Analysts Divided on Recession Peril : Some Expect One After Stocks Fall; Others Say U.S. Policy Can Thwart It
Can the U.S. economy avoid a recession in the wake of the stock market debacle? Some economists now are convinced that a serious economic downturn is inevitable within months. But many analysts insist there is no reason for the economy to fall significantly as long as government policy does not stumble badly in the days and weeks ahead.
“We can prevent this market crisis from turning (into a general economic collapse) by avoiding the three prime policy mistakes that brought on the Depression: protectionism, a tight monetary policy and sharp tax increases,” said Robert Hormats, a former top Treasury official who is now with Goldman Sachs in New York.
So far, monetary policy-makers have passed their first test. Economists give high praise to the Federal Reserve for quickly reversing course immediately after the crash two weeks ago and flooding the banking system with money to prevent any danger of a credit crunch. Interest rates have already declined significantly.
Protectionism Disliked
The jury is still out on trade policy. Congress, according to the virtually unanimous view of economists, should reject the protectionist features of pending trade bills, lest today’s trade tensions degenerate into a worldwide trade war.
Budget policy provides the trickiest choices. Although economists generally want Congress to avoid major tax increases that might depress the economy, they also recognize that long-term deficit reduction--including a politically palatable combination of modest tax increases and spending cuts--is an essential ingredient in easing the strains in the world economy that contributed to the stock market’s crash in the first place.
Some economists believe that the government, no matter how wise its policies, lacks the tools to stop a recession.
“A recession is rising very quickly over the horizon,” warned Irwin Kellner of Manufacturers Hanover Bank in New York, one of the most successful forecasters on the economy.
The reason, Kellner said: Consumers will spend less, out of fear that the market crash portends hard times ahead. Thus the fear itself, he warns, will generate the reality.
Could Aggravate Impact
Other economists hold that a recession is inevitable only if government decisions aggravate the impact of the stock market collapse.
David Levine, chief economist for the Wall Street firm of Sanford C. Bernstein & Co., said history is likely to look back on the market panic as “little more than a powerful but brief snowstorm. You’ll notice a sudden, dramatic dip, but then the economy will return to its upward course as if almost nothing had happened.”
In a curious way the debacle on Wall Street, instead of signaling an imminent economic decline, may trigger some actions that many economists regard as long overdue.
“The stock market crash may even help the economy,” said Lester Thurow, a liberal economist at the Massachusetts Institute of Technology. “It will do so because it scared the Federal Reserve Board into changing its policies. Lower interest rates may well in the end stimulate the economy more than the stock market crash depressed it.”
The crash also scared Congress and the Administration into making a serious effort to break their yearlong deadlock on budget policy. Administration officials and congressional leaders began meeting last week with that end in mind.
Finally, the crash may have dampened enthusiasm in Congress for protectionist legislation.
But in many economists’ view, there remain two serious risks.
--The budget negotiations may succeed too well and yield a combination of spending cuts and tax increases that would depress the economy.
--The Fed, having initially opened the monetary floodgates, may close them prematurely to force interest rates back up if the international value of the dollar sags too far. U.S. interest rates and the dollar’s value are closely linked because the bulk of foreign investments in the United States are in interest-bearing bank deposits and bonds.
The Fed can prop up the dollar by forcing interest rates up, thus making investments here more attractive to foreigners--but that can also dampen growth of the U.S. economy. This was the course the Fed followed starting last April--and ending with the stock market’s collapse.
“I can imagine monetary policy being immobilized by the presumed need to defend the dollar, “ said Herbert Stein, former chief economic adviser to President Gerald R. Ford. “I can imagine fiscal policy being immobilized by the presumed need to reduce the deficit in a declining economy. Both of those reponses would be rationalized as necessary to generate confidence, which would repeat the policy errors of 1931 and 1932.”
The ultimate goal of all economists, in the government and out, is a more balanced world economy than has prevailed in recent years. Influenced by massive budget deficits, the U.S. economy has grown vigorously while most other industrial countries--notably Japan and West Germany--have failed to generate much internal economic growth.
As a consequence, foreign capital has flooded the United States, helping to finance spending here. At the same time, the United States has rung up enormous trade deficits; in fact, many foreign manufacturers, facing slack demand for their products at home, have relied on the United States to buy their goods.
The job facing government policy-makers is to restore balance--to reduce the U.S. budget deficit and its dependence on foreign capital--without engineering a worldwide recession. Reagan Administration officials are painfully aware of the policy dilemmas but they are divided over how to resolve them.
The sharpest dispute is over the dollar.
Treasury Secretary James A. Baker III has been working with the other major industrial countries to prevent the dollar from falling sharply against other currencies. A plunging dollar, by increasing the cost of foreign goods in the United States, would damage export-dependent industries in Japan and West Germany. Baker figures that those countries will not heed U.S. calls to stimulate their economies if the United States allows the dollar to fall.
