior of the commercial and multifamily categories.1Commercial real estate has historically been subject to booms and busts. …

Benjamin Franklin observed that nothing in life is certain except death and taxes. But he was referring to the existence of taxes, not the amount. The federal liabilities of different income groups change constantly in response to new laws and shifting economic circumstances. For example, in recent years, Congress has lowered individual income rates, increased child and dependent care credits, and reduced taxes on dividends and capital gains. Much of the economic analysis and political debate about these federal changes concerns the impact on upper- or lower-income groups, while the impact on taxpayers sometimes gets forgotten.The trends in rates can be difficult for taxpayers, themselves, to discern. Modest revisions to the federal code may hardly be noticed in any given year; yet these revisions could build over time into a large change in the rate. Some taxpayers may also find it difficult to determine whether changes in their liability are due to legislated changes in the federal code or shifts in their own circumstances. For example, shifts in the composition of a household's income between labor income and capital gains could alter the household's liability, as could the birth of a new child or unusually large medical bills.This article shows that, while federal rates paid by households have generally declined in recent years, they are likely to rise in the future. The first section defines the effective federal for households and discusses the problems in computing this measure. The second section finds that the effective federal facing households has trended downward over the last 25 years and is currently low by historical standards. Moreover, the composition of liabilities over this period has shifted away from individual income taxes toward payroll taxes. Finally, the third section shows that under current law taxes are projected to rise in the future.I. MEASURING MIDDLE-INCOME TAX RATESPeople often talk about the on Americans, but both tax rate and middle-income are harder to define than might appear. The is hard to define partly because households pay a variety of taxes, both directly and indirectly. Likewise, a middleincome group can be defined in various ways, and the rates facing two households in the same income category may still turn out to be different. This section summarizes the simplest computation of a household's federal income liability. It then defines effective federal and household. Finally, it discusses some of the limitations of these concepts.Calculating liabilityTo understand the effects that changes in laws have on middleincome households, it is useful to briefly describe how the federal government determines a households liability using the 1040-EZ form (Table 1). This simple form has 36 pages of instructions, so the discussion omits many details.Taxable income is calculated asTaxable Income = Gross Income - Adjustments - Deductions - Personal Exemptions,where gross income includes all income from wages, interest, and pensions. Adjustments include contributions to retirement plans, moving expenses, and interest paid on educational loans. A household takes the greater of either the deduction or their itemized deductions. In 2005, the standard deduction for a household with a married couple filing joindy was $10,0004. Itemized deductions equal the sum of expenses, such as medical expenses, mortgage interest, charitable contributions, and state and local taxes. Personal exemptions work exacdy like adjustments and deductions, in that they reduce a households taxable income. For the majority of households, the personal exemption is equal to $3,200 multiplied by the number of individuals in the household. …

The personal saving rate has been drifting downward for last two decades. According to latest statistics, personal saving declined from about 10 percent of disposable income in early 1980s to 1.8 percent in 2004. The decline has received particular attention recently because saving was negative in 2005 for first time since Great Depression. Although saving declined in other developed countries during this period, U.S. decline was more pronounced than in most of these countries.Many analysts and policymakers have expressed concern about decline in personal saving rate. A major concern is whether U.S. households are providing adequately for long-term needs, such as future retirement and medical expenses. With average life expectancies lengthening and large baby-boom generation approaching retirement, many households will need to tap their personal savings to supplement increasingly pressured public and corporate retirement programs. In addition, low personal saving has created short-run concerns that a sudden increase in saving rate could reduce growth of consumer spending, real output, and employment.But there is another, often overlooked side to this story. Two major factors suggest decline in personal