RECOVERY IS COMING. That much almost everyone can agree on.
The housing market is clearly picking up, with sales and starts both up sharply from their lows. Auto sales have also climbed, although they slipped back somewhat in late January and early February. Unemployment declined in January, according to the Labor Department, and industry may well have started to increase production last month. All of these signal an end to the longest U.S. recession since World War II.
So the economy is getting better. But the crucial question is -- how much? And the answer is -- who knows? Forecasts for growth this year range from the gloomy to the quite optimistic. Some economists fear that the recovery may soon be choked off. But others believe that 1983 will be a transition year to steady, sustainable growth reminiscent of the 1960s rather than the disappointing past 10 years.
Interestingly, the administration's official 1983 growth forecast is one of the most pessimistic. On the other hand, Brookings Institution economist George Perry, a critic of Reagan's economic policy, is at the high end of the range. Reagan's budget numbers assumed the economy would grow by 3 percent during 1983 and by a steady 4 percent thereafter. Perry forecasts a 1983 growth rate of 5.8 percent.
To some extent that difference merely reflects different judgments about the timing of recovery. Chief Reagan economist Martin Feldstein -- largely responsible for the low official forecasts -- has said that if January was in fact the start of the upturn, then 1983 growth could be closer to 5 percent than 3 percent.
But there is more at issue than the precise moment that the economy hits bottom. What matters is how far and how fast it then climbs. And that depends largely on the Federal Reserve Board's monetary policy.
It was tight money that sent interest rates up and the economy down in 1981 and early 1982. As long as rates remained at or near their peaks, the economy could not struggle out of recession, even with the infusion of spending power provided by last summer's 10 percent income tax cuts. Conversely, as easier money policy in the last six or eight months has brought interest rates down, so the traditional signs of recovery have begun to appear. If rates start back up again, these could be destroyed.
For the time being, however, "we're looking at something fairly classical," according to Alan Greenspan, chairman of the Council of Economic Advisers under President Ford. Interest-sensitive industries such as housing and autos are leading the upswing, and a turnaround in business inventories -- slashed by a record amount in the final quarter of 1982 -- is expected to push up the economy this quarter.
For the next few months the typical pattern will probably continue. With inventories at such low levels, increases in orders or sales are likely to feed through swiftly to increased production. At first, companies may try to meet the extra demand by running a longer workweek with the same number of workers. If the higher level holds up, however, they will gradually start to build up the workforce again, rehiring laid-off workers and eventually hiring new people.
The consumer and the Pentagon are expected to show the way. Increased defense orders are already boosting overall factory orders and, despite a disappointing Christmas season, retailers are now anticipating higher sales, January's retail sales -- excluding autos -- were up well over the modest increase the previous month.
The mild weather in January also helped construction, which has anyway been lifted by the revival in the housing market. Housing starts leaped to an annual rate of 1.7 million last month, up a remarkable 96 percent from a year earlier.
As spending has perked up, so manufacturing industry -- hard hit by recession -- has begun to expand output. The Federal Reserve reported last week that production in manufacturing industry climbed by 0.9 percent last month.
Increased working hours in turn boost pay: personal income should start to climb more vigorously in coming weeks. Higher incomes should then underwrite higher spending, and give further impetus to output. Come July, the third year of President Reagan's income tax out will kick into effect with a 10 percent across-the-board cut in individual income tax rates. If all goes well, recovery should snowball.
But there is a serious danger that it will not.
Neither the administration nor the Federal Reserve wants a typical speedy recovery, when rising demand in one area of the economy feeds through swiftly to reinforce strength in another. Loath to abandon the fight against inflation, they are both aiming this year for much less than the 7.3 percent real growth that the U.S. has averaged, since World War II, in the first year of recovery.
The problem is that if policymakers aim for a weak recovery, they may end up getting one that is too fragile to last. After the deep and prolonged slowdown of the past two years, there is far more slack in the economy than after previous post-World-War-II recessions. While this means that there should be lots of room for rapid growth, if it once gets started, it also means that it will take more of a boost to trigger the secondary ripples of recovery.
If output picks up only slowly from today's depressed levels, high unemployment and idle factories will be with us for some time. With plenty of capacity available to meet the small increases in demand that the administration and the Federal Reserve project, why should industry start to invest? With only slow gains made against unemployment, what will give consumers the confidence they need to step up spending again?
Economist Lester Thurow believes that this year will see a repeat of the familiar pattern since 1979. The economy will grow for a few quarters, he predicts, but growth will then peter out.
The change that happened in 1979 was, of course, that the Federal Reserve switched to a tighter and more effective anti-inflation monetary policy. The "classical" recoveries of the post-war period have all been helped by an accommodating Federal Reserve that was willing to pump up the supply of money. But today, just as in 1980 when recovery lasted only a year before running into a money squeeze, the Federal Reserve is very anxious to avoid renewed inflation.
"There is little or no leeway at this stage for 'mistakes' on the side of inflation," Chairman Paul Volcker warned Congress last week. While lower interest rates "are certainly important" to sustain the housing revival and stimulate business investment, Volcker indicated that the Fed would not go on pushing rates down for fear of arousing inflationary expectations.
The Fed is already under attack from some conservative economists, such as those at the American Enterprise Institute, and from worried Wall Street analysts, for letting the money supply grow too fast. While senior officials agree that the recent money numbers make it hard to argue that money is tight, they are unsure what else they mean. Huge inflows of funds into new money market accounts at banks have hopelessly distorted the figures. For this reason it is hard to judge just what monetary policy is doing. But the fact that interest rates remain very high when compared to the rate of inflation indicates that monetary policy is still tight.
Another danger ahead is the prospect that continued high interest rates will sustain an artificially high price for the dollar compared to other currencies. An overvalued dollar makes it harder for U.S. industry to compete with foreign companies in both the U.S. and foreign markets.
Worldwide recession has made it impossible to expand exports. A weak trade performance is expected to pull the economy down throughout this year.
"You're asking the U.S. economy to do something that's very difficult -- get going while the rest of the world is not," Thurow said. In his words, policymakers have "got to put a blow torch under the economy, not a wet match," if they want to succeed in igniting a sustained recovery.
Volcker and President Reagan clearly would like to see the economy revive. The next year may tell whether this can be done without giving up on inflation, or whether a policy that remains focused on wringing out inflation is one that puts a permanent lid on economic growth.