Economy Grows at 3.1% Rate in Second Quarter : Higher Inflation Possible if Expansion Continues

Times Staff Writer

The nation's economy grew at a steady 3.1% annual rate in the spring, the Commerce Department said Wednesday, as increases in exports and unexpectedly strong growth in capital investment outpaced a modest expansion in consumer spending.

Most economists agreed that the report promised continued robust growth for the rest of the year but also held out the prospect of higher inflation.

A key indicator of inflation that accompanied Wednesday's report showed that prices for consumer goods and services during the months of April through June increased at an annual rate of 4.7%, the highest in six years.

"Good for the man on the street and lousy for the man on Wall Street," said Giulio Martini of Sanford C. Bernstein & Co., a New York investment banking firm. Fears of an overheating economy dominated the stock market in the wake of the report, and the Dow Jones industrial average fell 20 points to 2,053, its lowest level since early June.

The 3.1% annual growth rate for the second quarter of the year was down only slightly from a revised 3.4% increase in the first three months of the year. The gross national product, the total output of goods and services, also grew 3.4% in all of last year, up from a previous estimate of 2.9%.

Beryl Sprinkel, chief White House economic adviser, told reporters his recently revised forecast of steady 3% growth for all of 1988 stood unchanged in the face of Wednesday's report. That leaves room for the economy to cool off during the second half of the year, and Sprinkel said that in turn would forestall any threat of inflation.

Improved Trade Deficit Cited

The Federal Reserve Board has set a growth target for the year of 2.75% to 3% as one the economy can manage without overheating and forcing a counterattack against inflation.

The Commerce Department said the severe Farm Belt drought reduced economic growth in the second quarter by $5.5 billion, or about 0.5 percentage points. As it was, the economy grew by $30.2 billion, measured in 1982 dollars at annual rates.

The influence of the drought was far outweighed by an $18.9-billion improvement in the nation's trade deficit and by a $15.8-billion increase in business investment in new plants and equipment.

By contrast, consumption grew $14.4 billion, or only 2.3%, compared to a $28.1-billion spurt in consumer spending, or 4.5%, during the first three months of the year. In addition, business inventories during the quarter increased much more slowly than during the past six months.

Inventories had shot up in the final quarter of last year in the wake of the Oct. 19 stock market crash. That led to fears of a sharp economic contraction in 1988, with consumption falling off and output in steep deline.

Instead, strong growth in exports and business investment have more than taken up the slack, and the stage seems set for more steady growth for the rest of the year.

"The growth was in investment and net exports, which is where you want to see it," said John O. Wilson, senior vice president and chief economist at Bank of America in San Francisco. "You can't ask for a better number."

Allen Sinai, chief economist at Boston Co., called it "very good news for the real economy and the dream of any administration in power."

But Sinai also warned that the strong increases this year in capital investment and exports would inevitably push demand beyond the economy's ability to produce--the classic recipe for inflation. Like many other analysts, he believes that the Fed will ultimately have to raise interest rates to restrain growth.

'Not Repeat Errors'

"That's a great achievement," Sinai said of second-quarter growth, "but the consequence is inflation."

Sprinkel, however, saw hope in the burst in capital spending by American industry. That, he said, should add enough manufacturing capacity to prevent the economy from being squeezed by its own success.

For that reason, he added, the higher rate of inflation reflected in the 4.7% price increase in the second quarter should prove temporary and not translate into higher wages, followed by higher costs, followed by higher prices and wages in the sort of spiral that buffeted the economy a decade ago.

"This Administration and the Federal Reserve are determined to avoid a resurgence in inflation," Sprinkel said. "We will not repeat the errors of the later 1970s."

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