saving rate may not be as alarming as it is sometimes made out to be. First, various measurement problems with personal saving rate from national income and product accounts suggest household saving may not have declined as much as statistics suggest. Second, economic theory assumes that households rationally anticipate future labor income and asset returns and plan their spending accordingly. If this assumption is correct, low personal saving rate may not foreshadow wrenching future adjustments in consumer spending.This article provides some perspective on decline in personal saving rate over last two decades. The first section describes decline in most common measure of personal saving rate and economic explanations offered for this decline. The second section surveys some of measurement issues related to decline and presents some alternative saving measures. After weighing issues, third section concludes that, although there are some legitimate reasons for concern, decline in personal saving rate may not be as alarming as it first appears.I. THE DECLINE IN THE PERSONAL SAVING RATEThe downward trend in personal saving rate has prompted expressions of concern by economists and other observers. Roach wrote that the U.S. needs to end its buying binge and rediscover art of saving, while Eisinger worried that United States will end up with zombie similar to zombie companies that littered Japanese economic landscape in 1990s. Lansing warned that the decline in U.S. personal saving rate and dearth of internal saving raise concerns for future. Underlying these and virtually every other discussion of saving trends is a point of agreement-saving for future is important. This section begins by reviewing why saving is important and then provides some background on downward trend in U.S. personal saving rate.Why saving mattersThe purpose of saving is to increase resources available for future consumption. This point is true both for individual consumers and nation as a whole. Households put aside some of their current income to provide for future consumption, such as a major vacation or basic living expenses during retirement. Saving also helps protect against an unexpected loss of household income caused, for example, by illness or an unanticipated layoff. Typically, households invest their savings in financial assets, such as a bank account or mutual fund, or build equity in a real asset, such as a home. These assets can be redeemed or sold to others in future to provide funds needed to buy consumer goods and services. …

enjamin Franklin observed that nothing in life is certain except death and taxes. But he was referring to the existence of taxes, not the amount. The federal tax liabilities of different income groups change constantly in response to new tax laws and shifting economic circumstances. For example, in recent years, Congress has lowered indi- vidual income tax rates, increased child and dependent care credits, and reduced taxes on dividends and capital gains. Much of the economic analysis and political debate about these federal tax changes concerns the impact on upper- or lower-income groups, while the impact on middle- income taxpayers sometimes gets forgotten. The trends in tax rates can be difficult for middle-income taxpayers, themselves, to discern. Modest revisions to the federal tax code may hardly be noticed in any given year; yet these revisions could build over time into a large change in the middle-income tax rate. Some taxpayers may also find it difficult to determine whether changes in their tax lia- bility are due to legislated changes in the federal tax code or shifts in their own circumstances. For example, shifts in the composition of a household's income between labor income and capital gains could alter the household's tax liability, as could the birth of a new child or unusu- ally large medical bills.

Proposals for fundamental reform of the federal rax code are receiving increased attention in the business press and among economic analysts and policy-makers. President Bush has identified tax reform as a top priority, calling for a tax system that is pro-growth, easy to understand, and fair to all. Moreover, the President has appointed a commission to consider different approaches to tax reform. One approach might be to improve the current income-based federal tax code, perhaps by broadening the tax base and lowering income-tax rates. However, another approach might be to replace current income taxes altogether with a consumption tax.Switching the federal tax system from an income tax to a consumption tax could have important macroeconomic effects. Most economists believe that switching to a consumption tax could increase saving and real output per person over the long run, although studies differ on the size of these effects. However, switching to a consumption tax might also require sizable short-run economic adjustments and create challenges for monetary policymakers.This article analyzes the macroeconomic effects of replacing the