Recent economic reports must have produced widespread bewilderment: Signs of the end of the recession began to blossom at about the same time a Commerce Department report on the gross national product confirmed that production fell precipitously in the second quarter.
Those who wish to assess the merits of the various tax-cut proposals and other policy prescriptions that daily capture headlines should find it useful to have an explanation of what initially may seem to be contradictory bits and pieces of economic information.
Business cycles follow a logical sequence of events, during which a decline in sales initially produces an unanticipated accumulation of inventories. Then when sales pick up, these inventories must be drawn down before growth of prodction resumes. Growth of employment comes still later, since the initial pick-up in production usually is achieved by adding to the work week of those already on payrolls.
Business had been cautious in inventory policies for a long period before the current recession began, and the buildup of unsold goods has not been as great as in previous recessions.
Nevertheless, sharp sales drops this spring created excess inventories which must be worked off. The first signs of inventory reduction appreaed in May, and June's rising sales suggested another dip in inventories for that month. If June figures confirm this pattern, it would consitiute a remarkably quick beginning of the inventory correction.
Not only the early start of the inventory correction but signs of a pick-up in home-building and indications of reviving strength in consumer purchasing foretell the end of the recession. First, however, the remainder of the excess inventories must be worked off. This is the chief reason for forecasting a further, though more moderate, production decline in the current quarter.
Alathough the recession will come to an end without stimulative action by the federal government, prospects for an excessively slow 1981 recovery indicate the need for a tax cut next year to spark a faster return to full utilization of productive capacity. After-tax personal income (adjusted for inflation) dropped sharply in the second quarter and is now back where it was at the end of 1978. Income growth must resume if the consumption increases necessary for a healthy economic recovery are to occur.
In the absence of some presently unforseen outside stimulant to growth in employment, a well-structured tax cut would be the most reliable source of income stimulus.
Fiscal policy will be exerting a restrictive influence on the economy next year despite the large deficit now anticipated.
Were it not for the extra fiscal drain caused by high unemployment and reduced growth of taxable incomes, a rapidly growing budget surplus would emerge next year. The expected deficit results from the recession's automatic effect on the budget; it is not indicative of any stimulative policy in response to the recession. A tax cut of reasonable size would only partly offset the shift toward a more restrictive budget and would not be inflationery.
The inflation rate was substanially reduced in the second quarter. This was not apparent from the movement of the GNP deflator, cited in many newspaper accounts. The deflator rose more in the second quarter than the first. That was a statistical quirk in this usually valuable economywide measure of inflation, a quirk arising from an unusual combination of shifts in relative prices and in relative quantities of the types of goods purchased.
The fixed-weighted GNP price index (often referred to simply as the GNP price measure) is also an economywide measure. It is the one routinely featured in the Commerce Deppartment's GNP release because it measures only price changes, not shifts in the mix of goods purchased.
It indicates an 8.9 percent annual rate of rise in the second quarter compared with 10.9 percent in the first three months of the year.
The more familiar consumer price index also shows a similar pattern of improvement, dropping from an 18 percent rate of increase in the first quarter to 11.15 in the second.
While we can cite this as progress in the fight against inflation, the steady advance of labor and other production costs imply a basic inflation rate of 8 percent to 10 percent. This underlying inflation rate must be attacked as a long-term problem. In the interim, a narrow road must be trod between rising unemployment caused by too litlle stimulation of economic growth and rising inflation caused by too much.
Discussion of the size and kind of tax cut or other stimulus needed becomes even more comlicated when sectoral and geographic patterns are considered. The recession has been strongly concentrated in the automobile and homebuilding industries.
This leads to the difficult question: will a general tax reduction provide the stimulus where it is most needed?
The mpact from declining activity in homebuilding has been nationwide, albeit somewhat uneven. Its problems primarily were high interest rates and lack of funds available for mortgages. The drop in homebuilding everywhere has been sharp, but -- with interest rates having dropped rapidly -- recovery apparently has begun.
Interpreting current economic data is only slightly less risky than forecasting, but the recent data do seem to point to the following conclusions: f
despite the second-quarter plunge in output and the near certainty of some further output decline in the third quarter, this recession now shows signs of coming to an end surprisingly quickly. The bad news is that growth during the recovery initially is likely to be much slower than most of us would like.
The inflation rate was substantially reduced in the second quarter.bad news is that further progress toward price stability will be slow at best. The problem of inflation has been with us throughout the 1970's, and its solution will require a long-term effort.
This recession is more heavily concentrated in a single industry and a single region (the northcentral states) than usualy has been the case past recessions.
All this seems to point to the following policy guidlines: First, tax cuts or other stimulative measures should be considered, not to bring an end to the recession, (which will end soon anyway), but to strengthen the rate of economic growth next year and over the next several years.
Second, in light of the continuing problem of inflation, tax cuts and other stimulative measures, although important, should not be overdone: perhaps three-quarters of the nation is experiencing only a fairly mild recession.
Third, efforts are needed to respond directly to the much greater economic distress in those parts of the country where recession has struck with full and vicious force.