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December 15, 1991

Federal Reserve Bank of Cleveland

The Outlook: No Boom, No Doom
by John J. Erceg and Lydia K. Leovic

A he economy's mixed performance in
recent months has led to a growing perception that a recovery has not yet begun,
or that its sustainability is threatened.
Recent declines in housing sales and new
car sales, stalled industrial production,
and minimal growth in employment
have caused some observers to dismiss
the reported third-quarter revival in economic growth. Pending layoffs by some
manufacturers, financial institutions, and
retailers are seen as additional warning
flags of a faltering economy.
Is the economy indeed headed for a
double-dip recession in the coming
months? Not according to a panel of 25
experts who met at the Federal Reserve
Bank of Cleveland in late October. The
Fourth District Economists' Roundtable, which convenes three times a
year to discuss current conditions and to
present expectations for the economy,
unanimously believes that the 1990-91
recession ended last spring and that
growth is under way, albeit slowly.
• Recession Is Over,
but Recovery Is Weak
None of the Roundtable forecasters expects a decline in real GNP through at
least year-end 1992 (see figure 1). Instead, their median real GNP forecast
calls for a moderate growth rate of
about 3 percent from the present quarter through 1992:IVQ.' They expect
that industrial production, which rose
at a 7 percent annual rate in 1991 :IIIQ,
will increase at about a 4 percent rate
over the next four quarters. Consistent
with this relatively slow-growth scenario, the Roundtable group looks for

ISSN 0428-1276

labor markets to revive gradually, with
the unemployment rate holding at 6.8
percent again this quarter and then
receding to 6.3 percent by 1992:IVQ.
Compared with the seven previous
postwar recoveries, these predictions
indicate an uncommonly weak upturn,
which is consistent with the economy's
recent mixed and jagged performance.
One panelist acknowledged that some
information suggests an apparent stalling in economic activity since late summer, and noted that continued slow
growth will inevitably raise questions
about the sustainability of recovery. A
widespread mood of job insecurity is
said to be an important cause of the
recent waning in consumer confidence.
• What's Holding Us Back?
A variety of constraints are claimed to
be holding the growth rate of the 1991—
92 business upturn below average, according to the Roundtable. Some point
to the debt buildup of households and
firms in the 1980s, which must be
worked down before consumers and
businesses can resume a higher pace of
spending. Additional roadblocks are
restructuring in the service sector, especially financial, trade, and real estate;
declines in defense spending; a continued trend toward efficiency in inventories; plus fiscal and monetary policies
that are unlikely to be as stimulative as
in most previous upturns.
Still, as one panelist pointed out, export
growth can be expected to continue to
support the domestic economy, although
the path will be bumpy, and residential

Although economic growth apparently
has lost momentum in recent months,
there is reason for optimism. According
to the Fourth District Economists'
Roundtable, recovery is under way, and
no double-dip recession is anticipated.
Compared with previous episodes, however, the upturn is likely to remain
weak in response to a number of structural adjustments. The inflation rate is
expected to moderate.

construction, especially of one- to fourfamily units, should be reasonably
strong as a result of the lowest mortgage interest rates since the mid-1970s.
Although none of-the Roundtable members predicted recession, one economist acknowledged the possibility that
real GNP growth could revert to zero
in any one quarter, because the margin
between growth and no growth is relatively small. Yet even if the economy
expands at a 3 percent rate during its
first year of recovery, as the panel expects, this would still approximate the
pace of growth that prevailed during
the second half of the 1980s, and
would be similar to that of the two
slowest recoveries, in 1970-71 and
1980-81, when real GNP rose about
3.3 percent. Such a sluggish recovery
would fall far short of the seven upturns since the early 1950s, however,
when real GNP growth averaged 5.7



Percent change, annual rate



Percent change, annual rate

_ Median Real GNP Forecast

Median GNP Implicit Price Deflator Forecast























NOTE: High and low are the average of the three highest and lowest forecasts, respectively.
SOURCE: Fourth District Economists'Roundtable, October 25, 1991.