current federal tax system with a consumption tax. The first section provides some background on the goals of tax reform and the basic difference between an income tax and a consumption tax. The second section describes three widely discussed versions of a consumption tax: a national retail sales tax, a value-added tax, and a consumption-type flat tax. The third section examines the macroeconomic effects of adopting a consumption tax. All three proposals could raise U.S. output over the long run, but adopting a consumption tax could have sizable transition effects as well. These transition effects could vary depending on which consumption tax was adopted and how monetary policy responded to the reforms.I. BACKGROUND ON TAX REFORMWhen considering tax reform options, fiscal policymakers are likely to weigh several important goals of tax policy. This section briefly discusses these goals because tradeoffs among them have a major influence on tax policy in practice. The section also considers the basic economic difference between an income tax and a consumption tax, the treatment of saving.Goals of tax reformFiscal policymakers usually consider various goals for tax policy. Five possible goals are: simplicity, stability, fairness, adequate revenue, and economic efficiency. The macroeconomic effects emphasized in this article fall primarily under the heading of economic efficiency. However, the other policy goals also play an important role in motivating the recent interest in tax reform. Fiscal policymakers often must make tradeoffs between these goals. For example, research described later in this article illustrates some key tradeoffs between economic efficiency and fairness.Simplicity. Tax experts do not dispute that the current federal tax code is extremely complex, although some might argue that complexity is unavoidable. In 2000, the Internal Revenue Code and related regulations contained 9.4 million words, up from about 1 million words in 1940 (Graetz). This complexity requires extensive recordkeeping, large amounts of time devoted to preparing tax returns, and the hiring of expert tax advisors. In 2002, individuals, businesses, and nonprofit organizations spent 5.8 billion hours and over $194 billion complying with the federal tax code (Moody). Simplifying the tax code could reduce taxpayer frustration and free up resources for more productive uses.Stability. Greater stability of the tax code is another possible goal for tax reformers. Besides being complex, the federal tax code has been modified frequently as fiscal policymakers responded to changing economic circumstances and political pressures. An example is changes in the marginal tax rate, the percent of an additional dollar of income that must be paid in taxes. The federal government's highest marginal tax rate for individuals was 50 percent in 1986. …

The United States continues to run an international trade surplus in services, but business stories frequently appear about service-sector jobs moving offshore. Many Americans are particularly concerned about the loss of skilled, well-paid jobs in such fields as computer programming and accounting. These jobs seemed relatively secure at a time when many manufacturing jobs were being lost to import competition. Similarly, telephone call centers, once viewed as an economic development opportunity in some areas, increasingly are moving to low-wage countries, such as India and the Philippines. Reflecting this growing concern, some members of Congress and state legislators have focused attention on the offshoring of service jobs and production, even introducing legislation to limit the outsourcing of jobs to other countries. Offshoring raises many questions for policymakers and the general public. For example, which service jobs will be affected most by import competition? What are the most likely effects of service-sector offshoring on U.S. output, employment, and, most important, our standard of living? Is offshoring really a problem that requires restrictive government actions, or are other kinds of policies more appropriate to give Americans the highest possible living standard? ; Garner examines the economic effects of offshoring and possible policy responses. He finds that although the offshoring of service jobs hurts some workers, offshoring should not permanently lower U.S. employment or production. ; Moreover, the average living standard can benefit over the long run if the nation adopts policies to retrain displaced workers and move them into expanding industries.

This article examines recent inflationdevelopments and the policy implications offaster productivity growth. The first sectionreviews last year's price statistics and discussesvarious factors that affected overall and coreinflation. The second section considers whetherthe recent faster pace of productivity growthcan be expected to persist in the years ahead.Finally, the third section considers the inflationoutlook for 2000 and beyond, concluding thatmonetary policymakers must remain...

