An overview of the January 24, 1992 meeting of the Fourth District Economists' Roundtable, at which participants discussed how longer-term structural adjustments taking place in many of the nation's industries may be restraining the recovery.Business forecasting

John B. Martin

John J. Erceg

English

Research Papers in Economics

February 15, 1992
eCONOMIG
GOMM6NTCIRY
Federal Reserve Bank of Cleveland
Round table's Rx for the Economy:
First, Do No Harm
by John J. Erceg and John B. Martin
An this political season, there are as many
prescriptions being written for the econ-
omy as there are would-be healers.
Though the diagnosticians agree that the
patient will certainly recover, they are
divided on just how aggressively treat-
ment should proceed.
Participants in the latest meeting of the
Fourth District Economists' Round-
table, held January 24 at the Federal
Reserve Bank of Cleveland, did not give
the economy a clean bill of health, but
their prognosis for the next year and a
half is encouraging. Consequently, sup-
port for more expansive fiscal or mon-
etary policy actions was tempered.
All 24 panelists agree that the recovery
is likely to be more subdued than other
postwar upturns because of longer-run
adjustments taking place in many of the
nation's industries, particularly banking,
retailing, computer equipment, and autos.
As a result, policymakers are advised
to tread cautiously in attempting to restore
the nation's economic health, lest their
efforts interfere with this necessary
longer-term realignment.
• The Economic Overview
A spate of less-than-encouraging eco-
nomic indicators in recent months has
reinforced the view of those who think
that the economy has not yet begun to
rise from its sickbed. Roundtable mem-
bers acknowledged the recent slippage
by scaling down their growth rates of
real gross domestic product (GDP) to
near zero this quarter after a meager 0.3
percent rise in 1991:IVQ (see figure 1).
The group's forecast for the rest of 1992
is brighter. A step-up in growth of real
GDP is predicted for the second quarter,
followed by output and price increases
averaging an annualized 3 percent
through mid-1993 (see figure 2). Never-
theless, the group expects the pace of
renewed growth to be slow judged
against the average of past business
recoveries. Though some sectors and
regions of the country may expand
rapidly, others will likely be constrained
by longer-term structural adjustments.
The Roundtable focused on a few of the
industries in which this realignment is
expected to persist even after the econ-
omy regains its strength.
• Where's My Friendly Banker?
Banking underwent major changes in
the 1980s and apparently faces tougher
challenges in the years ahead, accord-
ing to one panelist and industry expert.
The domestic industry has been losing
market share to nonbank financial institu-
tions, as well as to global competition.
Between 1975 and 1990, banks' share
of commercial and industrial loans
shrank substantially, from about 71
percent of all short-term credit issued
to less than 50 percent. Their share of
consumer loans also fell, as Americans
Participants in the latest meeting of the
Fourth District Economists' Round-
table believe that growth will once
again be under way by spring, though
at a subdued rate compared to other
postwar recoveries. The group attri-
butes this slower pace to longer-term
structural adjustments taking place in
many U.S. industries — a realignment
that most panelists believe is beyond
the Federal Reserve's ability to control.
Thus, in attempting to remedy the
economy's woes, policymakers are
advised to tread cautiously, following
the physicians' oath to "first, do no
harm."
continued to turn to a variety of non-
bank financial sources.
The industry has become increasingly vul-
nerable to changes in the economy.
The same panelist reported that a succes-
sion of problem loans that began in
agriculture and then moved into energy
and real estate has sparked significant
increases in the number of nonperform-
ing loans and loan charge-offs. As a
result, the number of banks that have
had to merge or to fold has been on the
rise since the mid-1980s.
ISSN 0428-1276Despite this downsizing, there are still
too many banks and too many bank
employees, according to the econ-
omist. Acquisitions and mergers,
many of which occurred at the bank
holding company level, have neither pro-
duced the expected cost reductions nor
eliminated a significant number of banks.
Consequently, efforts to increase effi-
ciency and to improve revenues are likely
to result in further reductions in the
number of banks and bank employees.
• Too Many Retailers?
A retail industry representative claimed
that retailers, like bankers, will continue
to feel the pinch of a contracting market-
place over the coming decade. At the
heart of the industry's difficulties is a
downtrend in consumer spending.
Between 1970 and 1986, consumer out-
lays for goods rose at an average annual
rate of 3 percent. Since then, spending
has been trending down. In 1991:
IVQ, skittish buyers bought fewer
goods than in any quarter since 1988:
IQ. As part of this retrenchment, the
retailer noted, Americans have also
been cutting back on the number of
credit cards they hold.
He attributed the current declining trend
in consumer spending to demographic
