Reaganomics faces political, economic crunch
Economic recovery in the United States should begin this month or next month.Skip to next paragraph
Subscribe Today to the Monitor
That's what a computer-based model of the economy is telling Citibank, and, according to Leif Olsen, the New York bank's model ''tracks pretty well.'' In other words, the econometric model has a good forecasting record.
Citibank's forecast is not too far from the consensus of economic predictions. A survey of some 40 business economists by Blue Chip Economic Indicators finds that the recession should end this spring. But the upturn will be far from robust, the group reckons.
The large federal budget deficit and high interest rates have led to increased gloomy talk about the current slump in business activity worsening or interest rates climbing back up to astronomical heights.
For instance, Allen Sinai, an economist with Data Resources Inc., an economic consulting firm in Lexington, Mass., sees the economy in a ''Catch-22'' situation where recovery would produce such high interest rates that it would quickly abort and return to recession.
But Citibank's Mr. Olsen says the Sinai thesis ''is one of those mechanical scenarios that has no economic theory behind it.'' He maintains there is no magic relationship between the level of interest rates and changes in economic activity.
As an illustration, he noted that in the second half of 1980 interest rates climbed some 20 percent. Yet the economy boomed in the first quarter of 1981, rising at a 19 percent annual rate in nominal terms and a 9 percent rate after removing the impact of inflation. Interest rates then declined before starting to climb again in the summer. Despite those high rates, the economy grew at an 11.4 percent nominal annual rate and a 1.4 percent real rate in the third quarter.
Citibank's econometric model is ''monetarist,'' that is, it relies heavily on changes in the patterns of money-supply growth to forecast the economy. Its current indication of a recovery in February or March hangs on the sharp acceleration in the rate of growth of the money supply over the last three months. ''That will give a lift to the economy despite the boost in interest rates,'' Olsen says.
Already there is some evidence of possible recovery. The so-called economic indicators rose in December, the first increase since July. And Olsen would not be surprised if February retail sales showed ''a good increase.''
Allen Sinai's thesis hangs on a rapid recovery. ''Since periodic sharp recoveries from low levels of economic activity are inevitable,'' he writes, ''the prescriptions of the new Fed policy guarantee rising interest rates early in recovery and suggest only brief expansions.'' Since October 1979, the Federal Reserve System has put greater emphasis on controlling the growth of the nation's money supply rather than interest rates.
For the last few months, the Sinai argument goes, there has been an accidental rapid expansion in money. This will force the Fed, under its new policy, to tighten money in the midst of a recession. At the same time, the budget deficit will be growing. Since that deficit will need financing, there will be a clash with the Fed's sterner monetary policy and interest rates will rise, choking of the expansion.
''Either inflation rates must drop by more than expected, the administration or Congress compromise to tighten the budget, or the central bank ease to avoid what is turning out to be the worst recession experience in the postwar period, '' states Sinai.
Olsen also figures the Fed will soon rein in the growth of the money supply. But this, he says, will prompt interest rates ''to back off.'' That view is contrary to the view held by Sinai and many other economists that a tight monetary policy boosts interest rates. But it is a pattern that the money markets have seen for some years now -- faster money growth prompts higher interest rates; tight money, lower interest rates.
Further, the moderate monetary restraint will mean a moderate recovery, predicts Olsen. That recovery plus the budget deficit could eventually prompt interest rates to increase somewhat, but not back to the sky-high rates of last year.
Mr. Olsen regards predictions of $200 billion deficits or worse by 1984 as ''absurd.'' He adds: ''It has become a case of 'gamesmanship' as to who can come up with the most frightening budget forecast.''
He expects Congress to trim spending to reduce the deficits.
In its publication, Economic Week, Citibank holds that Congress will find that the only things worse than the President's budget are the alternatives. ''The looming deficits can only be closed by sharply raising scheduled taxes or by severely cutting total spending. Neither option will prove very appealing to Congress in this election year.'' Citibank expects Congress to pare defense outlays, but to refuse to make even a larger amount of the proposed cutbacks in nondefense programs. So large deficits will remain, creating problems for monetary management and adversely affecting investors' expectations.
''But the dangers should not be exaggerated,'' the bank publication cautions.
Citibank is predicting somewhat less economic growth this year than the President's Council of Economic Advisers. It expects nominal GNP to rise 9.1 percent and real GNP 2 percent, both about 1 percent less than the CEA forecast. Next year the bank expects nominal output to grow 10 percent and after-inflation GNP 4.1 percent, again about 1 percent less than the CEA. The Blue Chip consensus sees zero real growth in GNP this year and around 4 percent in 1983.