The Economy

Another soft landing?

After a torrid growth spurt over the last three quarters, the U.S. economy now shows signs of slowing down again. Isn't that great news? After all, the economy can't continue to grow at an annual rate of 5% forever. Eventually severe shortages would occur. Even the Miracle Man himself, Federal Reserve Chairman Alan Greenspan, couldn't finesse the situation. However, if growth slows down to about 3%, which is roughly equivalent to the long-term sustainable growth rate of the economy, we should all live happily ever after. At least that is what the stock market seems to be telling us. Maybe that is precisely what will happen, and the stock market will continue to rise 30% per year. But somehow I can't believe it. There are many signs of slowdown in the recent data. New orders for capital goods, after rising an average of 8% per year since 1993, have been virtually flat since last September. New-home sales have now declined for three consecutive months. And anyone who expected a quick turnaround in net exports had their hopes dashed by a huge increase in the January trade deficit. The optimists tell us not to worry about it -- the consumer is on a roll, and as long as consumer spending keeps rising at above-average rates, the economy will remain buoyant. But let's look at the consumer-spending picture for a moment. The personal-saving rate has fallen from 2.6% to -0.2% in the last two years, which means consumption has risen almost three percentage points more than income during that period. The major cause has been the benign supply shock that reduced inflation to 1.6% last year, bringing interest rates down in tandem and causing yet another year of a surging stock market. It seems to me that even the optimists must concede that the personal-saving rate cannot remain in free fall indefinitely. Even if it remained at its recent level of -0.2%, that would slice about one percentage point off the recent growth rate -- which would be just fine, because it would bring growth back to the optimal 3% rate. But suppose consumers take a less ebullient view of the future and start to become even modestly more cautious. Why would they do that? For one reason, the growth in jobs might be leveling off. Last month, payroll employment rose only 46,000, compared with an average gain of 270,000 during the previous four months. Some said it was a weather-related fluke, and that was undoubtedly part of the answer. However, manufacturing jobs have fallen an average of more than 30,000 per month during the last year, and while most of those people have managed to find other employment, the opportunities will become less frequent with the forthcoming slowdown in housing and capital spending and the continuing decline in net exports. This year, consumers won't have lower inflation and interest rates to bail them out. The slowdown won't happen immediately. One reason is the asymmetrical reaction of consumers to changes in interest rates. When rates decline, many homeowners will immediately refinance, reducing their monthly mortgage payments and providing them with more money to purchase other items. When rates rise, though, homeowners will stick with their existing monthly payments and wait until the year is up to get a notice from the lender informing them about their higher payments next year. That's what happened in 1994; the Fed kept tightening, but it wasn't until a year later that the economy stuttered, with real growth declining to a 1% annual rate in the first half of 1995. Nobody is talking recession next year. The slowdown in the economy, when it does come, is likely to pull the growth rate down to the 1%-to-2% range, not the minus-1%-to-2% range. That may be modest enough to be called a soft landing by many. But the odds of the growth rate gradually falling to 3% and then holding at that level are, in my view, quite remote. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected]

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