Trend line of US economy is upbeat. (With this column, the Monitor welcomes Leif H. Olsen, former chairman of economic policy at Citibank, to its pages. Mr. Olsen is a consultant to Citibank and a private economic adviser. His column appears monthly.)
Numbers telling us how the economy is doing have been ambiguous for many months. But, read correctly, economic data over recent months show unmistakable signs of a pickup in activity and employment. Furthermore, the moderate acceleration we have seen so far will continue through the winter.
Economic numbers fluctuate from month to month. For example, the leading indicators for September were up only 0.1 percent. This was taken as a sign the economy would weaken in the months ahead. But if that is so, what can we say about the relatively strong increases of 0.6 percent in July and 0.9 percent in August?
If the leading indicators tell the truth, then what happened to the good news about the future heralded by those numbers when they came out? The answer is that economists should not place too much emphasis on one month's number.
Averaging results over time provides a clearer picture of what is happening, and what may happen, to the economy. For example, in the three months through June, the leading indicators averaged out to no change; in the three months through September, the index averaged a 0.4 percent increase. Looked at that way, things are clearly getting better.
In one recent issue of the Monitor (Nov. 1), the leading indicators and the September trade balance were said to be troubling signs for the rest of the year. Robert Gough, vice-president of Data Resources, was quoted as saying that Federal Reserve chairman Paul Volcker ``is going to have to allow rates to come down a little bit more to bolster domestic activity.''
And in the same issue, economist Paul A. Samuelson said the United States economy is in good shape, adding that ``The fact that there have been recent signs of strength for the current recovery suggests how hard it would be for the Federal Reserve to force down real interest rates significantly.''
Who is right? I would side with Dr. Samuelson, who takes a longer view of events than one month. He notes the actual pickup in US output in the third quarter. But there are other reasons for agreeing with the professor. Real gross national product measures total output. It excludes changes in prices. It is the most popular measurement of economic performance. It rose 1.9 percent in the three months through June and 3.3 percent through September, according to the latest numbers available.
But monetary and fiscal policies also affect demand in the economy. Monetary policy in particular has been highly expansionary since October 1984. Where is the evidence of this policy? Well, if we look at domestic real demand, we will find it. This demand increased by an average of 3.8 percent in the six months through March of this year. It increased 5.8 percent in the six months through September. Once again, the average results over time reveal that demand is accelerating.
In fact, when Mr. Volcker spoke in Toronto Oct. 31, he peeled away some of the illusive numbers to speak expressly about how well domestic demand has been doing. The words were underscored in his text, signaling the importance he placed on them. He contrasted the relatively strong growth in demand with the weaker increase in output.
Domestic demand was up 5.8 percent in the past six months. How do we explain the relatively slow 2.5 percent increase in output? Here is the answer. Demand was met by imports and a reduction in inventories accumulated from earlier production.
Unless income and demand suddenly plummet, the persistent gap between output and real domestic demand implies a future pickup in production and employment to meet demand and replenish inventories. The gap cannot persist indefinitely. In fact, the September report from corporate purchasing agents said business had picked up; for October the improved performance was holding.
One more sign of improvement: The unemployment rate for October was unchanged. Was this good or bad? The unemployment rate, as a ratio, can often be misleading. Employment numbers are derived from surveys. The household survey numbers of employment levels are usually subject to greater revision and are not regarded as being as reliable as the establishment numbers.
Actually, employment climbed by 414,000 in October, compared with 250,000 in September. But again, let's look at the numbers over time. For the three months through October, employment increased 673,000, compared with 660,000 in the preceding three months. The pickup is slight, but it makes October impressive. More data in the months ahead will help determine the trend.
Studies show a loss of jobs to imports, particularly inmanufacturing. But the US economy has created more than 9 million jobs since the recession ended three years ago. And it occurred at the same time our trade deficit climbed from $30 billion to $130 billion. The huge buying by Americans in other markets of the world created employment for people in other countries.
The low value of foreign currencies in terms of dollars creates a competitive advantage to overseas producers which is so powerful it is as though factory capacity had been annexed to the US. In short, American consumers can buy more and more with less risk that demand will press against capacity and thus cause prices to climb. But that leaves US factories with excess capacity, less than full employment, and disappointing earnings. That's what the relatively small GNP numbers of the past year tell us.
From here on, one of the issue facing the Federal Reserve is: Should monetary policy seek to increase income, and hence demand, enough to give US producers a larger share after importers have received theirs?
Remember real domestic demand has already been growing in the last six months at the relatively fast annual rate of 5.8 percent. Raising it to, say, 7 percent to increase US output from 3 percent to 4 percent would be a neat performance, but experience tells us the risk of overshooting is high. Furthermore, if the dollar falls as sharply as some expect, knocking some overseas producers out of the US market, demand could be too much for domestic suppliers without prices rising to clear the market of t he excess demand.
The Federal Reserve worries about this, too, and Mr. Volcker subtly revealed this in his Toronto speech.