shifts, tax changes, and an apparent grow-
ing desire by households to save more.
Thus, a rebound in income growth seems
likely to translate into a higher rate of per-
sonal saving than in past recoveries.
While consumers were guarding their wal-
lets more closely, construction of retail
space exploded, jumping about one-
third between the first half and the
second half of the 1980s. As a result,
retail space productivity, or sales per
square foot, fell sharply, and the industry
began to downsize.
Over the remainder of the current decade,
the panelist expects that new construction
of retail space is unlikely to grow much
and that shrinkage in the number of
retail establishments and workers will
continue. The industry has already shed
half a million employees since mid-1990,
when its payrolls peaked at 19.7 million.
• Computers: More Like
Other Durable Goods?
The computer and office equipment
industry is also going through a restruc-
turing process that is restraining eco-
nomic growth. One Roundtable partici-
pant reported that both cyclical and
longer-term developments are behind the
industry's drive to increase efficiency and
to adjust to changing market needs.
After many years of rapid growth that
was relatively insensitive to business
fluctuations, the computer industry has
experienced only minimal expansion
since 1989. At the root of this slowdown
are the increasing substitution of used
computers for new ones, and the con-
tinued shift away from large mainframe
units to small personal computers (PCs).
The move to PCs, which began in the
early 1980s, has fostered the rise of a
group of small and efficient producers
both in this country and abroad.
Furthermore, the domestic industry has
been increasingly exposed to foreign
competition. Between October 1990
and November 1991, imports of office
and computer equipment rose at a 17
percent annual rate, while domestic pur-
chases were up only 1 percent. None-
theless, one Roundtable participant
reported that "computer technology in
the United States is still one to two
years ahead of the foreign competition,
especially for complex equipment."
• Automotive Realignment:
More to Come
U.S. automotive restructuring intensified
in the early 1980s, when Americans
increasingly opted for foreign cars
(especially Japanese models), leading
domestic producers to close plants and
cut employment. Protectionist pressures
in the United States and a desire to locate
plants close to markets led the Japanese
to begin transplanting their production
facilities into this country in 1982. Their
success both here and at home appears
to be based largely on a revolutionary
production system and on the wide-
spread use of new technology, according
to a guest panelist and industry authority.
The Japanese production method dif-
fers in several fundamental ways from
traditional mass production techniques
and forms the basis for the restructur-
ing going on in the U.S. auto industry.
Essentially, the "lean" system, as it has
been termed, requires doing more with
less. Lean producers use fewer suppliers
and carry lower inventories than mass
producers. They also employ a smaller,
but more flexible and presumably more
efficient, work force.
In the same expert's view, domestic auto-
makers' biggest adjustment will be made
in their supply chains. By the turn of
the century, the number of independent
U.S. motor vehicle suppliers is expected
to have shrunk by as much as 40 percent.
He also noted that motor vehicle imports
from Japan may be peaking. Coupled
with recent developments in trade policy
between our government, Canada, and
Mexico, this could mean that more of
the cars and trucks sold in North Amer-
ica will be made here. U.S. producers
are likely to specialize in large, high-cost
vehicles, he added, while the rapidly dev-
eloping Mexican auto industry appears
to be better suited for the production of
smaller, economy models.
These changes should ultimately result
in a more efficient and stable industry
as we approach the mid-1990s, with
vehicle assembly and parts production
increasingly concentrated in the Mid-
west, particularly in Ohio. "Perhaps the
most difficult question facing the motor
vehicle industry today," the panelist
speculated, "is how much production
capacity will go to the U.S. domestic
producers and how much will be gar-
nered by the Japanese transplants." In
large part, the answer lies with the U.S.
producers themselves and how well they
meet the twin challenges of lean produc-
tion and consumer preferences over the
next few years.
• Fiscal Policy:
Is Stimulus Appropriate?
The economy's lethargic performance
has triggered interest in using fiscal
actions (lower taxes, increased spending,
or both) to stimulate economic growth. Yet,FIGURE 1 REAL GDP
Percent change, s.a.a.r.
a
o
IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ
1990 1991 1992 1993
FIGURE 2 GDP IMPLICIT PRICE DEFLATOR
Percent change, s.a.a.r.
a
6
Actual
Median forecast
IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ IIIQ IVQ IQ IIQ
1990 1991 1992 1993
a. Seasonally adjusted annual rate.
NOTE: High and low are the average of the three highest and lowest forecasts, respectively.
SOURCES: Fourth District Economists' Roundtable, Federal Reserve Bank of Cleveland, January 24, 1992;
and U.S. Department of Commerce, Bureau of Economic Analysis.
