The pace of the economic expansion has slowed so dramatically this fall that forecasters suddenly are asking themselves whether the slower growth will turn into something worse -- another recession.
So far, virtually all of them still are betting that a recession is not in the cards for the next few quarters, but their worries are growing. After a glowing first half of 1984 in which the gross national product grew at an 8.6 percent annual rate after adjustment for inflation, things suddenly turned sour.
Everyone had expected somewhat slower growth in the second half of the year. Indeed, the Federal Reserve deliberately tightened its monetary policy stance last spring precisely to cool off the expansion, which its policy makers thought was so strong that it would generate higher inflation before long.
But few, if any, forecasters had counted on such a decisive turn toward slower growth. Consumers suddenly became so cautious that even with a substantial increase in personal consumption spending in September, the average for the whole quarter was hardly changed from the second. Retail sales last month were only slightly higher than they were at the end of 1983.
Industrial production fell for the first time in nearly two years in September and was up only about half a percent for the quarter compared with gains of 2 percent or 3 percent in previous quarters. New home construction is no higher than it was a year ago.
The civilian unemployment rate, at 7.4 percent, is well down from the 9.2 percent rate of September 1983, but it is no lower than it was four months earlier in May.
In addition, initial claims for unemployment benefits reached 392,000 in the week ended Oct. 13, the highest level in months and a fairly clear sign that layoffs are increasing. Consistent with that, the Labor Department reported that only 38.9 percent of the nation's industries were adding to their payrolls in September. That was the lowest proportion hiring additional workers since November 1982, the low point of the 1981-82 recession.
Meanwhile, business investment in new plants and equipment, which had been rising at an extraordinary clip -- at more than a 20 percent annual rate in the first half -- dropped back in the third quarter to a still strong but lower 8 percent rate. Housing investment was up very modestly for the second quarter in a row.
In fact, the biggest increase in the demand for goods and services during the third quarter came from the government sector, with federal buying accounting for most of the gain.
Overall, the level of final sales of goods and services grew not at all in the third quarter. All of the 2.7 percent rate of increase in GNP last quarter ended up as an addition to business inventories.
And on top of that, a bigger chunk of domestic demand was met with imports from abroad. Exports actually rose in the third quarter, but imports rose so much faster that the deterioration in the U.S. trade balance cut the GNP rise in half. That is, if the trade balance had not worsened in the third quarter, domestic production would have had to be larger than it was to meet the demand for goods and services, and GNP would have risen at about a 5.5 percent rate instead of a 2.7 percent rate.
Forecasters are poring over all the latest economic statistics, examining every nuance for clues about where the economy is headed. Forecasts for GNP growth this quarter range from about a 2 percent rate all the way up to 5 percent, an unusually wide spread for a quarter already under way.
There is much more agreement that inflation, which despite the rapid economic expansion has not accelerated very much, will remain about where it is or perhaps creep up a little next year.
Even some of those economists who think GNP growth will rebound this quarter expect that there will be more very slow quarters sometime in 1985.
For instance, economist Irwin Kellner of Manufacturers Hanover Trust Co. has just issued a new forecast putting growth at 4.6 percent this quarter and 3.1 percent in the first quarter of 1985. But then he shows GNP rising at only about a 1 percent rate for the remainder of 1985, a growth rate so low that the unemployment rate is slightly higher in the fourth quarter of next year than it is now.
"The reasons for this slowdown in growth stem from its composition," Kellner explained. "This year and last were largely powered by the consumer, making up for time lost during the recession of 1981-82 as well as the dip of first-half 1980.
"Now the torch is being passed to business, and while corporate expenditures should rise at a healthy clip, it will not be enough to offset the slowing expected in the much larger level of consumer spending, as more and more people find that their pent-up demands have been satisfied and/or discover that high interest rates will make it difficult for them to buy housing and other big-ticket items," Kellner continued.
"Job creation, which has already slowed somewhat, will slow some more; this, too, will cut into growth of consumer spending. And of course, a good part of these demands will be met by imported merchandise while the dollar remains strong.
"The point to remember is that as long as inflation and inventories remain modest, neither the Federal Reserve nor the private sector will step on the brakes. Thus, the current slowdown is unlikely to develop into a recession -- at least not yet," he concluded.
History is on the side of those who do not expect a recession at this point. Economist Alan Greenspan of Townsend-Greenspan & Co. told his clients recently that most post-World War II slowdowns were "not the beginning of a recession, but rather a pause which was followed by a reacceleration in the growth rate."
