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1987 AEI Economist 1 (1987)

handle is hein.amenin/aeieco1987 and id is 1 raw text is: the economist American Enterprise Institute for Public Policy Research January 1987 I ~. I Will the Expansion Continue? Murray F. Foss Will the expansion that started in late 1982 continue for another year? Chances are fairly good that it will, but many crosscur- rents can be observed that make continued expansion far from certain. Real output has risen only 2.3 percent over the past year and business fixed investment remains weak; these are not the characteristics of the two other postwar expansions that lasted as long as four years. Signs are just beginning to emerge that the nation's trade deficit may be halting its deterioration and turning around. This has been a familiar expectation over the past year and a half, but now its realization seems more likely. In a setting of many uncertainties, this issue of the AEI Economist presents a forecast for 1987 along with a discussion of recent developments. Revised figures for third quarter real GNP have not changed very much the initial estimate of an improvement over the low second quarter rate of increase. The 2.8 percent rise (annual rate) is a little above the rather slow rate of increase of the past two years. The summer results were dominated by a large rise in consumer spending, most of which reflected a burst in automobile sales in response to major concessions in financing charges by auto producers at the end of the model year. Private investment fell, mainly because inventory investment turned negative as dealer stocks of automobiles were pulled down by the sales increase. Despite the large increase in auto sales, the reduction in auto inventories caused a decrease in auto output from the second quarter, which subtracted a bit from the rise in GNP. Petroleum imports surged for the second quarter in a row as businessmen took advantage of the fall in oil prices; this increase in imports more than offset the small improvement in net exports, not counting petroleum imports. In terms of quarter-to-quarter changes in GNP, however, the worsening in net exports from the second to the third quarter was much milder than that from the first to the second quarter. This slower rate of deterioration was the principal reason for the pickup in GNP in the third quarter as compared with the second. The third quarter of 1986 was the fifteenth quarter of expan- sion in the current upturn, which may be divided into a rapid phase lasting six quarters and a slow phase that has now lasted Murray F. Foss is a visiting scholar at the American Enterprise Institute. more than two years (see table 1). The important role of the trade deficit is brought out in gross domestic purchases, defined by the Bureau of Economic Analysis as GNP minus gross exports plus gross imports; this is a measure of domestic demand. Like GNP, gross domestic purchases have slowed down since mid-1984, but over the past year their growth has accelerated and has been well in excess of the growth in GNP. Since the end of World War II the economy has experienced nine upturns, but only three have lasted as long as fifteen quarters. GNP has not risen as much in this expansion as it did from 1961 to 1964 or from 1975 to 1978. Nonetheless, the average rise of 4 ¼ percent per year is well above the long-term growth rate of 3.2 percent and has been accompanied by a pronounced decline in the inflation rate (see table 2). The 3.3 percent annual rate of price increase is better than the 1975-1978 performance but not as good as the average rise of I percent of the early 1960s. Since the inflation of the 1950s was far less than that of the late 1960s and 1970s, the task of winding down inflationary expectations has been more diffi- cult. The civilian unemployment rate has fallen more in abso- lute terms than in either of the other two expansions, but the level of unemployment remains higher than before. Although in its entirety and in its first year and a half this expansion compares favorably with the two earlier ones, the experience since mid-1984 is troubling. When the latest nine quarters of the current expansion are compared with the corre- sponding periods in the two previous long expansions, the favorable picture disappears. Over the past nine quarters real GNP has increased at an annual rate of only 2.5 percent, far below the 4.3 and 5.4 percent rates over similar phases of the earlier upturns (see table 3). What is perhaps disturbing in the current scene is that nonresidential fixed investment has risen only 3.6 percent, whereas at similar phases in each of the two earlier expansions it grew much more rapidly and was clearly an important factor in the rise in total output. (The recent experience would look worse if inventory investment were included.) Slow output growth coupled with a slow improve- ment in productivity has permitted unemployment to continue falling at a relatively moderate pace in the past two and one quarter years. The inflation rate has continued to be quite low-not quite as low as in 1962-1964 but far lower than in 1976-1978. The AEI Economist / 1

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