The nation's economic roller coaster appears to have begun a new upswing. As a new year begins, employment and production are rising and the danger of recession has disappeared.
The slowdown in economic growth to just over a 2 percent annual rate in the second half of 1984 from the extremely rapid pace of the first half has relieved pressures in financial markets and trimmed interest rates substantially. Some forecasters had been worried that the slowdown would turn into a recession, but none of the usual signs associated with an imminent business cycle peak, such as soaring commodity prices and labor shortages has appeared.
"Moderate growth through the year is still the most likely outcome," says economist Alan Greenspan of Townsend-Greenspan & Co. "Moderate" to Greenspan means an increase of 3 to 3 1/2 percent in the gross national product after adjustment for inflation, a growth rate that likely would mean little change in last month's 7.2 percent unemployment rate.
Despite continued unemployment at that level, Greenspan expects inflation to be somewhat higher in 1985 than the estimated 4.3 percent rise in consumer prices last year -- unless oil prices break significantly.
Other economic forecasters, however, think prices could rise by less in 1985 than in 1984, perhaps even in the context of a more rapidly growing economy. For one thing, wage increases have remained distinctly moderate. The Labor Department's index of average hourly earnings rose only 3.8 percent in the 12 months ended in December.
Most of the inflation forecasts would be revised upward quickly if there were a sudden, large drop in the value of the U.S. dollar on foreign exchange markets, making imports more expensive and perhaps easing some price pressure on U.S. producers whose goods compete with imports.
There are several reasons why virtually no economists are looking for another surge of economic growth following 1984's weak second half. The primary reason is that they generally expect a renewed clash between the economy's need for credit and the willingness of the Federal Reserve to provide more than a measured amount.
With both consumers and businesses needing more credit in the first half of last year when the economy was expanding at an extraordinary clip, and with the federal government borrowing large amounts of money to finance its big budget deficits, interest rates rose several percentage points. The Federal Reserve encouraged the interest rate increases at some points and at others did not resist the upward pressure on rates being generated by the markets. Federal Reserve officials were worried that the rapid economic growth would generate a new burst of inflation if it were not slowed.
Since September, some short-term rates have dropped 3 percentage points and long-term rates are down more than 1 1/2 percentage points -- again both in response to an explicit easing of policy by the Fed and the slowdown in economic growth.
George Perry of the Brookings Institution, who has had one of the best records among forecasters for the last couple of years, thinks this same sort of scenario will be played out again this year, though in a more subdued fashion. "I think that the economy will pick up speed and that the Fed will lean against it again," says Perry. "Interest rates will be rising again by midyear.
"If growth surprised us on the upside, then we could see interest rate pressures coming back in a big way," Perry continues. "We could get back to last summer's peaks. But remember, such a reemergence of financial problems would be symptoms of growth, not the opposite."
Like the majority of economists, Perry believes that concrete actions to reduce the federal government's $200 billion deficits could reduce this clash between a central bank determined to keep control of money supply growth, and therefore inflation, and the credit demands generated by a growing economy.
Another reason for believing that the economy will not spurt ahead this year is the trade deficit. Sales of imports will continue to grow faster than sales of exports this year, and that means that part of the gain in domestic demand for goods and services again will boost production and employment growth abroad rather than in the United States.
In the first 11 months of 1984, by one measure, the nation's merchandise trade deficit jumped to $115.4 billion from $62.6 billion in the same period in 1983. For the year as a whole, about $60 billion worth of the increase in the total demand for goods and services in the United States effectively supported increases in production in other nations rather than here.
That unprecedented shift is unlikely to be repeated this year, but only in the sense that the worsening of the trade deficit is not expected to be as great. Instead of $60 billion, the worsening is predicted to be on the order of $15 billion to $30 billion.
But that will be enough of a drag on the economy to offset half or more of the expected increase in business investment for new plants and equipment.
Unless and until the value of the dollar begins to fall, there is little likelihood of any improvement in the trade picture -- and the dollar has reached record highs recently against a number of foreign currencies, including the British pound and the French franc. The rise in the dollar's value has made imports cost less here while making U.S. exports cost more abroad.
However, the dollar's value -- which is much too high in terms of what it will buy in the United States compared with what it will buy abroad -- is being determined primarily by the flow of capital into the United States as foreign investors seek safe and profitable places for their money. Altogether, the net capital inflow last year topped $100 billion, allowing the United States to cover the size of its merchandise trade deficit. A portion of the deficit was offset by a continuing, but declining, surplus in trade of services, which includes earnings on U.S. investments abroad and other gaps such as in tourism and private remittances sent to other countries. This deficit on current account, as it is called, is expected to rise by another $10 billion to $25 billion this year.
