Recession: Long and Deep

The sharp slump mil be followed by an anemic recovery

The TIME Board of Economists met last week in Manhattan to review the nation's quickly deteriorating business situation. After looking at the economy's vital signs, the experts concluded that the recession of 1980 will be longer, deeper and more painful than was expected only a few weeks ago. Unemployment threatens to climb to a peak of 9% or more by early 1981, matching and perhaps even surpassing the 9% jobless rate that was briefly touched during the 1973-75 slump. Next month's release of growth figures for the second quarter is expected to show the economy dropping by about 8% on an annual rate during April, May and June.

It will be next year before the U.S. will enter a slow, fitful and anemic recovery. Said Joseph Pechman, director of economic studies at the Brookings Institution: "From the end of 1979 through the end of 1981, there will be no net growth in the real gross national product."

This recession has a character very different from the last one, which started in 1973. Aggravating the earlier plunge was a buying spree by businesses during the boom just prior to the recession. When the economy started to grow stagnant, firms were suddenly forced to cut back inventories, thus causing the economic avalanche. The present slide has been triggered almost exclusively by a cutback in consumer spending. Sometime in late winter Americans simply closed their wallets and snapped shut their purses. Sales of everything from autos and home appliances to airline tickets have dropped sharply.

Inventory-fueled recessions are essentially self-correcting because, once company stocks become manageable, firms start ordering again, and the economy picks up quickly. But a consumer-led recession lacks that built-in mechanism. Board members said that it could take a long time to get the American public spending again, without, of course, launching them on another inflationary shopping spree such as prevailed last winter.

One piece of good news that the economists could offer was some moderation in inflation. After a flirtation with hyperinflation earlier this year, the nation's price-rise fever seems at last to have broken--at least for now. Curbing the price explosion, even at the expense of a recession, has all along been the objective of the Federal Reserve's eight-month-old tight monetary policy. By steadfastly holding down the growth rate of the nation's money supply, Fed Chairman Paul Volcker has pushed interest rates to their highest levels in a century, slowed borrowing by businesses and individuals alike, and sent the housing and auto industries into a tail spin.

Producer price figures for May released last week showed that the strategy is paying off. From a peak of 19.6% on a compound annual basis in March, prices grew last month at an annual rate of only 3.7%, indicating that increases in retail prices to consumers, which are also slowing, will continue to decelerate in the months ahead. Indeed most Board members predicted that consumer price rises would be about 9% by the end of the year. Walter Heller, chief economic adviser to President Kennedy, was more sanguine, predicting that price increases would be running at an annual rate of between 7% and 8% by October. This would be a significant drop from the 18.1% rate for the first three months of the year.

Beryl Sprinkel, chief economist of Chicago's Harris Bank, welcomed the decline as evidence that the Federal Reserve is really serious about "beating inflation down." He predicted that by the end of 1981 a sustained and steady course of slow money growth will result in an inflation rate of about 6.7%.

The decline in inflation from 18% to 9% or so, however, may be the easiest part of the war on high prices. Heller argued that any seeming improvement will, to a considerable extent, be illusory and of only short duration. Inflation surged during 1979 and early this year in large part because of the explosion of petroleum prices, interest rates and housing costs. Petroleum prices are still rising, but not nearly as sharply as in 1979. And interest rates have been falling rapidly in recent weeks. These two factors alone will help to lower the Consumer Price Index.

Yet short-term price fluctuations simply mask what Heller termed the "hardcore," or "base," inflation rate. This inflation is largely independent of any temporary shock effects, like shifts in gasoline prices or mortgage rates. It is caused by the momentum of generally rising prices, as everyone in a society passes on his rising costs. The hard-core inflation is especially linked to wages, which continue to move steadily higher to catch up with the cost of living. This base inflation rate, Heller warned, is not likely to be slowed very much by the recession. Said he: "What disturbs me is the progression of this hard-core inflation rate. In the early 1960s it was 1%, in the early 1970s it was 3%, by the mid-1970s it had climbed to 6%, and by now the base rate is 9%." Returning to a base inflation rate of 1% to 2% will be as difficult as sobering up a drunk after a ten-year binge.

Both Heller and Otto Eckstein, president of Data Resources, a Lexington, Mass., consulting firm, warn that short-term improvement in consumer prices in the next few months will not be evidence that inflation itself has been beaten. Said Democrat Eckstein: "The politicians will think that they've licked inflation, but it will only turn out to be that fruits and vegetables, or some other such component of the consumer price index, performed better than expected for a couple of months."