By contrast, conservative economists within the Administration favor a free-market approach to the dollar. They argue that Baker’s approach has left U.S. economic policies hostage to foreign governments’ concerns. Beryl W. Sprinkel, who announced last week that he would stay on as chairman of the Council of Economic Advisers, and Budget Director James C. Miller III say privately that defending the dollar has been a mistake.
In the immediate aftermath of the stock market crash, the risks of trying to prevent the dollar from falling are considered far too high by everyone within the Administration. Supporting the dollar requires the Fed to keep money tight and interest rates high so that dollar-denominated investments look attractive to foreigners, and in the present climate, no one wants high interest rates.
“The Fed had to decide between defending the dollar and defending the economy,” said David Wyss, chief financial economist at Data Resources Inc. in Lexington, Mass. “It has decided to defend the economy first and worry about the dollar later.”
But that decision does not mean that Baker has lost the internal battles to his free-market opponents. The Administration is still committed to Baker’s policy of forging international accords in which Japan and West Germany would agree to stimulate their economies.
Baker’s goal, Treasury officials say, is to exploit the stock-market crisis by working with Congress to put together a deficit-reduction package that would represent the U.S. contribution to such an accord.
Such an agreement would involve letting the dollar fall gradually to lower levels against the Japanese yen and German mark. These levels could be more easily defended than those established last February--but never made public--during a meeting of the finance ministers of the seven leading industrial countries at the Louvre in Paris.
Currency market traders believe that the finance ministers committed themselves in Paris to hold the dollar’s value at more than 1.8 marks and 150 yen. But under pressure from the markets, U.S. officials have worked out two separate deals already to allow modest changes in the currency targets--once in April to 140 yen with the Japanese and then Oct. 19 with West Germany. By Friday, the dollar had fallen to about 1.73 marks and 138 yen.
A key to any further changes in those currency levels would be coordinated interest-rate reductions in all three countries.
More such adjustments are expected at a future meeting of economic officials from the seven industrial nations, but no get-together is expected until current budget negotiations with Congress are completed. “There’s no way Jim Baker is going to leave Jim Miller in charge of the budget talks,” one White House official said.
But many economists outside the Administration, echoing the dissident officials inside the White House, are escalating their attacks against currency stabilization.
“The United States should acknowledge that the dollar must decline significantly and return to a policy of non-interference with the exchange rate,” argued Martin Feldstein, once Reagan’s chief economic adviser and now a Harvard economist. The Administration, he said, “should explicitly but amicably abandon the policy of international macroeconomic coordination.”
The government cannot establish a policy toward the dollar without regard to budget policy. If the Fed maintains its loose monetary policy, most economists believe that it would also risk reigniting inflation in the absence of steps to narrow the federal budget deficit. Looser monetary policy, they argue, must be accompanied by a tighter fiscal policy.
Although congressional and Administration officials began meeting on the deficit last week, the Administration initially continued to resist tax increases and Congress hewed to its reluctance to cut domestic spending.
“Stop this ideological argument about how much (deficit reduction) should be spending, how much taxes,” Anthony M. Solomon, a former chairman of the New York Fed and senior policy-maker in Democratic administrations, lectured a congressional committee last week. “This argument has been going on for five years and it’s ridiculous. Here we are faced with a global recession. There is a real urgency to the situation right now.”
There seems little danger for now that the White House and Congress will slash the deficit enough to depress the economy. The $23 billion to $30 billion in cuts under consideration would leave the deficit in fiscal 1988, which began Oct. 1, roughly at the $148-billion level achieved in fiscal 1987.
The greater risk is that the current budget talks will fail, leaving any hopes for a bipartisan economic policy in shambles.
“Time is running out,” said John D. Paulus, chief economist at the New York investment banking firm of Morgan Stanley. “Without an irrevocable commitment to do whatever is necessary to shrink the budget deficit, the danger remains of another surge in interest rates, perhaps triggering another crash in the stock market.”
With the stakes so high, most observers are convinced that the budget negotiations between the Administration and Congress will succeed. Then the next challenge will come as Congress and the Administration square off over the pending trade bill.
Solomon warned that the trade legislation, which has been approved in different forms by both houses of Congress but not yet reconciled by a conference committee, could “cause a global downturn that will rival the worst of previous slumps.”
Many Democratic lawmakers, worried that they will be accused of promoting a latter-day version of the 1930 Smoot-Hawley tariff bill, which sharply worsened the Depression, are having second thoughts about some of the more protectionist features of the proposed legislation.
But Sen. Lloyd Bentsen (D-Tex.), a key sponsor of one bill as chairman of the Senate Finance Committee, lashed out at outgoing Labor Secretary William E. Brock III when he suggested Wednesday that the trade bill should be withdrawn. “This is not a protectionist bill,” Bentsen insisted.
As long as government policy-makers make no blunders, many analysts are convinced that the economy, which gathered strength over the summer, will sail right through autumn’s financial storm clouds.
“There was a knee-jerk reaction (on Wall Street) right after the market crash to get on the recession bandwagon,” said Edward Yardeni, chief economist at Prudential-Bache Securities in New York. “But, while we may think the world is coming to an end, the rest of the country looks to be in pretty good shape.”
