May 14, 1995
"Place Your Bet: No Recession"
San Jose Mercury News
By Timothy Taylor
<< Back to 1995 menu

THE ECONOMY is slowing down, no question about it. After booming at an annual rate of 5.1 percent in the last quarter of 1994, it grew at a more moderate 2.8 percent in the first quarter of 1995. This growth wasn't sufficient to keep the lid on unemployment, which crept up from 5.5 percent in March to 5.8 percent in April.

But slowing is not the same as stopping, as any police officer will be glad to explain the next time you glide past a stop sign at reduced speed.

Furthermore, stopping is not the same as going into reverse, which is what defines a recession. From July 1990 to March 1991, the dates of the most recent recession, the economy actually shrunk by more than 2 percent.

The historical pattern of business cycles offers some reason to fear that we're due for a recession. The U.S. economy has had nine recessions since World War II; we're now in the middle of the ninth recovery.

The average postwar recession has been 11 months in length; by contrast, the 1990-91 recession was only 8 months. The average economic upswing has lasted 51 months, and the present recovery will reach that age next month.

Of course, just because a period of economic growth has reached the average age of other postwar upswings doesn't mean that we're doomed to an immediate recession. The economic boom of the 1960s, from February 1961 to December 1969, lasted 106 months. The powerful expansion of the 1980s continued for 92 months, from November 1982 to July 1990.

At least in recent decades, U.S. economic expansions do not die of old age. Nor do they end because of some gradual accumulation of adverse factors. The economy may be tottering or striding, but it seems to keep moving forward until its progress is clearly interrupted.

In fact, the last four recessions have followed much the same script, including both events in the Middle East that affected the price of oil and the reaction of the Federal Reserve to higher prices.

For example, the OPEC oil embargo late in 1973 nearly quadrupled gasoline prices, helping push inflation over 12 percent in 1974. The Federal Reserve cracked down on inflation by raising interest rates to choke off demand. The federal funds rate, which is the overnight interest rate that the Fed charges banks that borrow from it, went from 4.4 percent in 1972 to 10.5 percent in 1974. The higher interest rates held down demand and brought inflation back under 5 percent by 1976 -- but also caused a deep recession.

This pattern played itself out again in 1979, when the fall of the shah of Iran led to instability that almost doubled the price of gasoline, and helped push inflation back above 12 percent in 1979 and 1980.

This time, the Fed under Paul Volcker strangled inflation by pushing the federal funds interest rate from 5.5 percent in 1977 to 16.4 percent in 1981. By 1983, inflation was back under 4 percent. But the tremendous pressure of higher interest rates dragged the U.S. economy through two recessions -- or one "double-dip" recession -- between 1980 and 1982.

The most recent recession follows a similar pattern. As the Iraqi invasion of Kuwait in 1990 put oil supplies in doubt, gasoline prices went up 25 percent in six months and consumer confidence plunged. Even before the invasion, the Fed had feared that inflation was making a comeback, and had raised the federal funds interest rate from 6.5 percent early in 1988 to 9.8 percent early in 1989.

Again, the higher interest rates brought on a recession, but also shoved inflation back under 3 percent, where it has remained ever since.

Of course, the Middle East and the Fed don't explain everything about the last four recessions. But if you had to guess about the timing of the next recession, those two factors are a sensible place to start.

The news from the Middle East always has a few stories that could be a prelude to disaster: perhaps Clinton's embargo on dealings with Iran will turn out badly, or some horrible setback will occur in the Israeli-Palestinian negotiations. But at the moment, the Middle East looks about as peaceful as it ever does.

After raising short-term interest rates seven times since February 1994, the Federal Reserve looks quiet as well. The key federal funds interest rate is at 6 percent, which is considerably lower than when it dragged the economy into the last few recessions.

In fact, long-term interest rates -- like rates on 30-year Treasury bonds and on home mortgages -- have actually been dropping in recent weeks, after rising during most of 1994. Apparently, long-term investors are willing to accept a lower interest rate, because after the Fed actions of this last year, they are less worried that their returns will be eaten up by a resurgence of inflation. These lower rates should help extend the economic expansion.

There are no certainties in economic forecasting. But if you had to place your bet today, the smart money says that Bill Clinton will face the November 1996 election without having suffered a recession during his term of office.

<< Back to 1995 menu