Meanwhile, with all the uncertainty about the pace of future sales, American businesses probably will be adding fewer goods to their inventories in 1985 than they did last year. There are sharply differing opinions among economists on how much this cutback will be.
Wharton Econometric Forecasting Associates, which has one of the more bullish sets of predictions for 1985, thinks business people will be adding to their stocks of goods on hand at only a slightly slower pace. Data Resources Inc., another major economic forecasting firm, believes that the economy will grow more slowly -- only about a 2.4 percent rise in real GNP between the fourth quarter of 1984 and the fourth quarter of this year -- and that much of that continued slow growth will be because of a sharp reduction in the rate of inventory accumulation.
Meanwhile, no other sector of the economy will be surging ahead strongly enough to counter these relative weaknesses. Consumer spending, the biggest single part of GNP, is generally expected to rise only between 3 and 3 1/2 percent, and even that would be somewhat faster than disposable personal incomes are predicted to go up after adjustment for inflation.
With defense spending rising sharply, federal government purchases of goods and services will be a strong point in total demand, while state and local government spending rises more slowly. But the government sector is simply not large enough to overcome the impact of the other parts of the economy in which demand either is rising more slowly or actually falling.
The Reagan administration has indicated that it will forecast GNP growth of about 4 percent for 1985 and for several years thereafter, putting it distinctly among the more optimistic forecasters, particularly for the longer run. However, White House spokesman Larry Speakes hinted last week that the forecast might be revised upward in some fashion to show more federal revenue, and hence a smaller deficit.
The nation's longer-term growth path -- what economists regard as increases in the economy's potential to produce when employment is at a high level -- is the product of labor force growth, the average number of hours worked and any increase in labor productivity, that is, output per hour worked. A minority of economists, including John Kendrick of George Washington University, one of the most highly regarded economists in this field, are convinced that productivity growth has gotten back on a higher trend.
"We have returned to the stronger productivity growth path," Kendrick said in connection with a productivity study released last month by the Conference Board, a respected business-sponsored research group. "This view is not grounded on the recent cyclical rebound, although the very fact that this rebound was within the normal range of past recoveries is encouraging. It is based on the apparent reversal of most of the negative factors that produced the productivity slowdown of 1973-1982."
Output per hour worked rose less than 0.1 percent a year during that 10-year period as a result of a wide range of factors such as a younger, less experienced work force, a drop in the amount of capital invested per worker, and new safety and environmental controls. A major portion of the slowdown has never been explained to the satisfaction of many experts in the field.
Kendrick predicts that productivity will rise at an annual rate of about 2.5 percent through the rest of this decade. But a large number of analysts -- including Perry and his Brookings colleague Edward Denison, a productivity expert -- see little evidence that productivity growth has been raised substantially.
This sharply divergent assessment of future productivity growth is a key element in setting economic policy. With faster productivity growth, the overall economy can expand more rapidly with less danger of running into shortages of production capacity or labor and thereby adding to inflation.
Most Federal Reserve officials, such as Perry and Denison, remain unconvinced that growth of the economy's potential output has gone up substantially, and that is one reason they were so concerned about the big gains in GNP in the first half of 1984.
But a number of Reagan administration officials, including Treasury Secretary Donald T. Regan, take the view that the Fed should not have let interest rates rise and expansion of the money supply slow down from June onward. Regan, who will become White House chief of staff shortly, no longer is pushing the possibility of real GNP growth in excess of 5 percent a year for several years in a row, a possibility only if productivity growth is truly on a fast track, as some supply-side economists at Treasury and elsewhere maintain. He was sharply critical of the Fed for following what he called an unnecessarily restrictive policy.
With fiscal policy being determined largely by factors other than stabilizing the economy, monetary policy will continue to play the key role that it has for the last three years. The Fed's objective remains achieving a rate of growth in current dollars, as opposed to inflation- adjusted GNP, that is consistent with long-term control of inflation.
To that end, Fed policy makers have set a tentative target for growth of the money measure M1 of 4 to 7 percent for the period from the fourth quarter of 1984 to the fourth quarter of this year. That is down from a 4 to 8 percent range for the last four quarters, when M1 actually grew by almost 5 percent.
But last year's 5 percent figure masks some very rapid growth of money in the first half of the year and, on average, none at all between June and October. That period of slow money growth is another reason that some economists expect no more than a moderate increase in economic activity in the first half of this year.