The U.S. economy turned in an exceptional performance in 1999, combining strong real output growth with moderate inflation. Real GDP, a broad measure of the nation's output of goods and services, grew 4.6 percent from the fourth quarter of 1998 to the fourth quarter of 1999. Employment also rose solidly, and the civilian unemployment rate declined to the lowest level in about 30 years. Although rising world oil prices caused consumer prices to increase faster than in 1998, core inflation measures, which exclude food and energy prices, were about the same or slightly lower. Moreover, survey measures of long-term inflation expectations were stable despite the robust pace of the economic expansion. What accounts for this exceptional combination of rapid growth and moderate inflation? Several factors helped hold down the inflation rate, including strong import competition and ample industrial capacity at home and abroad. But many recent discussions have emphasized the pronounced increase in productivity growth, reflecting both the high level of business investment and accelerated technological change. In particular, new information technologies, such as computers and the Internet, may be increasing economic efficiency through better coordination of business activities and reduced inventories. The evidence is unclear, however, about how much of the productivity acceleration is due to new technologies, and whether faster productivity growth can be sustained in the years ahead. Such questions are crucial in judging whether rapid growth can continue without undermining the Federal Reserve's long-run objectives of price stability and sustainable economic growth. This article examines recent inflation developments and the policy implications of faster productivity growth. The first section reviews last year's price statistics and discusses various factors that affected overall and core inflation. The second section considers whether the recent faster pace of productivity growth can be expected to persist in the years ahead. Finally, the third section considers the inflation outlook for 2000 and beyond, concluding that monetary policymakers must remain vigilant even if faster productivity growth continues. 1. INFLATION IN 1999 Early in 1999, some commentators expressed concern that the economy was heading toward deflation, a persistent decline in the general price level. In the following months, however, crude oil prices rose sharply and other commodity prices increased in response to signs of faster world growth. Depreciation of the dollar in the second half of the year helped halt the decline in nonoil import prices. In addition, the domestic economy expanded rapidly last year, and labor markets tightened. As a result, deflation faded as a topic of concern, replaced by worries about possible future increases in the inflation rate. The actual inflation statistics, though, were mixed. Measures of inflation that directly reflect energy prices, such as the CPI and the PPI, rose at a somewhat faster rate last year, but core inflation measures were about the same or slightly lower. Inflation statistics and forecasts Measures of consumer price inflation that include food and energy prices increased somewhat in 1999. The inflation rate of the all-items CPI rose to 2.6 percent last year from 1.5 percent in 1998 (Chart 1). The CPI inflation rate was slightly above most forecasts made in late 1998 or early 1999 (Table 1). An alternative measure of consumer prices from the national income and product accounts also rose at a faster rate last year. The chain-weighted personal consumption expenditure index (PCE price index) rose 2.0 percent after a modest 0.9 percent gain in 1998.1 In contrast, measures of core consumer prices did not accelerate markedly last year. Core CPI inflation actually decreased to 2.1 percent from 2.4 percent in 1998. However, core PCE inflation increased slightly to 1.5 percent from 1. …

Many economists believe that price stability is the primary goal of monetary policy because it is thought to foster maximum sustainable economic growth. Price stability is often said to exist when changes in the general price level cease to be a factor in the decision processes of businesses and individuals. By this definition, price stability was not literally achieved in 1998, as many measures of the price level continued to rise, and inflation expectations were well above zero. Yet in 1998, consumer prices rose at the lowest rate in over a decade, and any upward pressures on inflation were surprisingly subdued. Although many economists still worry about potential upward pressures on the inflation rate, last year's low inflation and foreign economic crises have produced a new set of concerns. In particular, some economic observers and financial market participants are concerned that disinflation, the process of lowering the inflation rate, may go so far as to produce deflation, a persistent decline in the general price level. These observers point to large decreases in petroleum prices and other primary commodity prices, rapidly falling computer prices, and moderate declines in U. S. nonoil import prices as possible signs of deflation. This article argues that last year's favorable inflation performance, while suggestive of further modest progress toward price stability, does not foreshadow an emerging deflationary period. The first section reviews price developments over the last year, showing that many broad measures of inflation declined in 1998, but most remained positive. The second section argues that the factors that produced disinflation in 1998 are not likely to produce deflation this year. The third section examines the slight decline in long-term inflation expectations last year and its implications for future monetary policy. INFLATION IN 1998 Many broad measures ofthe U.S. inflation rate declined last year. However, excluding food and energy prices, the inflation performance was more mixed. A sharp decline in energy prices was an important factor in last year's unexpectedly low inflation rates. International influences also played an important role in slowing U.S. inflation, with the strong dollar, intense import competition, and falling commodity prices having a dramatic effect on the prices of internationally traded goods. But tight labor markets helped prevent an equally large decline in service-sector inflation. Inflation statistics and forecasts Consumer price inflation was lower than expected in 1998. Measured by the all-items consumer price index (CPI), the inflation rate declined to 1.5 percent