Signs Point to a Recovery That Is Slow, Steady and Has Staying Power

While the U.S. economy has never moved through business cycles monolithically, the contrasting trends in different sectors have never been as vivid as they are today. This is because of the peculiar nature of the 1990-91 recession.

For one thing, it was not caused by rapid inflation and rising interest rates that would tend to curtail spending on such big-ticket items as new cars and houses. Rather, it was a byproduct of the drop in real estate values and bank lending that followed in the wake of the Tax Reform Act of 1986, stricter examination standards and higher capital requirements. Two stock market crashes and a sudden end to the frenzied deal activity of the 1980s were factors as well.

The net result was that the brunt of the drop in business activity took place in the Northeast. The contrast is all the more vivid when one recalls that the Northeast was one of the fastest-growing regions of the United States during the 1980s.

Some states in this region, as well as those in other parts of the country, took the opportunity afforded by their booming economies to expand their spending programs. They were able to do this even though the flow of revenue-sharing funds from Washington began to slow as the federal government grappled with a burgeoning budget deficit.

Indeed, many had to spend more because Washington was passing laws ordering more social spending at the state and local level--even as it was cutting back aid to those governments. As a result, state and local budgets ballooned, as did the number of employees on their payrolls.

While any economic downturn affects tax revenues flowing to Washington, it hits state and local governments harder. This is because they depend not just on income tax receipts but also on revenues from sales and property taxes. And these sources were especially hard-hit in the Northeast.

Unlike the federal government, states and local governments cannot run deficits in their budgets for very long. The net result: Many are cutting spending, laying off workers and raising taxes. This, of course, is bad news for those directly affected by these actions, but also constitutes one of the extra pieces of baggage that the nascent recovery will have to bear, since in the past, states and local governments usually aided an economic upturn by increasing spending.

Washington won’t be of much help, either. True, the federal deficit will probably reach a record level in dollar terms during the government’s fiscal year that ends Sept. 30, and it figures to go even higher next year. Unlike past recessions, there has been no tax cut or deliberate expansion of federal spending to help boost economic activity out of recession.

On the monetary front, the best that can be said about Federal Reserve policy is that it is not as tight as it was from 1988 through last summer. However, it is not very accommodating, either.

It may be true that short-term rates, over which the Fed exerts direct control, have come down nearly five percentage points since the spring of 1989.

It is also a fact that in “real” terms, adjusted for inflation, these rates are down to their postwar average. But given the weakness in loan demand, some would say that rates have fallen because the Fed has let them fall--not because the Fed actively pushed them down. At any rate, the central bank’s obsession with higher capital ratios, coupled with the continued strictness by various bank examiners, suggests that even lower rates and faster money growth might be more appropriate in the current economic and regulatory setting.

Having said all this, is it reasonable to expect a double-dip recession, or merely a slow-but-steady economic recovery?

Those who believe that a double dip lies in our future are, of course, cognizant of the weaknesses noted above. However, they also point out that five of the last eight recessions saw the GNP rise after one or two quarters of decline--only to fall back once again, thereby prolonging the downturn.

But past double dips have been traced to either or both of the following two developments: an early tightening by the Fed and business moves to cut inventories. As far as the first item is concerned, the Fed never really eased aggressively during the past recession, so it is unlikely to have to tighten soon. In addition, the rate of inflation has cooled, consumer prices rose at an annual rate of just 3% in this year’s second quarter, while producer prices climbed only half as fast and most raw materials’ tags were actually falling. As for inventories, they were liquidated even before the recession began, leading to a rather unusual decline in inventory-sales ratios during the recession.

Thus, the best bet remains a slow but steady upswing in economic activity--one that will keep the jobless rate from falling as fast as it usually does and that will keep sales and earnings from rising as fast as they usually do. But one, that by keeping wage and price pressures at bay, may well turn out to have greater staying power than is generally anticipated.