Economy's mixed signals indicate slowdown for recovery, but early peak on interest rates
When Ronald Reagan takes office Jan. 20, he probably will inherit an economy that has "wobbly kness." Sharply escalating interest rates have almost assured the President-elect of this. In recent weeks, interest rates have been racheting upward, with the prime interest rate most recently hitting 16 1/4 percent. Still higher rates are likely.
At the same time, investors are telling the US they expect better times ahead. Trading on Tuesday renewed talk of the Dow Jones industrial average pushing well into what has been forbidden economic territory -- beyond the 1,000 mark.
What do these mixed signals mean? Economics say the outlook isn't all bad, nor is it entirely rosy.
"President Reagan is going to see a weaker economy," says economist Edward Yardeni of the investment firm E. F. Hutton, "but not necessarily an economy in the middle of another recession."
Economist William V. Sullivan Jr. of the Bank of New York agrees, noting: "The economy could be showing some signs of strees -- particularly in the housing sector -- but don't look for any major signs of weakness, such as a full-blown recession."
In past years, Mr Sullivan says, higher interest rates have had a braking effect; housing starts, auto sales, and consumer buying have tailed off as interest rates have soares. However, the economy is showing a great deal of resilience in the face of high interest rated.
This silience is being tested, says kevin Hurley, director of financial forecasting for Chase Econometrics , a Philadelphia-based economic forecasting firm. The housing sector, in particular, is being hurt as mortgage rates rise. In most areas of the country, mortgage rates currently are 15 percent (in California they are 16 percent). "These rates," Mr. Hurley says, "will discourage people from taking out mortgages."
In the past two months, new-housing sales have been down even though builders have been building more new homes. The backlog of unsold houses is rising and is expected to continue to rise.
One of the reasons economists don't expect the economy to swing back into a recession is because of the current conservative business practices of large corporations. Inventories have remained in balance, and companies have not adopted a hoarding type of inflationarypsychology. At the same time, durable goods orders have remained relatively strong and retail sales are encouraging. Federal spending has been strong, Sullivan notes, "offsetting many pockets of weakness."
A further boost to the economy in the new year would be a tax cut. Mr. Yardeni says he expects a tax cut would be sufficiently stimulative to keep the economy humming through the end of 1981. Hurley estimates the cut will be about cut to offset the increase in social security taxes.
The tax cut could give the consumer a feeling of "well being" in spite of a persistently high inflation rate expected to be in the 10 percent range. "The tax cut," forecasts Sullivan, "will help the economy muddle along."
One of the key questions will be whether or not the Reagan administration can cut spending. If the federal budget is reduced by $30 billion, as the Reagan camp hopes to do, this could reduce some pressure on interest rates.