Federal Reserve Vice Chairman Preston Martin promised yesterday that the Fed "will do its part to sustain economic expansion," but he warned that uncertainty over the federal budget and tax reform nevertheless could cause a recession in 1986.
Martin said at an Agriculture Department outlook conference that "the most likely outcome, though, is for the continued moderate economic growth so necessary for long-term improvement in the health of the economy."
But he continued, "One scenario for recession could begin with an impasse in the ongoing efforts to reduce federal budget deficits over a multiyear horizon and continued uncertainty about the timing and structure of tax reform. Some market makers would then see continued high interest rates resulting from massive budget deficits and deep uncertainty.
"Higher interest rates would push against recent progress toward realistic exchange rates" for the U.S. dollar, Martin said. "Strains on less-developed-country debtors, thrift institutions and agricultural lenders would be reinforced."
On the other hand, Martin said, a "credible program to reduce U.S. government spending and, thus, budget deficits . . . could unleash consumer and investor confidence that would lead to healthy economic growth without reinflation."
The Fed vice chairman said the recent revisions showing a 4.3 percent rate of increase in the gross national product in the third quarter overstate the current robustness of the economic expansion. "The relatively rapid third-quarter growth was built on shifting sands," he declared. "It resulted from temporary factors that do not provide a basis for sustainable growth."
Those factors included a sharp rise in auto purchases and an exceptionally large increase in government spending for defense and farm crop supports, he said.
Martin predicted that, after rising more than 12 percent in 1984 and 1985 adjusted for inflation, government purchases of goods and services that are part of the gross national product are likely to decline next year. (Federal budget outlays still will rise even after adjustment for inflation because of the rapid growth of transfer payments for programs such as Social Security that are not included as part of GNP.)
That drag on the economy will be offset by improvement in the nation's trade balance that will follow the decline in the value of the dollar relative to other major nations' currencies, he continued.
Meanwhile, consumer spending gains should be limited by the inability of households to continue to take on more debt. "Household debt as a percent of disposable personal income recently has reached an all-time high of over 75 percent," Martin observed.