Why The Expansion Still Has LegsBy
Based on the length of past expansions, 1996 should be a year in which the economy is increasingly vulnerable to a recession. But rest easy. Sure, this expansion is an old-timer by postwar standards, and it's not nearly as spry as it was a year ago. But with the Geritol of low inflation and interest rates, there is every reason to believe the consensus view of the 50 forecasters surveyed by BUSINESS WEEK: The economy will continue to grow at a steady, if plodding, pace for the sixth year in a row (table).
Although inventories look a bit high and household debt is rising, there are no imbalances of the size that usually precede downturns. And don't worry about the budget deal. Washington's seven-year plan to balance the budget is likely to have tax cuts up front with spending cuts later on. So any fiscal drag in 1996 will be small or nonexistent. Of course, if Congress and the White House fail to come up with a credible blueprint, all bets on lower interest rates are off.
More important, inflation pressures are expected to remain practically nil and economic growth only lukewarm, so the Federal Reserve will be cutting interest rates, not raising them. Such tame inflation prospects six years into an expansion--and their impact on rates--are a key difference in this business cycle, vs. those in the past.
Low interest rates are the primary catalyst for continued growth. Long-term rates dropped two points in 1995. That's worth $200 billion in stimulus over the next two years, if rates stay down. Indeed, 1995's huge jump in stock and bond prices hardly presage bad times. As Laurence H. Meyer, head of his own St. Louis-based consulting firm notes, recessions usually follow a boom-bust pattern as strong growth forces the Fed to jack up interest rates in an effort to head off inflation. "This time the Fed has effectively contained the boom," he says, "so why a bust?"
We agree. BUSINESS WEEK expects the economy will grow 2.3% next year, measured from fourth quarter to fourth quarter, a bit better than the 1.9% average pace expected in BUSINESS WEEK's annual roundup. Note that these projections are based on the Commerce Dept.'s chain-weighted measure of gross domestic product, which is expected to show 1995 growth of about 2% (see box). We also believe inflation will end the year at 2.7%, close to its 1995 rate, and that joblessness, although rising a bit early on, will finish at a low 5.5%.
CHRISTMAS BILLS. We expect 1996 to begin slowly, as businesses continue to wrestle their inventories into better alignment with 1995's slower pace of sales--a process that is taking longer than anticipated. Also, households will struggle with big credit-card bills from Christmas '95. But growth will pick up later in response to lower interest rates and renewed momentum in the manufacturing sector.
The top-performing sectors will be exports--helped by competitive gains from past investments and a healthy world economy--and capital spending for equipment as businesses invest heavily, if a bit more slowly, in technology. Also, lower interest rates will underpin the housing and durable goods sectors.
New technology is at the heart of another year of solid, if less robust, gains in corporate profits. "Good profit growth in a slow-growth, low-inflation economy is testimony to all the cost-cutting, the strong investment spending with its focus on productivity, and the benefits from the technology revolution," says Donald H. Straszheim of Merrill Lynch & Co. The mix of decent earnings and low interest rates should keep Wall Street percolating.
Corporate America's new competitiveness is the chief reason why exports will continue to be a growth leader, at least matching their 10% pace of 1995. At the same time, imports will slow, reflecting modest demand in the U.S. The result: an improving trade deficit that could add handsomely to GDP. "World growth prospects are decent, and Mexico should be less of a drag." says C. Heather Dillenbeck, a consultant to U.S. Trust Co. One area to keep an eye on, however, is Europe. Germany, the Continent's lead economy, was surprisingly weak in the second half of 1995, and economists are lowering their 1996 projections. Japan's prospects are improving, and East Asia will continue to post strong growth.
CONSENSUS? NOT. The dollar should remain firm as world financial markets reward U.S. steps toward fiscal responsibility and the Fed's inflation control. The buck, which has strengthened recently vs. the Japanese yen and the German mark, will continue to do so, but it will not rise so much as to harm the competitiveness of U.S. exporters.
At home, the ongoing substitution of capital for labor will limit consumer spending. Job and income gains will continue to slow as household debt increases. "But as long as employment is at least growing," says Constantine G. Soras of Nynex Corp., "rising debt should not be a concern." Also, the labor market should stay tight enough to generate wage gains above inflation, a boost for many consumers' real pay. Another round of mortgage refinancings may also help household budgets.
Of course, you'll never get 100% agreement from 50 economists. Maureen F. Allyn of Scudder, Stevens & Clark Inc. expects a recession to begin by the middle of the year. She blames a sharper than expected falloff in corporate profits. "That leads to layoffs and falling income growth, which exposes household debt problems," she says, causing consumers to pack it in. It's a scenario that deserves some thought. But with low inflation and low rates to support 1996 growth, recession seems more like a worry for 1997.
THE NEW GDP STATISTICS
On Dec. 19, the Commerce Dept. switches to a new measurement of gross domestic product called chain-weighted GDP. Since this gauge gives less weight to fast-growth sectors where prices are falling, such as computers, it yields a slower pace of economic growth for the most recent years compared with the old 1987-dollar, fixed-weight measure previously used. Based on economists' projections, 1995's fixed-weight GDP growth would have been about 2.8%. On a comparable basis, the forecast for 1996 would have been 2.5%.