Moreover, Economist Eckstein warned that the current slowdown in petroleum prices is not going to last. This week the 13 members of the Organization of Petroleum Exporting Countries will meet in Algiers, and are likely to agree on yet another boost in the cost of crude. At present the average worldwide cost of oil is about $31 per bbl., but Eckstein projects that it will rise to $35 per bbl. by year's end and $42 per bbl. by the end of 1981. A rise of that magnitude, more than double the U.S.'s projected climb in consumer prices during the period, would stoke up inflation all over again.

The economic experts saw some modest encouragement in the continuing strength of the world's other leading economies. During the 1973-75 downturn, nearly all industrial countries marched lockstep into a deep recession, knocking world trade flat and devastating export industries. Yet in the present situation only the U.S. and Britain are reeling. The economies of most of Continental Europe and Japan remain relatively buoyant, with inflation under greater control. This should help U.S. exports and give new strength to the American dollar. Said Heller: "One of the upbeat aspects of a downbeat economy is that real exports will improve." The return to stable economic growth in the U.S. is likely to be slow and arduous. Any quick moves to provide eco-nomic shock treatment would probably only result in another round of inflation. The two sickest sectors of business, housing and autos, do not appear to be near immediate recovery. Guest Panelist Marina Whitman, chief economist for General Motors, forecast a modest pickup in car sales during the summer and then stronger sales after the introduction of new models in the fall. Much of the increase is likely to come from customers seeking small, fuel-efficient cars. Washington Economic Consultant Robert Nathan pointed out, though, that since Detroit's production capacity for such models remains limited, aggressive Japanese automen are likely to make further inroads on the American market.

Housing is also likely to remain very sluggish, despite the drop in mortgage rates from 17% to about 12 1/2% over the past two months. Alan Greenspan, former chief economic adviser to President Ford, predicted that they will have to decline another 1% to 2% before there is a significant rebound in home sales.

Board members are concerned that, with unemployment increasing and the economy slipping into a steeper-than-anticipated slump as the November election approaches, vote-hungry politicians will forget the fight against inflation. They fear a scramble to hold down unemployment by stimulating the economy with easy money and big new federal spending programs. The political rationale for swinging back to a policy of spend and spend is likely to seem all the more beguiling as a result of the hopeless muddle that both Carter and the Congress have made of their joint effort to produce a balanced budget for fiscal 1981.

Because of the deepening recession, there is now no chance of balancing the budget next year. Each percentage point increase in unemployment beyond the unrealistic 7.2% that Carter estimated in preparing his budget, means an increase in the deficit of about $25 billion. But both Republican Greenspan and Democrat Pechman feared that Congressmen will now simply despair and start throwing money at the nation's economic troubles. This could have important effects on both inflation and the nation's political process (see box). Greenspan also warned of future economic troubles. Said he: "Because of the long lead times that it takes for federal spending to work through the economy, we will, in effect, be making policy for 1982 and 1983 in the coming months. If we blow it now we'll be looking at 25% interest rates in 1982 and double-digit unemployment in 1983."

To Eckstein the whole budgetmaking process has by now become, in effect, little more than rhetorical waltzing. Quipped he: "The so-called full employment budget concept, invoked since the Kennedy years, in which Government ran deficits equal to the taxes that would have been collected if the economy were at full employment, has now given way to an even more slippery concept--the January assumption budget, or 'JAB.' This is an attempt to balance the budget in the hypothetical world of January economic forecasts that are long obsolete."

Murry Weidenbaum, a visiting scholar at the American Enterprise Institute in Washington, warned that much of the runaway spending does not actually appear in the budget at all. Said he: "The whole approach must be: don't just stand there--un-do something. The Government must not only cut its budget deficit; it must reduce the expenditures of off-budget agencies, such as those that provide guaranteed loans to students, farmers and homeowners."

In spite of the evident need for steadiness and fiscal restraint, the Board showed surprising agreement on the likelihood of a tax cut of perhaps $30 billion early next year. Greenspan suggested that Carter, who has repeatedly opposed tax relief until the budget is brought into balance, is now preparing to call for a cut. He predicted a tax reduction proposal "as early as next month in the midyear budget review, with the tax cut taking effect on Jan. 1,1981."

Next year's heavy increases in Social Security taxes, the continuing phase-in of Carter's windfall-profits tax on the oil industry and the added taxes on inflation-induced salary increases will raise the tax burden by some $44 billion next year. Board members generally favored some relief from the tax load, which is already the heaviest at any point since World War II.

A quick-fix solution to the recession in the form of a big spending program or a huge tax cut will be an attractive temptation in this election year. But the legacy of ten years of stop-go economic policy is ever deeper recessions and ever higher inflations. If the nation takes off into another business-go-round without knocking down its hard-core rate of 9% price rises, the inflation fire next time could be 20% or even higher. The economic, social and political costs of fighting the nation's dangerous inflation will be great, but they must be paid now if the U.S. is to avoid an even greater price at some later time.

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