The economic outlook for 1981 is growing steadily worse.Most forecasters now expect unemployment to go up and inflation to be only slightly lower than in 1980; and that's the good news. The bad news is that the reality may turn out to be worse than the forecasts.
During the first half of the year "the economy will essentially stagger sideways," with a distinct possibility of at least one quarter of outright decline in economic activity, predicts economist Otto Eckstein of Data Resources Inc.
The second half of the year will see a resumption of economic growth, but only barely enough to begin to reduce unemployment very slowly, if President-elect Ronald Reagan and Congress approve a large $30 billion to $40 billion personal and business tax cut, Eckstein says.
Moreover, he fears stimulative effect of the tax cut "will be defeated by the Federal Reserve," as its low targets for growth of the money supply run head on into the economy's need for cash to finance both real growth and inflation. Unless inflation slows abruptly -- a development some of Reagan's economic advisers confidently predict can occur -- or else the rate at which each dollar is used over and over speeds up more than exptected, Eckstein warns there will be no recovery in the last six months of 1981.
At Chase Econometrics, an equally gloomy Lawrence Chimerine declares, "Although recent increases in industrial production and the psychological lift of the election results have raised hopes of a stronger economy, underlying demand remains very sluggish. In fact, the current situation in many ways is similar to early 1980 when the rise in interest rates and inflation, combined with a reversal of several temporary buoying factors, led to the sharp decline in the economy."
A second severe recession is not the most probable outcome this time, Chimerine believes, but adds, "Economic activity over the next four to six months will flatten out."
Or as Alan Greenspan, the former chairman of the Council of Economic Advisers who is now aiding Reagan, succinctly put it in the headline of a recent forecast sent to the clients of Townsend-Greenspan & Co., "GNP Forecast: Stagflation Near-term." In explanation, he declared, "The recovery is likely to be quite labored and there are significant risks that it could stall before solid growth is resumed."
Specifically, these and many other economists generally foresee the following for 1981:
Economic growth -- essentially none or perhaps a small drop in the first quarter, very modest growth in the second quarter and then a resumption of growth in the 3 percent to 4 percent range for the final two quarters.
Unemployment -- increasing from 7.6 percent in October to 8 percent or more in the first half of the year with only a small drop before the end of 1981 even with a large tax cut.
Inflation -- Consumer Price Index rising about 11 percent during the year, down from about 12 percent in 1981, though Greenspan believes there will be significant improvement with the CPI going up only about 9 percent.
Meanwhile, there are several risks that could cause the economy to perform even more badly in 1981 than these forecasts indicate, with two heading the list: Oil prices could explode again if the Iran-Iraq war continues indefinitely; and poor growing weather could again hit the world, only this time with grain reserves much reduced because of 1980's near crop failures. Either of these developments could make inflation much worse, and with the normal response of governments to that, plunge the whole world into a new recession cycle.
Whatever proposals Reagan makes when he becomes president will change this economic outlook very little. For one thing, any change in policy will begin to have an impact only in the second half of the year. In addition, he will be assuming office against a background of the tightest monetary and fiscal policies the United States economy has seen in years.
The recent surge in interest rates, which took banks' prime lending rate to 17 1/2 percent last week, is the direct result of deliberately chosen policies at the Federal Reserve. The Fed's severest critics, while still complaining about its inability to chart a smoother course, are beginning to agree the central bank really means what it says about slowing the growth of the money supply to fight inflation, even at the cost of a renewed recession. Reagan and his economic advisers, of course, have been crying, "Right on."
Not so as far as government spending and taxing policies are concerned. Reagan advisers still complain about the "hemorrhaging" federal budget in strident terms reminiscent of the latter days of the campaign.
In fact, using the same measures many of these advisers relied upon while part of past Republican administrations, the fiscal 1981 budget is significantly more restrictive than the 1980 budget, continuing a move away from stimulus and toward restraint that began in fiscal 1977. One element of this restraint is the large increase in Social Security taxes due Jan. 1 and the higher personal income tax liabilities that will arise as individuals are pushed into higher brackets by inflation.