last year from 1.9 percent in 1997 (Chart 1). At the end of 1997 and in early 1998, most forecasters had expected CPI inflation to be about 2.0 percent to 2.5 percent in 1998 (Table 1). An alternative measure of consumer price inflation from the national income and product accounts also declined last year. The chain-weighted personal consumption expenditure index (PCE price index) rose by only 0.8 percent in 1998, down from a 1.5 percent gain in the previous year. Changes in core measures of consumer price inflation, which exclude food and energy prices, were mixed last year. Core CPI inflation was 2.4 percent in 1998, up slightly from a 2.2 percent rate in 1997. In contrast, the core PCE price index grew at a somewhat slower pace last year, rising 1.2 percent after a 1.6 percent gain in 1997. Other broad measures of inflation were also mixed in 1998 (Chart 2). The chain-weighted price index for gross domestic product (GDP price index) is the broadest inflation rate considered here, measuring the average price change for all final goods and services produced in the United States. The GDP price index increased 0.9 percent in 1998, down from a 1.7 percent gain in 1997. This low inflation rate was well below forecasts for an increase of 2.0 percent or slightly higher last year (Table 1). …

rowing public awareness of future pressures on Social Security is eroding many Americans' confidence in this key retirement program. These pressures are nearly certain in the next century, stemming from the retirement of the large baby-boom generation, longer average life spans, and lower projected fertility rates. To meet such pressures, various reforms of Social Security have been proposed, ranging from simple repairs to the current system all the way to full privatization. In this context, privatization usually means moving the public retirement system toward a set of individual accounts with the workers' funds invested partly in private securities and with workers having some measure of control over investment allocations. Choosing among the competing reform proposals is a daunting task. Supporters of privatization believe such reforms would boost economic efficiency, resulting in higher real output per worker and helping the nation cope with the future pressures from population aging. Supporters also believe privatization would produce a retirement system that treats different generations more fairly. Critics fear, however, that the privatization of Social Security would produce a more unequal income distribution for retirees and expose them to greater investment risks. This article examines these fundamental issues of economic efficiency and fairness that should be weighed when considering Social Security privatization. The first section summarizes the challenges to the current system and outlines various options for reform. The second section explains how privatization could improve economic efficiency, and briefly considers the difficult issue of the transition costs in moving from the current system to full privatization. The third section discusses important issues of fairness within and across generations. Any decision to privatize Social Security will require balancing the likely gains of greater real output and fairer returns to younger generations with the possible adverse effects of a more unequal income distribution among retirees and greater investment risks. This balancing must occur through the political process because fairness is a matter of values rather than economic analysis. I. THE GROWING INTEREST IN PRIVATIZATION The many achievements of Social Security should not be forgotten in discussing possible reforms. Social Security has provided a secure retirement income for millions of Americans, lowering poverty rates among the elderly and protecting working families against the disability or premature death of a breadwinner. Moreover, such Social Security benefits are not currently in jeopardy because the system faces no immediate problem in meeting its financial obligations. Recent interest in privatizing Social Security comes, instead, from a growing awareness of the pressures that will emerge in the early decades of the next century, along with some long-standing issues about how to balance economic efficiency and fairness. Financial challenges Social Security is essentially a pay-as-you-go retirement system in which most of the payroll taxes paid in by employers and current employees are immediately paid out as benefits to retirees. An estimated 144 million people paid contributions to the old-age and survivors insurance and disability insurance (OASDI) trust funds in 1996, with the combined tax rate on employers and employees being 12.4 percent.1 Benefits were paid to almost 44 million people at the end of 1996, with initial benefit levels depending on the workers' earnings histories and changes in national average wages. After retirement, benefit levels are adjusted upward to reflect changes in the consumer price level. Despite the existence of the OASDI trust funds as an accounting device, Social Security is really unfunded in the sense that there is no portfolio of private securities backing the program that could be sold to maintain future benefit payments. …

Some analysts and business executives are becoming concerned that recent increases in the consumer debt burden may foreshadow an economic slowdown. Higher debt increases the risk that a household may experience financial distress in the event of an adverse economic shock, such as the loss of a job or large uninsured medical expenses. As the risk of financial distress rises, households may become less willing to spend on consumer goods, particularly big ticket items such as automobiles and home computers, which in turn would hurt economic growth.> Different measures of the consumer debt burden are currently giving conflicting signals about the seriousness of the problem. It is not clear whether these measures have been useful indicators of consumer spending and economic growth in the past. Moreover, a measure of the debt burden that was useful in the past might be unreliable today if recent changes in the financial system, such as greater use of credit cards, are distorting the relationship between consumer debt and real economic variables.> Garner examines whether various measures of the consumer debt burden can reliably predict a slowdown in economic growth. He concludes that analysts should continue to monitor various measures of the consumer debt burden, but these measures are not highly reliable in predicting future economic slowdowns.

