Last year was one of broken records and extremes for the economy. It showed how volatile economic developments have become, and how wrong forecasters can be. It saw interest rates -- a barometer of the economy -- climb to record levels in the spring, plunge swiftly during the summer and then surprise almost all the experts by soaring to a new record level last month.
The nation's output dropped in what was described as a "free fall" in the last spring, as the long awaited and predicted recession hit with a vengeance. But the economy proved more resilient than expected and industrial output bounced back after the shortest recession on record.
Inflation is clearly working on the economy in ways that are not completely understood. A year ago analysts and policy makers were confounded by continued consumer spending in the face of declining real incomes. Rather than trim spending as inflation eroded pay checks, many Americans decided to spend money quickly before it lost more of its value. Savings as a proportion of income dropped to a record low, credit demand expanded and the nation was said to be in the grip of "an inflationary psychology."
The fear of inflation then clearly took precedence over that of unemployment. Rather than avoiding an election-year recession at all costs, the administration actually hastened last year's slowdown. After waiting in vain for the economy to turn down by itself, President Carter -- together with Federal Reserve Board Chairman Paul Volcker -- announced an anti-inflation package last March that knocked the consumer boom on the head, sent interest rates spiraling upward and brought on a steep recession.
Thus, after growing at an annual rate of 3.1 percent in the first three months of the year, the nation's gross national product shrank by almost 10 percent, measured at an annual rate, in the second quarter of 1980.
Credit controls, reluctantly imposed by the Federal Reserve Board at the urging of the administration, were far more effective at curbing credit demand than expected or intended. It is likely that the rather mild measures were widely misunderstood, with some people apparently believing that it had become illegal to use a credit card. In any event, as the key prime lending rate charged by banks to their best corporate customers climbed to 20 percent in April 1980, demand for money plunged.
The Federal Reserve has been roundly criticized for the seesawing of monetary policy last year. The introduction of a new method of money control in October 1979 was supposed to ease the Fed's job of sticking to its money targets. It was expected to make interest rates somewhat more volatle, but to smooth the path of money growth.
In fact, last year was marked by sharp and extreme movements in both interest rates and the money supply. It turned out to be much harder to steer the money aggregates, even with very flexible interest rates, than the Fed had expected. It braked the summer drop in interest rates that followed the plunge in money supply, rather than following the new control method to the letter. But, in retrospect, Volcker believes that the Fed should have been even tougher.
Hard on the heels of the recession and fall in interest rates came a rebound in economic activity and the money supply that drove interest rates back up again. It is possible that if the Fed had stepped in to stop rates falling so rapidly in June and July, the subsequent spurt in money growth would not have been so marked, and would not have led in turn to such high interest rates at the end of the year.
But there is a lot of truth in Volcker's contention that the swings in money policy were due to the uneven course of the real economy, and the resulting shifts in demand for money, rather than to inherent weakness in the methods of money control. The latest figures from the Commerce Department suggest that the surge in money growth in the second half of the year reflected a more buoyant economy than forecast.
Far from sliding back into recession in the last few months of 1980, the economy is now thought to have grown during the last three months of 1980 at an annual rate of 4 percent, after a revised annual growth of 2.4 percent, during the third quarter of the year. This helps to explain why credit demand was so strong in the last half of 1980.
The unexpected strength in the economy made 1980 a more comfortable year for consumers and wage earners than seemed likely in midsummer. Then unemployment was forecast to go on rising for the rest of the year with levelling out only in 1981 -- perhaps at as much as 8 percent of the work force.But instead the number out of work have dwindled slightly: from 7.8 percent in July to 7.5 percent in November.
As well as being a short, sharp recession, the slowdown last year was remarkably concentrated geographically and sectorally. Housing and autos were hardest hit, with the steel industry also suffering considerably. Although there was a generalized weakness in demand for durable goods in the summer, this was fairly shortlived. Many areas, such as this one, did not really feel much of the recession. It was over before it filtered through to them.
But persistent high inflation, in conflict with the Fed's attempts to run a tight, anti-inflationary money policy and a switch to a tighter budgetary stance, is likely to knock the economy back again this year and make the 1980 recovery almost as shortlived as the 1980 recession. Most economists expect the housing and auto markets to drop again now in the wake of a 21 1/2 percent prime, and the economy in general to slow to a standstill, if not fall back into recession.