Introduction
The expansion of the U.S economy continued for the fifth consecutive year in 2006. Economic growth was strong, with real gross domestic product (GDP) growing at 3.4 percent during the four quarters of 2006. This strong economic growth comes in the face of numerous headwinds and resulted from the inherent strengths of the U.S. economy and pro-growth policies such as tax relief, regulatory restraint, and opening foreign markets to U.S. goods and services. Growth in the first quarter rebounded from the effects of the 2005 hurricanes, including a recovery in consumer confidence and consumer spending, and the rebuilding of oil and natural gas infrastructure in the Gulf of Mexico. Although growth slowed in the middle two quarters of the year, the overall pace of real activity was strong in the face of near-record inflation-adjusted prices of crude oil and a sharp decline in home construction. On the inflation front, energy prices fell substantially towards the end of the year, allowing overall consumer price inflation to moderate in 2006; however, price inflation increased for goods and services other than food and energy. In response to these output and inflation developments, the Federal Reserve continued raising the federal funds rate through June, and then held it constant for the rest of the year. The Administration forecast calls for the economic expansion to continue in 2007, but we must continue to pursue pro-growth policies such as those designed to keep tax relief in place, restrain government spending, slow the rate of health care inflation, enhance national energy security, and expand free and fair trade.
This chapter reviews the economic developments of 2006 and discusses the Administration's forecast for the years ahead. The key points of this chapter are:
1. Real GDP posted strong 3.4 percent growth in 2006, up from the 3.1 percent 2005 pace. The composition of aggregate demand changed from preceding years. More growth came from exports and business structures investment, while residential investment flipped from contributing to GDP growth in 2005 to subtracting from it in 2006.
2. Labor markets continued to strengthen, with the unemployment rate descending to 4.5 percent in the fourth quarter, and payroll job growth averaging 187,000 per month.
3. Energy prices, which rose through August and then declined, dominated the movement of overall inflation in the consumer price index. Core inflation (which excludes food and energy inflation) moved up from 2.2 percent during the 12 months of 2005 to 2.6 percent in 2006, with much of this upward trend due to an acceleration in the amount that renters pay for apartments and other rental properties and the estimated rent on owner-occupied housing. Energy prices fell sharply from September through October, and core inflation fell toward the end of the year.
4. Real average hourly earnings accelerated to a 1.7 percent increase during the 12 months of 2006, reflecting solid labor markets combined with tamer energy prices.
5. The Administration's forecast calls for the economic expansion to continue in 2007 and beyond, although the pace of expansion is projected to slow somewhat from the stronger growth of recent years. The unemployment rate is projected to edge up slightly in 2007, while remaining below 5 percent. Real GDP growth is projected to continue at around 3 percent in 2008 and thereafter, while the unemployment rate is projected to remain stable and below 5 percent.