However, the coming tax cuts and higher defense spending, all other things being equal, will stimulate the economy, at least temporarily. Cutting non-defense spending will act to restrain it.
But after adding all the likely changes together, Reagan's policies will certainly not offset the move toward restraint that would occur absent any changes at all, most economists agree. If so, the budget will be restraining the economy in 1981, not encouraging a more vigourous recovery.
Taken together, fiscal and monetary restraints are likely to be tough enough to keep any recovery very weak. For the moment, high interest rates are doing the damage.
"The recent sharp increase in mortgage rates has aborted the rebound in new housing construction," Chase's Chimerine declares. "Furthermore, many corporations have postponed long-term financing in recent months. Unless interest rates come down soon, this will cause some postponement in capital spending and some additional inventory liquidation over and above the modest declines already likely."
Eckstein agrees."There is no question that housing will be declining in the first part of 1981." And he thinks high interest rates, along with other pressures on consumer incomes, have ruled out the kind of rebound in new-car sales -- to about the 10-million-unit level -- that the auto industry needs for its own economic recovery.
With a decline in housing and at the least a lack of any further improvement in new-car sales, rule out much in real economic activity early in 1981, the DRI forecaster says.
Nevertheless, the economy has continued to expand so far this quarter, Greenspan and the other forecasters calculate, with increases in industrial production and employment. There could even be a small drop in the unemployment rate for November, he says. But these lingering improvements should end shortly.
Consumer incomes will be squeezed by the declines in some parts of the economy, and the lack of growth in others, just as higher taxes take a bigger bite out of take-home pay. Meanwhile, inflation will be taking its toll, too.
Except for Greenspan, the forecasters expect food prices to climb 12 percent to 13 percent during 1981. This year's poor growing weather in the United States and elsewhere around the world has boosted grain prices significantly, which will mean higher meat and dairy product prices later. Greenspan thinks the big increases in food prices will taper significantly after the middle of the year, with such prices in the end up only about 9 percent for the year as a whole.
Very sharp energy price increases are on the way as well. Eckstein, for instance, says prices at the pump for leaded regular gasoline will probably reach $1.48 a gallon by the fourth quarter of 1981, compared to $1.22 now. Oil product prices will be going up because of a combination of an assumed 15 percent or so increase in the world price of oil due to changes in official prices charged by OPEC nations, and to decontrol of remaining domestic crude oil prices in the United States.
Greenspan is more sanguine about inflation next year than some other forecasts because he expects wages to continue to rise more slowly than inflation. If productivity begins to increase more rapidly in the second half of the year as the economy begins to expand again, unit labor costs could decline somewhat and lead to lower inflation later.
Most of the forecasters agree such a process will be underway in 1981, but others expect a much slower improvement in inflation from it.
To an unusual degree, all economic forecasts should be taken these days with many grains of salt, even their authors stress. "This clearly is a unique period in American history," Greenspan cautions. "The process of economic development over the next two years is not readily inferred from historical analogies" or mathematical equations describing economic relationships. "It is a period of significant uncertainty, and one which easily could create a number of surprises," Greenspan adds.
He holds out some hope that as financial markets become convinced that the Federal Reserve does mean what it says and that Reagan will keep the budget under tight rein, expectations of future inflation will drop. Then there might be a greater anti-inflation payoff -- and faster real growth -- than he is forecasting.
On the other hand, unless there is some such change in inflation expectations, he also warns, then long-term interest rates may stay so high no recovery will be possible. "In a sense, we cannot have full recovery until mortgage interest rates, and long-term interest rates generally, come down substantially," he told his clients.
But Eckstein for one is highly skeptical the Reagan program will have any such anti-inflation payoff. "If expectations are formed in the future like they have been in the past, then this thing is not going to work.
"We are running a noble experiment" by trying slowly to reduce the rate of growth of the money supply in the face of a roaring inflation, he continues. "What we are likely to end up with is a constant collision between the Fed and the economy."