• Manufacturing: A Respectable
Recoveries in manufacturing production have typically coincided with overall economic expansions, and the rise
in output has averaged about twice the
gain in real GNP in the past seven recoveries. In the latest manufacturing
upturn, which began in April 1991, production rose at about a 6 percent annual
rate through October, slightly more than
the initially reported rate of increase in
The turnaround in manufacturing has
been broad-based, led especially by a
revival in consumer durable goods.
Automobile production rose from an annual rate of about 5.1 million units in
1991: IQ to about 6 million units in October. For 1992, an auto economist expects domestic car output at about 9 million units and light truck output at about
4.7 million units—below levels that are
indicative of a "good" year. In his view, a
lower-than-usual level of car inventories
for this season, strengthening in used car
prices, and relatively low inflation and interest rates are all positive factors in the
auto outlook. Slow growth in employment and income, and personal tax increases in many states, are said to be
negative influences.
Capital goods industries have also been
contributing to the revival in manufacturing output, but the comeback has
been mixed and sluggish. Year-over-

year comparisons can conceal changes
in direction, but a three-month moving
average shows a slow and uneven upturn in the electronics industry since
1991 :IQ, according to a capital goods
economist. He expects further improvement because inventories are below
their longer-term trend. Semiconductor
orders have been increasing at about a
10 percent annual rate in recent
months, supported by higher demand
from several markets, especially
automotive and computer and office
machinery. Further growth is expected
in 1992, but at about half the pace of
previous recoveries. The decline in orders for communications equipment
has not yet ended, but is expected to do
so within the next few months.
The steel industry has mounted a slow
comeback from recession. Steel shipments have been picking up gradually
since early this year, but are expected
to fall a few percent short of the 85million-ton average of the past three
years. Some producers are reported to
be operating their flat-rolled steel facilities at close to capacity. For 1992,
rebuilding of steel stocks and higher
steel consumption are expected to boost
both shipments and production a few
percent from 1991 levels, according to
the median of steel forecasts. An economist noted that better management of
steel stocks, from raw materials to finished steel, has resulted in a lower ratio

of steel inventories to total manufacturing stocks in recent years compared
with 10 years ago.
• Inflation: Some Good News
For the past several years, the underlying inflation rate has been close to its
long-term trend of 4 percent annually.
The persistence of that rate has been
disappointing to some economists, who
expected to see signs of improvement
in response to moderated growth in the
money stock (M2), which has averaged
about 4.5 percent annually since 1987.
As recently as last June, the Fourth District panel expected the inflation rate
(as measured by the GNP implicit price
deflator) for 1991 to hold at about 3.7
percent at least through the second half
of 1992.
At the October 25 Roundtable meeting,
however, the economists nudged downward their expectations of inflation.
Their median forecast calls for a 3.1
percent rate of price increase between
1991 :IIQ and 1992:IIQ, and for only a
slight step-up to about 3.3 percent in
the second half of 1992 (see figure 2).
These expectations are a bit lower than
most other public forecasts.
This slight improvement in inflation expectations since June does not yet
appear to be reflected in long-term bond
yields. The 30-year Treasury bond yield
has hovered narrowly around 8 percent in

Billions of dollars

began promptly with the beginning of
the recession, continuing into the third
quarter of 1991.

6V2 %











Roundtable economists predict a relatively small inventory accumulation
during the first year of this recovery,
and expect it to occur later than has
traditionally been the case. If this
proves correct, the buildup would rank
among the mildest of the postwar
recoveries and hence could add much
less to output growth than in the past.





SOURCE: Board of Governors of the Federal Reserve System.

recent months, which some economists
view as including a premium for the
risk that the Federal Reserve will
subordinate its long-term goal of price
stability to that of sustaining the economic recovery. Financial-market participants apparently want more
evidence that inflation measures are indeed improving.
• Inventories: Sharp Correction
but Mild Buildup
Inventory liquidation has typically accounted for the bulk of the declines in
real GNP during each of the past seven
recessions, and inventory buildup has
typically been a major contributor to
the revival in output by the second to
third quarter after a recession trough.
In addition to their swings in response
to cyclical changes in economic activity, inventories have been shrinking relative to sales in the past decade, as
firms have increasingly used better
inventory-control techniques ("just-intime" systems) and up-to-date information on sales and stocks.
Forecasters had generally expected that
the business inventory liquidation in
the 1990-91 recession would be mild
relative to past episodes of cutbacks,
mostly because the buildup of stocks
prior to the recession was judged to be
moderate. As it turned out, the liquidation phase was larger than average and

A guest panelist, who is the purchasing
director for a major automotive and
electronic parts producer, elaborated on
how inventory practices have been
upgraded. He emphasized that it is not
only improved technology and information systems that have helped to bring
about better control over inventories, but
also changes in management attitudes
(inventories are now perceived as a waste
instead of an asset), improvement in
customer-supplier relationships, and a
streamlined manufacturing process.
• Some Short-Run Monetary Policy
Issues: What's Appropriate?
Persistent weakness in M2 growth since
last spring has raised several issues
about monetary policy objectives and
appropriate responses. The reason for
the concern is that M2 is the primary
policy target of the Federal Reserve
System, and year-to-date growth of the
aggregate is at the bottom of the Fed's
2.5 to 6.5 percent target range for
1991. Moreover, M2 growth so far this
year is well below its 4'/2 percent trend
rate since 1987. The Roundtable group
raised several issues concerning
monetary policy:
• Which is the "correct" or most
appropriate measure of money and monetary thrust? M2 showed virtually no
growth between April and October, and
since 1990:IVQ, growth has amounted to
only about a 2.5 percent annual rate (see
figure 3). The M2 shortfall is commonly
explained in terms of a long-term shift
out of small time deposits at thrift institutions and banks into other higher-yielding
financial assets, especially bond funds,
that are not included in M2.

