The furrows on Wall Street's brow are multiplying.
It's not just that the Federal Reserve raised short-term interest rates another half a percentage point last week and that stock prices have been falling.
There's a growing suspicion that the New Economy, with its handsome productivity gains, will not save either the New or Old Economy from trouble.
"The mood has definitely changed," says Matt Higgins, an international economist with Merrill Lynch, a major investment bank in New York.
The happy glow from the extended bull market has faded. Most economists foresee a modest slowdown in the United States economy. But many see a risk of something worse. Their concern is based in part on the lengthy rise in the prices of corporate stocks and other assets and also of the debts of individuals and companies. Both are rising at a faster pace than growth in gross domestic product (GDP) - the output of all goods and services in the nation.
"As this process goes on over time, it tends to become destabilizing," says David Levy, director of forecasting at the Levy Institute in Mt. Kisco, N.Y.
Even the R word - recession - is appearing. Kathleen Camilli, an analyst with Tucker Anthony Inc. in Boston, notes that a "reverse wealth effect" from a drop in the stock market, accompanied by a drop in the foreign exchange value of the US dollar and an outflow of foreign investment money, could produce a recession.
Such an outcome would be significant: The economy has been in recession only nine months over the past 18 years.
Treasury Secretary Lawrence Summers sounds more cheery. In a recent speech, he spoke of a "new market dynamic" in which the knowledge-based New Economy - with its computers, software, and the Internet - creates greater efficiency as growth rises, keeping prices and inflation in check.
But the Fed, concerned that the reading on the economic thermostat is too high, has decided to turn down the heat with a tighter monetary policy.
Wall Street analysts are now debating whether the Fed will raise interest rates again by the same 50 basis points as in May, or just half that, when its policymakers meet June 27-28. (A hundred basis points amounts to a full percentage point.)
Since last June, central bankers around the world have raised interest rates some 80 times, according to Merrill Lynch. As a result, Mr. Higgins sees a "moderate to low risk" of a "hard landing" for the US economy. Instead of the 3.5 to 4 percent real growth for GDP that the Fed wants, after-inflation growth would drop to 1.5 percent or less - or even turn negative.
The worries are several. One concern is that the impact of Fed interest-rate hikes is always somewhat uncertain. "It's more than an on-and-off switch," says Stan Shipley, another Merrill Lynch economist. "There's a risk the Fed will slow the economy too much."
Another worry is that the New Economy is so new. It has introduced unusual elements into the system. It has raised productivity, provided a rush of new jobs, and helped tame inflation at a point far into the business cycle. "Nobody alive has seen what it is like when the underlying trend of productivity picks up again," says James Glassman, chief economist of Chase Securities in New York. "That is why everyone is disoriented."
"Enough unusual or unexpected things have taken place that it becomes an uncertain environment in which to operate," says Peter Kretzner, an economist with Banc of America Securities in New York. "If the Fed can't answer why things are the way they are, it can't say what can be done to keep things the way they are."
Beware irrational optimism
Other forces are at work that could lead to a sharp downturn as well. Bill Dudley, an economist with Goldman Sachs & Co., a New York investment firm, worries about "excessive optimism" for future corporate earnings and stock prices, which has fueled a boom in business investment. "If disappointment occurs, the result could be an investment bust," he says.
Mr. Dudley is also concerned that the stock-market rise of recent years has created imbalances in the real economy.
Household savings dropped as investors saw the value of their portfolios climb. They spent some of their capital gains, realized or not. If stocks decline for a longer time, investors may increase savings dramatically to offset their losses, spending less and slowing the economy.
Dudley and some others also believe that the Fed let the jobless rate fall too low. As a result, workers are winning big wage hikes, raising costs and spurring inflation.
Let's not panic yet
Still, for now Goldman Sachs is forecasting only a modest slowdown in real GDP growth as this year progresses.
Some economists are keeping a close eye on the slowdown in the growth of the money supply - the fuel for economic expansion. Mr. Kretzner foresees a "significant slowdown" this month. But he figures the strong growth in the economy gives the Fed "some margin for error" in its moves.
Noting the same money trend, Paul Kasriel, an economist with Northern Trust Co. in Chicago, says that tougher Fed action could trigger "a sharp decline in equity prices, a significant increase in private-sector credit problems, and an abrupt slowdown in private domestic demand."
(c) Copyright 2000. The Christian Science Publishing Society