Many economists expect inflation to rise in 1995. These expectations are based on various approaches to forecasting inflation. One approach is based on the standard economic theory that inflation rises when slack is eliminated from the economy and production exceeds capacity constraints. According to this view, measures of economic slack such as unemployment and capacity utilization provide useful information about the inflation outlook. But the relationship between slack and inflation is complicated and subject to variable lags. Uncomfortable with this complex relationship, some analysts rely on alternative approaches to forecasting inflation. One approach is based on of inflation. The leading indicators typically incorporate information on selected prices to augment or replace information on economic slack. The prices selected are usually key commodity prices that fluctuate more or less continuously in response to changing economic conditions. Prominent leading indicators of inflation include the price of gold, broader indexes of commodity prices, and composite indicators that combine several economic series believed to predict the inflation rate. How useful are these leading indicators for forecasting inflation? This article examines five widely watched leading indicators. The first section evaluates the strengths and weaknesses of these indicators based on economic theory. The second section evaluates the leading indicators empirically, looking at how the indicators have performed by themselves and whether the indicators add useful information to a standard model relating inflation to economic slack. It is concluded that, of the five leading indicators, the composite indicators have given the most useful early warning signals of inflation turning points, but none of the indicators has recently been successful in predicting inflation magnitudes. FIVE LEADING INDICATORS OF INFLATION Five leading indicators of inflation are described in this section. The first is the price of gold, a commodity that once played an important role in the world monetary system and is still held as a store of value by investors in many countries. The next two indicators are the Commodity Research Bureau (CRB) index of commodity futures prices and the Journal of Commerce (JOC) index of industrial materials prices. These leading indicators are differing broad-based baskets of commodities that play a more important role than gold in current economic activity. The last two indicators are the Center for International Business Cycle Research (CIBCR) leading inflation index and the PaineWebber (PW) leading index. These indexes are composite leading indicators of inflation that combine broad-based commodity indexes with other economic variables believed to be useful in inflation forecasting. The price of gold The price of gold is viewed by some analysts as a leading indicator of inflation because gold is widely held as a store of value. Gold is a store of value partly because of its physical characteristics, such as durability and attractiveness, and partly because of its historical role as the centerpiece of the world monetary system (Laurent). Many countries issued gold coins and held stocks of gold bullion to fully or partially back their paper currencies. Thus, although gold has industrial uses, much of the demand for gold has always been as a store of value. Moreover, the supply of gold is relatively fixed because new gold production is small compared with the existing stock of the metal. Even though gold no longer plays a key role in the world monetary system, the price of gold might be a good leading indicator of inflation. The rationale is that if enough people regard gold as a good store of value, the expectation of rising inflation could cause some investors to shift their funds out of financial assets with fixed nominal interest rates into gold coins or jewelry. Because the gold supply is relatively fixed, the price of gold might rise sharply with even a small increase in demand. …

Policymakers and economic analysts have recently been concerned about potential inflationary pressures in the U.S. economy. Various economic statistics show the amount of unused productive resources has been diminishing. For example, the civilian unemployment rate has decreased and the capacity utilization rate of the nation's factories has risen. If real output grows rapidly in the future, the competition for scarce productive resources could put upward pressure on wages and other production costs and ultimately could raise consumer price inflation. Some analysts have challenged the view that productive resources are becoming so scarce that higher inflation is a danger. This challenge partly turns on whether the capacity utilization rate, which measures the percent of manufacturing capacity currently in use, is a reliable indicator of inflationary pressures. Most economic forecasters believe inflationary pressures build after capacity utilization rises above a certain level. Some analysts have claimed, however, this historical relationship is no longer valid because the economy has become more open, allowing imported goods to relieve any shortage of domestic capacity. Some analysts also have argued that manufacturing capacity shortages will not be a problem in the foreseeable