Virtually all economic forecasters now believe the economy has entered a recession, and it probably has. Chase Econometrics Inc., a major forecasting firm, thinks unemployment will rise from March's 6.2 percent to more than 8 percent by December and stay there for most of 1981. The administration's more optimistic prediction puts unemployment at 7.2 percent at year's end. But Lyle E. Gramley, a member of the Council of Economic Advisers, already was disturbed in mid April by a string of economic statistics: a sharp increase in initial claims for unemployment insurance, a larger-than-expected drop in housing permits and a continued slump in auto sales. Gramley said the recession was either arriving earlier or going to be worse than expected. The subsequent jump in the unemployment rate to 7 percent confirmed his worst fears.
If gramley sounds shaky about his predictions, so do most forecasters. They should. Their record of the past three years has been deplorable. They consistently have underestimated inflation and overestimated inflation and overestimated the potential for recession. That doesn't mean that last week's errors will be next week's, but the basic problem remains. The economy's performance -- including now the recession's depth, duration and effects -- depends mostly on things they don't know or can't know. It is like a giant detective story: It is like a giant detective story: a lot of facts on the prowl on a plot.
The biggest unknown is inflation itself. We really don't understand yet how it affects the behavior of individuals or companies. Indeed, we aren't even sure what the rate of inflation is. Consider the consumer price index. It has increased at an annual rate of 18 percent in 1980, but most people don't experience price increases of that magnitude.
There is no paradox here. Many components of the index simply have risen far less rapidly than the whole index. In the past year, food prices have increased 7.4 percent, clothing prices 7.1 percent and entertainment prices 8.1 percent. What has acounted for much of the index's huge jump is the explosion of energy prices (up 47.2 percent) and the spectacular leap in mortgage interest rates. But current mortgage rates don't affect most people and consumers have offset higher energy prices partially by using less Gasoline consumption is down almost one-tenth from 1979 levels, heating oil about one-sixth.
All this is important, because personal consumption constitutes about two-thirds of all spending and remains the economy's key driving force. We need to know how much inflation has reduced purchasing power. Applying an increase of 14.7 percent in the CPI since March 1979 against a rise of between 7 percent and 8 percent in earnings indicates a drop of between 7 percent and 8 percent in purchasing power. But another index, the "deflator" for personal consumption expenditures, has increased about 10 percent over the same period, implying a loss of only between 2 percent and 3 percent. The deflator shows the price increases for the things people actually buy, weighted by the amount they buy.
A second big unknown is how employers will adjust their work forces to a slowdown. Typically, unemployment rises sharply only after the onset of a recession. "There's a large cost in firing, rehiring and training. So they wait." said Sandra Shaber, an economist for Chase Econometrics.
Over the past five years, jobs have increased at an astonishing rate. At the end of 1979, employment totaled nearly 98 million against an average of 86 million in 1974. Does that mean a lot of marginal workers can expect to be fired once companies hit a profits squeeze? Maybe. Already, auto company layoffs have cut deeply into the ranks of white-collar workers.
But beware. About 60 percent of the employment increase has occurred in services and in wholesale and retail trade. Although that seems to imply a lot of vulnerable sales clerks, it may not. Retail employment has grown rapidly because a boom in shopping centers created a lot of new stores, says Stuart M. Robbins, an analyst for the securities firm of Paine Webber Mitchell Hutchins Inc. Between 1973 and 1978, retail square footage in shopping centers expanded nearly one-third, according to the firm's figures.
You need people to run stores. Robbins, for one, believes that most retail chains have kept their payrolls tight and that there isn't much room for further reductions. Sears, Roebuck & Co., the nation's largest retailer, provides indirect confirmation. Since 1977, it has cut employment 17 percent despite a small increase in store space.
A third major unknown is whether -- and by how much -- reduced spending in one sector will depress the economy or simply permit an increase elsewhere. For example, a rise in consumer saving traditionally has been viewed as a drag on the economy because it implies less consumer spending. Likewise, lower government spending has been seen as a depressant. But increased saving and reduced government borrowing also would exert downward pressure on interest rates. Would that revive the housing industry and sustain business investment?
We don't know, of course. Indeed, we don't know whether individuals will increase the savings rate from today's puny 3.4 percent level. Worried about past debts and future dangers, they might. But a determination to maintain living standards could produce just the opposite result.
All this makes the recession's outline hazy, but the basic unknown is the economy's adaptability. Today's most insistent pressures include uncertain oil supplies and the Federal Reserve's determination to cut inflation by slowly reducing the growth of money. The great danger is stagnation: not just recession, but sickly recovery. The way to avoid the trap is to reduce price pressures, lowering the amount of money required to pay ransom to inflation and leaving more to stimulate new production and more jobs.
But will the economy favor production that reduces price pressures? We need more investment to minimize consumption and price pressures on world oil markets. We need more home building to house the baby-boom generation and stem real estate inflation. We need more innovation to offset labor costs in production and distribution processes. We need more competition to hold down wage gains extorted only by market power. The individual decisions of consumers, business and government produce collective results. The question is whether they give us something better than an unsatisfactory standoff between inflation and unemployment.