sentiment for a fiscal stimulus package
is divided, at least among economists.
Slightly more than half the Roundtable
participants favor such legislation,
while the rest believe either that no stim-
ulus is needed, or that such measures,
because of the lags involved, would pro-
vide no thrust until after the expansion is
well under way.
One guest panelist and tax authority
noted that it is not recession but the
lack of economic growth that should
form the basis for any tax relief. Virtually
any kind of a tax cut will mean pushing
the federal budget even deeper into deficit
unless policymakers abandon the 1990
budget agreement and tap future defense
spending cuts to finance the reductions.
He also pointed out that it is unclear
whether the proposed tax cuts are aimed
at consumption or saving, or if they
are intended to stimulate growth in the
short term or over a longer horizon.
The same expert questioned whether
even a $50 billion tax cut, which is about
1 percent of nominal GDP, would help to
lower the unemployment rate. Because
it takes time for tax changes to filter
through the system, any stimulative effect
would not be noticed this year. More-
over, some economists believe that the
fiscal proposals currently on the table
might have no stimulative effect at all.
In their view, short-run tax changes could
do more damage than good in an econ-
omy that needs incentives for saving
and investment in order to improve pro-
ductivity growth. Given these circum-
stances, one participant remarked that
"doing nothing at all for a while might
be the most appropriate policy."
• Monetary Policy: Easy or Not?
At the core of the debate over whether
monetary policy is tight or easy is the
disagreement about which set of
money stock measures is the best indi-
cator of policy: Ml, which expanded
rapidly last year, or M2, which grew 3.1
percent, slightly above the lower bound
of its 2.5 to 6.5 percent target range.
The Federal Reserve uses M2, the broader
measure, as its policy target.
Some economists believe that M2 is no
longer the most appropriate indicator of
monetary policy because of a portfolio
shift by depositors out of low-yielding
instruments into higher-yielding finan-
cial assets not included in M2, especially
bond funds. Others are concerned that
last year's rapid growth in Ml (as well
as in bank reserves and the monetary
base) was too expansive and thus incon-
sistent with longer-term price stability.
However, one participant asserted that
the accelerated pace of Ml growth is
not necessarily inflationary, since the
aggregate typically expands at a brisk
rate when short-term interest rates fall.
Another financial economist argued that
M2 is still the most reliable signal of
policy because its velocity is more stablethan that of other reserve and monetary
measures, and because it has been a good
predictor of nominal GDP. He concluded
that the link between M2 and inflation
suggests the Federal Reserve is on a 1
to 2 percent inflation path over the next
few quarters, but remarked, "I don't think
the market expects sustained 2 percent in-
flation." He also argued that the Fed has
not moved away from its price stability
path recently, as evidenced by that fact
that yields on both Treasury bills and
Treasury bonds remain above nominal
GDP growth, unlike the case in most
past business recoveries.
In essence, this panelist's view is that
the Federal Reserve has provided suffi-
cient liquidity to encourage economic
growth, and that any further easing
would be inappropriate because of
supply constraints in the economy that
are beyond the power of the central
bank to control.
• Concluding Comment
A mood of cautious optimism emerged
from the Roundtable proceedings. Partic-
ipants acknowledge a virtually flat econ-
omy, but one that is unlikely to relapse
into recession. Most expect a step-up in
growth to be under way by spring.
All those gathered predict that the renewed
growth will be moderate relative to past
recoveries. This subdued pace was attrib-
uted to ongoing adjustments in many
U.S. industries.
Panelists warned against policies that
could prove costly to the economy's
future health. Serious reservations were
expressed about the appropriateness,
timing, and effects of the so-called fiscal
stimulus packages currently before Con-
gress. Monetary policy was described
by some as still tight, though on a path
toward price stability.
The forecasts of output and prices por-
tend better economic times ahead. The
group predicts that GDP will grow at an
average annual rate of approximately 6
percent over the next five quarters,
about evenly divided between output
and prices. Yet, in the last two quarters,
prices rose at a better-than-expected an-
nualized rate of about 2 percent. If the
Federal Reserve continues to hold the
line on M2 growth, that split could
well be 4 percent output and 2 percent
inflation. That's not a bad prognosis.
John J. Erceg is an assistant vice president and
economist and John B. Martin 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
System.
Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
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Roundtable's Rx for the economy: first, do no harm

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Roundtable's Rx for the economy: first, do no harm

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