future because of rapid technological progress and strong business investment. This article examines whether the capacity utilization rate for the manufacturing sector is still a reliable indicator of inflationary pressures. The first section describes the capacity utilization rate and summarizes recent arguments about whether the relationship between capacity utilization and inflation has changed. The second section presents empirical evidence testing whether the economy can now operate at a higher utilization rate than in the past without the inflation rate rising. The article concludes that the historical relationship between capacity utilization and inflation still holds, indicating the capacity utilization rate remains a reliable indicator of inflationary pressures. BACKGROUND ARGUMENTS Inflationary pressures typically emerge when the overall demand for goods and services grows faster than the supply, causing a decrease in the amount of unused productive resources, or economic slack. Economists measure economic slack in various ways. Perhaps the most common measure is the unemployment rate, which measures unused resources in the labor market. Another measure of slack is the real output gap, the estimated difference between actual real output and the economy's potential output. This section examines a third major measure of economic slack, the capacity utilization rate. Stable-inflation capacity utilization The capacity utilization rate measures the operating rate of the nation's industrial capacity. This article focuses on capacity utilization in the manufacturing sector and thus excludes mining and utility output. The capacity utilization rate equals the Federal Reserve's index of manufacturing output divided by the index of manufacturing capacity. Capacity is defined as the highest sustainable level of output by the manufacturing sector. [1] Because estimates of capacity evolve slowly over time, short-term movements in the capacity utilization rate primarily reflect changes in manufacturing output. But over longer periods, the growth rate of manufacturing capacity varies in response to technological progress and changing levels of business investment. Most economic forecasters believe the capacity utilization rate is a useful indicator of inflationary pressures. Historically, capacity utilization in the manufacturing sector has tightened before the rate of consumer price inflation has increased (Chart 1). (Chart 1 omitted) As the slack in the economy diminishes, firms typically face higher production costs in order to raise their output further. Firms may have to hire inexperienced workers or put older, less efficient plant and equipment back into service. …

Many Americans believe the low national savings rate is a serious economic problem. Because savings, and in turn investment, are key determinants of real income growth and future living standards, economists and fiscal policymakers have proposed various policy changes as possible cures for the low national savings rate. A popular proposal has been to encourage greater participation in Individual Retirement Accounts (IRAs), which provide a tax-advantaged account for retirement savings. Last year, for example, the Bush administration proposed a new flexible IRA, and Senators Bentsen and Roth introduced a bill liberalizing IRA eligibility and creating a new kind IRA. Legislation based on the Bentsen-Roth plan was passed by Congress late in 1992, but was not signed into law. Discussion IRAs has temporarily waned as the Clinton administration focuses on such issues as long-term deficit reduction, health care costs, and infrastructure investment. Nevertheless, in coming years, proposals for expanding IRA participation are likely to reappear. IRA reform remains popular with many fiscal policymakers anxious to raise the national savings rate. And IRAs are politically appealing as a form of middle-class tax relief. There is disagreement, however, about whether increased IRA participation would actually raise national savings. National savings is the sum of government savings and private savings. Increased IRA participation would reduce government savings by decreasing tax revenues and raising the budget deficit. Nevertheless, higher IRA contributions could increase national savings if private savings were to rise by more than the decline in government savings. However, economic studies reach differing conclusions about whether, and how much, IRAs increase private savings. This article argues that changing the tax laws to encourage greater IRA participation would not be a reliable way to boost the nation's savings. The first section explains why the low savings rate is a source of concern and briefly describes how IRAs work. The second section shows that IRAs were not successful in raising the national savings rate in 1982-86, the period of broadest IRA participation. Finally, the third section identifies three basic problems that kept IRAs from being an effective savings incentive in the 1980s and shows why recent reform proposals would not solve these problems. NATIONAL SAVINGS AND IRAs Many Americans are concerned about future U.S. living standards because of the sluggish growth of productivity and real output over the last two decades.