The foregoing discussion of previous
recoveries is based on the U.S. Department of Commerce's series of national income and product accounts (NIPA),
which incorporate 1982 prices. According
to a senior official of the Bureau of Economic Analysis, the Commerce Department will release revised data in December
incorporating several changes, the most
significant of which is a revision in the
price base, which will affect both output
and inflation data. The Department has already released preliminary estimates of
real GNP since 1982 rebased in 1987
prices. The revisions show a slightly
deeper recession in 1990-91 than
reported in 1982 dollars, but only a twoquarter drop in real GNP instead of the
three-quarter decline that was reported in
1982 dollars.
Also included will be improvements in
data and changes in definitions and classifications. The Commerce Department
plans to issue an alternative measure of
real GNP based on changing weights, a
procedure similar to that used for some
other measures of economic activity,
such as the industrial production index.
The panelist reported that in future
releases of NIPA, emphasis will be
shifted from gross national product to
gross domestic product, which excludes
net foreign income.
The overall result of these changes is
that the U.S. national income and
product accounts will be more compatible with those of other nations than
has previously been the case.

Other monetary and reserve aggregates
have displayed strength, however. The
monetary base, Ml, and M2 excluding
time deposits have all risen at annual
rates between 6 and 7 percent since
1990:1 VQ. The Roundtable group was
not in agreement as to which measure
of the money stock is most appropriate,
and what the risks are if the Federal
Reserve ignores the M2 weakness or
continues to attempt to push M2 growth
above the bottom of its target range.
• What should be the short-run policy
objective of the Federal Reserve? In
the view of one panelist, it should be to
"...provide sufficient liquidity to facilitate a modest recovery consistent with
low inflation." Restoring M2 growth to
its recent trend rate of 4.5 percent
would require a sharp step-up in the
money supply that he contends would
be inconsistent with a noninflationary
economic recovery.
• How should monetary policy
respond to present credit-market conditions, especially to the perceived credit
crunch? A suggested way of dealing
with a supply-constrained credit market
is through regulatory changes, such as
by easing capital requirements, rather
than through a more rapid expansion of
money. One economist posited that the
problem may be the result of a reduction in demand, not in supply. If the
supply of credit were constrained, he

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observed, interest rates would have
risen rather than declined, as they have
done since early 1989.
• What should be the appropriate
monetary policy response to fiscal policy changes? According to a panelist,
monetary and fiscal policies are not
substitutes. Monetary policy has longrun effects on inflation and should be
used to pursue the long-term objective
of price stability. Fiscal policy has its
own set of objectives, and its effects
are unclear.
While no clear-cut answers to these
issues emerged, some members cautioned the Federal Reserve to be mindful of the recent weakness in M2, while
others warned the central bank about
repeating errors of the past that have
caused the inflation rate to accelerate.
• What's the Prognosis?
The recession ended last spring, but so
far the recovery is off to a slow start relative to the average of postwar business
upturns, according to the Roundtable
panel. Consequently, not all regions and
industries may yet be experiencing a
comeback from the 1990-91 recession.
Moreover, the Roundtable group acknowledges that growth of the economy
apparently stalled in recent months, but
uniformly rules out prospects for a
double-dip recession. Several structural

adjustments, such as the overbuilding
in commercial real estate and more conservative inventory practices, coupled
with less stimulative fiscal and monetary policies, are among the constraints
on the recovery.
Expectations about inflation, however,
are becoming more favorable. Indeed,
prices so far in this business upturn have
been rising even less than in 1970-71
and 1980-81, the two previous slowrecovery episodes. The problem now is
how to stay on that disinflationary path.


1. An informal telephone survey of most
Roundtable members taken in late November
suggests a downward revision of real GNP
growth to about a 1 percent annual rate in
1991 :IVQ and to about a 2 percent annual
rate in 1992:IQ from the forecasts prepared
in October. For the second half of 1992, however, several economists raised their real
GNP forecast, and most forecasts were in a 3
percent to 4 percent range.

John J. Erceg is an assistant vice president and
economist andLydia K. Leovic is a senior research assistant at the Federal Reserve Bank
of Cleveland. The authors thank Gerald H.
Anderson for helpful comments.
The views stated herein are reported by the
authors and are not necessarily those of the
Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve

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