Since the fourth quarter of 1982, real gross national product (GNP) has grown at a 6.3 percent annual rate -- more than double the U.S. economy's normal 3 percent growth rate. This fact accounts in no small measure for President Reagan's landslide victory. But how did we manage to grow so fast?
The answer is the Joe Palooka Effect. Those of you who are old enough will remember a tall, inflatable toy with a picture of the cartoon prizefighter Joe Palooka on it. Many young boys of a generation ago worked out (some of) their aggressions by using Joe as a punching bag. Because he was weighted at the bottom, he snapped right back when you punched him to the floor. And the harder you hit him, the faster he came bouncing back.
The economy behaves like that. When it is pummeled to the ground by a recession, it tends to rebound. And the most severe recessions tend to be followed by the sharpest recoveries -- if for no other reason than that the economy has so much more ground to make up.
A year and a half ago, many economists worried that high real interest rates might prevent our economy from staging a recovery that matched historical norms. But the worries proved groundless. Our economy shrugged off high interest rates and came roaring back like Joe Palooka.
Now, however, the Joe Palooka Effect is over, and we enter the more difficult phase. We surely will not be able to keep up 6 to 7 percent growth. The question is: Will the economy even top the 3 percent growth rate that is necessary to keep the unemployment rate from rising?
A little-noticed fact in the most recent GNP report is disquieting in this regard. While GNP growth in the July- September quarter was at a 1.9 percent rate, all the growth came from inventory accumulation. Real final sales (defined as GNP minus inventory accumulation) declined slightly. In plain English, that means that customers bought slightly fewer goods in the third quarter of 1984 than they did in the second. Businesses did produce more; but their added production just wound up as unsold inventories. That is bad news because GNP growth that is not backed up by growing sales is not sustainable.
Now, one quarter's statistics are not definitive. The third-quarter data have already been revised. They may be revised again or prove to be a fluke, and the current quarter may be much stronger. It is certainly premature to declare the expansion over, and I am not doing so.
Nevertheless, there is cause for concern. The unemployment rate has not improved since May, and we cannot dismiss the possibility that the recovery will peter out prematurely with the unemployment rate about where it is now (at 7.4 percent -- almost exactly where it was when President Reagan first took office). That is not a happy scenario to contemplate.
For one thing, Joe Palooka is not yet standing upright. Even if we accept 6 percent as an estimate of the lowest unemployment rate our economy can sustain, we are not there yet. The difference between 7.4 percent unemployment and 6 percent unemployment is 1.6 million unemployed workers -- which is a shameful waste of resources and a festering social sore.
Worse yet, what if a recession begins in 1985? This recession would start from an unemployment rate we used to associate with the bottom of a recession, not with the top of a recovery. That is exactly what happened in 1981, and by the time the 1981-1982 recession had run its course, the unemployment rate was flirting with 11 percent. Does anyone want to repeat that performance?
Furthermore, the next recession will be harder to fight than the last one because of the legacy that President Reagan I has left to President Reagan II. Last time around, Joe Palooka was assisted by both fiscal and monetary policy, which turned sharply expansionary in the last half of 1982. But things may be quite different if recession strikes during the second Reagan term.
Most obviously, the bloated budget deficit will probably paralyze fiscal policy. Suppose a serious recession pushes the federal deficit to $300 billion or beyond. Can anyone really believe that the president would propose, and Congress would enact, policy measures that widen the deficit even more?
That puts the burden squarely on monetary policy. Would the Federal Reserve take a firm anti-recessionary stand? Don't bet the family farm.
The Fed, which may no longer have the towering figure of Paul Volcker at the helm, might be afraid that an expansionary shift in monetary policy would re-ignite inflationary fears on Wall Street. A more realistic fear, in my view, comes from the foreign exchange markets. If an aggressive monetary policy pushes interest rates down, foreign capital might stop flowing into the United States, or even start flowing out. This would start the dollar depreciating. If the fall of the dollar became alarming, the Fed would no doubt reverse its expansionary policy and push interest rates up in order to defend the dollar.
So, when the next recession comes, we will not be able to count on either the strong right arm of fiscal policy or the strong left arm of monetary policy. Even the legendary Joe Palooka could not fight recessions with both hands tied behind his back.