The term "gap" is an overworked expression that we often use to describe a lack of connection, such as the "generation gap" and the "gender gap." To economist the term "gap" is used to describe the difference between how the economy is currently performing and its potential to perform. If we are performing below our potential, the resulting "recessionary gap" calls for expansionary monetary policy, but if we are performing above our potential, the resulting "inflationary gap" calls for tighter monetary policy.

While we have the ability to measure current economic performance very well, there continues to be uncertainty about whether or not the current unemployment rate is a good measure of our potential rate of output. When the unemployment rate is used to measure potential output, we talk about the non-accelerating inflation rate of unemployment (NAIRU), also called the natural rate of unemployment.

Low rates of inflation have been recorded in recent years, despite a decline in the unemployment rate to historic low levels that previously would have been associated with rising inflation. Indeed, since 1990 there has been a positive correlation between the inflation rate and the unemployment rate.

Is there a permanently lower natural rate of unemployment, or has the United States economy merely benefited from a series of fortuitous, temporary influences that have more than offset inflationary pressures caused by unemployment being below its natural level? These fortuitous benefits are attributed to a lower cost of imports due to the strong international value of the dollar and the downward pressures on resource demand due to recessions abroad.

If there has been no permanent change in the economy, then inflationary pressures are expected to re-assert themselves once these temporary fortuitous influences have ceased.

The Federal Reserve is obviously more prone to the conclusion that inflationary pressures are only temporarily under wraps and could renew in the near future. Hence, they are unlikely to move toward lower interest rates in light of the unexpectedly strong growth in fourth quarter GDP (preliminary 5.6 percent.)

Despite concern over labor shortages and rising labor costs, the economy has added 246,000 positions per month over the past six months. Impressively, the job gains have been well distributed across the economy. Only the manufacturing sector failed to grow among non-agricultural industries. Labor shortages are being reflected in higher employee costs, and the recent stronger dollar against the Yen is causing inflation forecasts to be increased slightly to around 2 percent from its present 1.6 percent rate.

Tom Kelly, Chairman

With December employment 2.6 percent higher and the labor force growing only 1.6 percent over the same period, the Waco economy is experiencing even tighter labor conditions than the average for the total economy. The 2.6 percent annual growth in Waco employment ranked 12^th among the State's Metro Areas.

Even though Waco's unemployment rate in December amounted to 3.2 percent compared with 4.4 percent statewide and 4.3 percent nationwide, it ranks as only the 9^th lowest among the 27 metropolitan areas in the State. Among the 8 Metro Areas with lower unemployment rates a large percentage of the State's new jobs were created in Austin-San Marcos, Fort-Worth Arlington, and Dallas. Despite the relatively high annual averages, the rates of growth in each of these three Metro Areas have declined significantly since their peak growth rates in January 1998. Dallas fell from over 6 percent growth to 2.9 percent; Fort Worth-Arlington from almost 5 percent growth to 3.2 percent; and Austin-San Marcos from almost 6 percent to 3.5 percent. This slower pace in major metropolitan areas is a major factor in the Federal Reserve Beige Book's prediction of slower growth for the region.

Although international forces have adversely affected U.S. industrial performance, there is new evidence that strong domestic consumption and improved export demand are increasing the fortunes of manufacturing firms. New orders for manufactured goods are finally beginning to kick in, as the demand for both durable (3.1%) and non- durable (1.2%) goods increased solidly.

Employment by local manufacturing firms in December was up 1.2 percent compared with the same period last year. Announced expansions and new additions and expansions are likely to add even more jobs over the next six months, according to reports by the Industrial Development Committee.

It is clear that households continue to hold the key to continued economic growth. But, while construction and trade continue to drive the local economy, year-end employment in every major sector increased or remained stable.

With the strong labor market, low interest rates, and low inflationary pressure there is every reason to be optimistic about the near future. However, when things are going this well, economist often return to their underlying pessimism--the reason economics is called the "dismal science." (Fortunately, consumers are not economists.)

Perhaps nothing is more reflective of consumer optimism than the demand for housing. Year-end construction employment in the State of Texas was 4.9 percent higher than a year ago. During the same period Waco construction employment increased 10.9 percent. Not all of the increase in construction employment was for housing, as several significant non-residential projects are underway. But, as shown in Figure 1, 1998 unit housing sales in the Waco Metro Area reached its highest level in the last 20 years.

Not only did the number of housing units sold increase 23.9 percent in 1998 from the previous year, but the average selling price continued its upward trend since 1993. Figure 2 shows that the average selling price for single unit housing in 1998 amounted to $90,900 which was 5.8 percent higher than during 1997.

The increase in average selling price is primarily due to more rapid sales in the higher-priced segments of the market. With lower interest rates the affordability rate of new housing increased, so that households could purchase more housing services with the same monthly

payments.

Quarterly comparisons of MultiList sales of single family units indicate show no signs of diminishing. Fourth quarter 1998 MLS sales were up 24 percent from the same quarter in 1997, which is the same as the annual rate of change for the entire year.

Single unit housing demand is projected to continue to rise in the Waco Metro Area in 1999, as long as the number of jobs continue to grow. Job growth is the force for immigration and growth in the number of households. Last year, the labor force expanded by 1,600 persons, adding over 880 area households.

The Census Bureau is projecting the population segment of Texans 65 years and older to increase by 20 percent over the next ten years. Table 2 shows that the aging of the population toward retirement years will be even greater in the Waco Metro Area than for the Sate average or other Metro Areas along the Central Texas corridor. The percent over age 50 in Waco is almost five percent higher than the State average.

The aging of the Waco population has several implications for local occupations. Employment within a majority of the health occupations is expected to grow faster than the overall area growth rate. Also, the demand for housing is likely to shift toward greater linkages to retirement amenities.

Although Waco has a disproportionate number of senior citizens, the impact of its educational institutions is reflected in the relatively high percentage of persons between age 18 and 24. (Were it not for this group, the average age of Waco citizens would be even higher.)

Over the next five years the Waco population is projected to increase 4.2 percent while the number of households is growing 6.3 percent. Effective buying income is projected to increase 28.4 percent, reaching an average of $45,330 by the year 2002. Retail sales are projected to increase 20.7 percent over the five-year period with retail sales per household reaching $27,210 by the year 2002.