The March employment report was a distinct, and very pleasant, surprise: payroll jobs increased by 308,000, the largest in four years. Levels of employment in January and February, moreover, were revised up. The increases in March were quite widespread; 61 percent of the reporting industries indicated additions to numbers of employees. Manufacturing employment was unchanged in March, but even that was a notable accomplishment after 42 consecutive months of negative growth.

Favorable weather and the end of a grocery strike bolstered job gains in March, and the length of the workweek declined, taking some of the gloss off the March employment report. But over the first 3 months of this year, job gains have averaged 171,000 per month; and since last August, when the employment totals hit bottom, payroll employment has risen 108,000 per month. It seems fair to conclude that worries that the economy might stall out for lack of job creation are now behind us.

While the March report was very encouraging, there is no reason to expect gains of 300,000 a month to continue. For one thing, productivity gains continue at a solid pace. Real GDP appears to have risen at about a 4-1/4 percent annual rate in the first quarter, and that would imply an increase in productivity of more than 3 percent at an annual rate. For another, there are a few signs that the economy's growth may be moderating a bit in the more cyclical areas of the economy.

Orders for durable goods have declined slightly in the past 5 months, following a substantial run-up from April through October of last year. Orders for business equipment and consumer durable goods have lost some of their steam. Consumer spending for durables, adjusted for inflation, rose more slowly in the fourth quarter of last year than in the third, and monthly data through February indicate a decline in the first quarter. Construction outlays may also be down slightly in the first quarter, judging by available data through February. And with mortgage rates backing up in response to the March employment report, a resurgence of home-building activity is not in the cards.

There is certainly no indication in recent data that the economy is stumbling, and our current forecast for growth over the four quarters of this year--4.1 percent for real GDP--is little changed from a month ago. But the downside risks appear to have increased a bit over the past month.

The bond market reacted strongly to the news of large job gains in March, reflecting expectations that the Federal Reserve might soon have to start increasing interest rates. The Fed has indicated in recent releases that it can be patient in removing policy accommodation because of slack resource use and low inflation. One month's employment numbers do not change the fundamentals in that regard. Indeed, the March employment report indicated a slight up-tick in the unemployment rate, as the civilian labor force increased. The numbers of individuals seeking work could increase further with improvement in labor demand, since the labor force participation rate-the proportion of the adult population working or seeking jobs-has declined sharply since the peak in early 2001. The rise in average hourly earnings, moreover, has moderated considerably, and with productivity gains continuing to be robust, unit labor costs remain under good control. To be sure, rising energy prices, increases in prices of basic commodities other than oil, and the fall in the value of the dollar are threats to inflation that will continue. But their impact on overall inflation has been blunted by declining unit labor costs, and we expect that to continue for at least the next several quarters.

Worries are developing in financial markets that the Federal Reserve, in maintaining 40-year low interest rates for an extended period, is getting behind the curve, and will eventually have to raise interest rates sharply to compensate for its present profligacy. That might be the case if the economy were now poised to grow in boom-like proportions. There is good reason to expect, however, that the economy's growth is more likely to pursue a more moderate course.

The principal reason is the outlook for consumer spending, which constitutes two-thirds of GDP. Consumers have been buying with abandon in recent years. The surge of consumer spending began in the 1990s, when strong job gains, declining inflation and a roaring stock market raised consumer confidence to levels not seen since the mid-1960s. As early as 1993, the growth of consumer spending began to outstrip the increase in consumers' after-tax income, so that the personal saving rate began to fall. One might have expected the prolonged bear market in stocks from the spring of 2000 to the spring of last year, the lack of job creation for an extended period, and the threat of terrorism to damp consumers' spirits, but that hasn't happened. Thanks in part to exceptionally low interest rates, sharply rising home prices, and a return to a bull market in equities, the consumer spending binge has persisted. Growth in spending has continued to outpace the rise in disposable income, driving the personal saving rate to below 2 percent, compared with a postwar average of between 7 and 8 percent. Expansion of consumer debts, of course, has been an integral part of that process. Household debts amounted to a little over 80 percent of after-tax incomes when the spending binge began in 1993; those debts now amount to more than 110 percent of disposable income.

There seems little reason to expect a drastic change to more conservative consumer buying patterns-barring a frightening outbreak of domestic terrorism, a renewed bear market in stocks, or some other unpredictable event. Consumers are handling their debts reasonably well, job opportunities are improving, and consumer confidence has rebounded from the steep three-year decline that ended in the spring of last year. But continued growth of consumer spending at a pace above the rise in disposable income seems highly unlikely. A more reasonable expectation is that the rise in consumer spending will equal, or lag somewhat behind, the increase in after-tax incomes. And with the end of the tax rebates coming this quarter, a slowdown in consumer spending during the latter half of this year appears in the offing. Strength in business capital spending and exports will keep the expansion alive and well, but economic growth is not apt to reach proportions that put strains on resources at any time soon.

If our economic forecast materializes, there appears to be little reason for the Federal Reserve to begin removing its present level of policy accommodation at any time soon. At the meetings of the Federal Open Market Committee (FOMC) in May and late June, there is bound to be discussion of the timing of the next move in monetary policy. Support for a near-term increase in the federal funds rate will exist among some FOMC members, but the majority are likely to recognize the potential for a second-half slowdown and argue for delaying the first move toward higher interest rates. We continue to expect the first increase in the target funds rate to occur at the December FOMC meeting, and for the course of increases in short-term rates next year to be a gradual progression.



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