The Recession of 1996
Mueller, John
The Recession of 1996 by John Mueller To hear tell , the Economyis the main thing Bill Clinton h as going for him in his reelection bid. The unemployment rate was down to 5.6 percent in May,...
...Businesses and families tend to compare their situations with the same time a year earlier...
...The unemployment rate was down to 5.6 percent in May, falling from 7.3 percent in November 1992...
...the rise triggered one last surge of investment financing...
...Instead, we got a recession...
...What effect would a recession later this year have on Clinton's chances...
...In fact, the opposite happened: There was a surge in investments, and economic growth, in 1994...
...Nevertheless I think we will be in a recession by Election Day...
...At the same time, White House staff expressed relief that the slowdown would be over before the 1996 election cycle...
...What this suggests is that, after the strong first quarter of this year, growth will slow and then output will decline over the last half of the year...
...Or so the theory goes...
...Likewise, the spurts of growth at the end of 1992 and the end of 1993 corresponded to sharp cuts in the Federal Funds rate at the end of 1990 and again at the end of 1991...
...The pattern is uncannily similar to 1990, when the last recession began...
...The reason the same outcome is likely later this year has to do with the way the economy interacts with Federal Reserve policy...
...People have more time to think about the bad news...
...And the latest numbers suggest the economy grew at an annual rate of 2.3 percent in the first quarter of the year...
...But by July we were in recession-and that was before, not after, Saddam Hussein invaded Kuwait...
...Conventional wisdom (including conventional wisdom at the Fed) has it that monetary policy affects the economy fairly rapidly: Alan Greenspan and company act to raise or lower interest rates, and six to nine months later the economy slows or accelerates...
...That's one reason why the recovery seemed agonizingly slow in 1991 and 1992...
...In fact, business-cycle fluctuations seem to be dominated by the Federal Reserve's policy on short-term interest rates, once you take account of the two-year lag...
...In general, though, there is one thing worse than a recession in an election year: a recession that begins the year before an election...
...It's only when rates bottom out and start to tick up that everyone gets off the dime and rushes to lock in the new investments that have been made more attractive by lower interest rates...
...Could fast action by the Federal Reserve in cutting interest rates head off the downturn...
...Raising interest rates-the Federal Funds rate went up sharply after April 1994...
...If the two-year lag between Fed actions and economic results holds up-as it consistently has in recent decades- the decline in output should be concentrated in the second half of this year, and the economy will hit bottom in the first part of 1997...
...So the economy will have turned up or down for some time before any change is noticed...
...On Election Day 1992, most people were convinced that we were still in a recession, even though the economy had been recovering for more than a year...
...Unemployment fell to 5.1 percent in June 1990, and real growth in the first quarter of that year was a sharp 4.2 percent...
...So what was the Fed up to two years ago...
...If a third-quarter drop in output is reported before Election Day 1996, it may be similarly dismissed as an aberration, unless people are more attuned to bad news this year...
...If, as I expect, the economy weakens at about mid-year, the Fed will most likely respond by cutting its interest rate target...
...Of course in 1990 everyone "knew" that the Fed was pulling off a "soft landing...
...The odds are that we will again...
...The central bank's interest-rate policy does affect the business cycle, but it takes much longer than two or three quarters-in fact, it takes a full two years...
...But the facts reveal a different story...
...When Alan Greenspan testified before Congress in early 1994, after the Fed had started raising interest rates, many members of Congress complained that the action would slow the economy before the 1994 congressional elections...
...And the effects of the Federal Reserve's interest rate hikes in the latter part of 1994 have still not been felt by the real economy...
...Industrial capacity use and manufacturing employment have been falling for over a year now (as they did before the last recession...
...Not necessarily as much as you would imagine...
...The bottom of the last recession in the first quarter of 1991 corresponded to the peak of short-term interest rates in the first quarter of 1989...
...people were waiting for the Fed to stop cutting interest rates...
...A personal rule of thumb is that perceptions about the economy-not only among the public, but also among forecasters-take about a year to catch up with reality...
...To forecast a recession starting in the second half of 1996 defies what everyone "knows" about the economy...
...John Mueller is a principal of Lehrman Bell Mueller Cannon, Inc., an Arlington, Va., financial markets fore-casting firm...
...Probably not...
...When interest rates are falling, every sensible business executive or householder tries to put off investments as long as possible, in hopes the rates will fall even more...
...But that will actually accelerate the decline at first...
...Not only was it too soon for the rate hikes to slow down growth...
Vol. 1 • June 1996 • No. 39