Greenspan, more optimistic than most forecasters, expects real GNP to be up 4.3 percent in 1985 and 3.3 percent the following year. That contrasts with Kellner's 1.5 percent prediction for 1985, which in turn is very similar to that from Data Resources Inc., another forecasting firm.
But, like any good forecaster who occasionally has been wrong, Greenspan hedged his bets. After recalling episodes in 1955, 1962, 1966 and 1976 when growth slowed sharply but then reaccelerated, he added, "This is not to say that in retrospect the current period will not prove to be the beginnings of a recession."
Fundamentally, the forecasters don't see an imminent recession because there are few of the usual economic imbalances that usually lead to one. There are few, if any, shortages of labor or materials. The use of existing production capacity fell in September and by all assessments remains well below the levels normally associated with a business cycle peak.
Nor have short-term interest rates run up sharply so that they are higher than long-term rates, a situation that often occurs at a business cycle peak. Short-term and long-term rates have both been falling recently as the Federal Reserve eased its pressure on the banking system and the economy cooled. Mortgage interest rates have softened less, but while housing starts have come down, they have not collapsed.
Businesses generally have been keeping a close eye on the level of their inventories as part of their strong effort to keep control of costs. With the unexpected drop in sales in the third quarter, stocks in some industries have risen to unwanted levels relative to sales. As a result, it is unlikely that inventories will be accumulated at as fast a rate this quarter as last quarter. But the inventory situation does not seem to have the potential for the massive liquidation of stocks that usually intensifies the swing from expansion to recession. In short, inventories should be a drag on GNP this quarter, but not enough of a drag to produce a drop in real GNP, according to most analysts.
Similarly, there is no reason that consumers could not begin to increase their spending again, at least in a moderate way. Disposable personal income rose at more than a 3.5 percent rate after adjustment for inflation last quarter, while personal spending rose hardly at all. Personal saving rose from 5.7 percent of personal income to 6.3 percent.
However, there are no more cuts in real tax burdens coming along to boost after-tax incomes. At the same time, most of the pent-up demand from the last recession has been satisfied, judging by long-term buying patterns, as Kellner noted. And with wage increases and employment levels likely to rise only fairly slowly in coming months, personal income will not surge ahead.
All those factors suggest that consumers will be in a position to increase spending, albeit in modest fashion, in contrast to the third quarter when they did not at all.
Business investment should chalk up good gains next year, though probably much more in line with the 8 percent rate of the third quarter, or even a lower rate, than the 20 percent rates of the first half of this year. Housing investment, on the other hand, probably won't rise much and could fall somewhat, depending upon the course of interest rates.
Government spending should be up at a healthy rate, according to most forecasters.
So what does all that add up to? A year in which real GNP should grow much more slowly than this year and perhaps with some very weak quarters. One major uncertainty is how much of the growth in domestic demand will be met with foreign production.
When the total demand for goods and services went shooting up like an ICBM, it did not matter so much that the trade deficit was widening in unprecedented fashion. There still was enough demand for domestic goods and services that most industries experienced strong recoveries from the recession. Now total demand is rising much more slowly, and the effect of the worsening trade situation is hitting the order books of U.S. companies with a vengeance.
So long as the dollar maintains its extraordinarily high value on foreign exchange markets, imports will threaten to take a rising share of the U.S. market. Economic forecasters have been burned repeatedly in predicting that the dollar will decline in value, and now they are very wary about incorporating such predictions into their overall forecasts.
To the extent that the trade deficit continues to worsen next year, demand for domestic goods will be lower and economic growth weaker.
A handful of economists, including some in the Reagan administration, continue to believe that growth hardly will be diminished next year. The official forecast is for 4 percent real growth during 1985, but there is still some pressure being exerted for a higher figure, perhaps as much as 5.5 percent.
Many forecasters did underestimate the strength of the recovery so far, and conceivably they are doing so again. However, some of the sources of that earlier strength -- the pent-up consumer demand for goods and houses, the income tax cuts, businesses' desire to snap up a new generation of computer and communications technology -- are either absent or have spent much of their force.
Next year will be the true testing ground of whether all the fiscal policy changes that have been made during this administration have produced fundamental changes in economic behavior that can keep the economy growing strongly year in and year out, regardless of large federal budget deficits and wholly unprecedented trade deficits.