(1) Workers often feel uneasy about their own living standards in retirement and about the economic prospects for their children and grandchildren. Recent debate about future living standards has centered on the low U.S. savings rate and policy options, such as IRAs, for raising the savings rate. THE LOW SAVINGS RATE The national savings rate has been low in recent years compared with both past US. savings rates and savings rates in other industrial countries. For example, the national savings rate averaged 2.4 percent of net national product over the last five years, which was well below the average 8.8 percent rate in the 1960s. International statistics also suggest that the savings rate is far lower in the United States than in other industrial countries, such as Canada, Germany, and Japan.(2) A low national savings rate may hurt future living standards by reducing domestic investment and productivity growth. If an economy is closed to international capital flows, domestic investment and savings are closely related because capital formation requires that real output be shifted away from consumer goods into new plant and equipment. A low savings rate would thus reduce the quantity of capital available for workers to use in the production process. A lower level of capital per worker would make workers less productive and cause firms to pay lower real wages than if the savings rate were higher. …

Home ownership has long been part of the American dream. From the mid-1960s to the late 1970s, the wealth of home owners rose substantially due to increases in the real price of housing--the price of housing adjusted for inflation. As a result, many people came to believe that buying a home was the safest and highest yielding investment that a household could make. But a drop in the real price of housing in the early 1980s challenged this view, and a further drop during the recent recession has raised concerns that home owners may face declining real home prices throughout the decade. Analysts differ about the outlook for real housing prices in the 1990s. Some observers argue that real housing prices may drop because the baby-boom generation is being followed into the housing market by a smaller baby-bust generation (Laing; Mankiw and Weil). The resulting weaker growth in housing demand may put downward pressure on the real price of housing. Other analysts argue, however, that such economic factors as real income growth and reduced home supply will offset these adverse demographic factors (DiPasquale and Wheaton; Downs). This article argues that economic factors in the housing market are likely to prevent a severe decline of real housing prices in the 1990s. The first section shows why some observers are concerned that the baby bust may depress future housing prices. The second section shows that demand-side economic factors also have important effects on real housing prices. In fact, some of the past increases in the real price of housing that have often been attributed to the baby boom may have been due to such factors. The third section discusses supply-side economic factors and explores the outlook for real housing prices in the 1990s. Recent concern about future housing prices has been fueled partly by sharp declines in housing prices in such cities as Boston and San Francisco.(1) But changes in metropolitan housing prices often reflect unique local factors in addition to national economic conditions. Fears of a prolonged fall in real housing prices at the national level are more realistically based on demographic factors, particularly the effect of the baby bust on future housing demand. Postwar experience shows that baby booms and busts have an important effect on the housing market. The real price of housing has fluctuated significantly over the postwar period. The real price of housing can be measured by the GNP deflator for residential investment divided by the GNP deflator for all goods and services (Chart 1). (Chart 1 omitted) Because this measure represents the price of housing relative to the general price level, the real price of housing falls if observed housing prices increase more slowly than the prices of other goods and services.(2) Although the real price of housing has fluctuated over the postwar period, Chart 1 shows no evidence of a persistent upward or downward trend. Changes in the real price of housing can be interpreted in a simple supply and demand model of the housing market (Figure 1). (Figure 1 omitted) The real price of housing is measured on the vertical scale, and the quantity of housing on the horizontal scale. The upward-sloping line S represents the supply curve of housing.(3) In the short run, changes in the price of housing induce only small changes in the quantity of housing offered on the market. The downward-sloping line D sub 1 represents the initial demand curve for housing. The demand curve is downward sloping because a rise in the real price of housing reduces the quantity of housing demanded, other factors held constant. A change in the birth rate influences the real price of housing by shifting the demand curve. After a period of years, a baby boom increases the quantity of housing demanded at any given real price of housing. As a result, the housing demand curve shifts to the right--for example, from D sub 1 to D sub 2 in Figure 1. …