Oil and interest rates point to fresh oomph for an aging expansion
DURING the first two months of 1986, the outlook for the economy grew considerably brighter. Although the United States is in the fourth year of an economic expansion -- mature by most measurements -- at least two elements make 1986 look more like the start of an expansion: declining interest rates and declining oil prices.
The usual government reaction to recession is to stimulate the economy through fiscal and monetary measures such as tax cuts, more government spending, and easier money. But falling interest rates and a drastic drop in oil prices are the equivalent of both fiscal and monetary stimulus.
For several years interest rates have been too high. With inflation under control, at least for now, the real rate of interest (that is, adjusted for inflation) has been far above its historic norm. But just as investors were slow to demand enough real interest when inflation was worsening in the late '70s, they were reluctant to believe that inflation was finished for a while.
The collapse of the oil market, however, seems to have convinced the markets that inflationary fears can be put back in the closet for now.
Just how much help interest rates are getting from any plan of the big-five industrial nations to force rates down is not yet clear. With the US dollar having fallen as much as it has since last September, it seems clear the US is not going to lead the way down.
But if Japan and West Germany lower their rates, there would be room for US rates to drop further.
In any case, all this is helping the real estate market and other areas that depend on long-term credit. It has to be bullish for the economy, producing the same effect as if the Federal Reserve had engineered the rate decline.
If that is the monetary side of things, what about the fiscal?
Here the drop in oil prices comes in again, but in an even more direct way. It puts money into the pockets of consumers, money that would otherwise have been spent paying heating bills or buying gasoline.
David D. Hale, chief economist at Kemper Financial Services in Chicago, notes in his current outlook: ``In many ways, OPEC is now implementing the policy recommendations proposed by the G-5 finance ministers at their New York summit conference last September.
``It is providing the industrial world with a $40 billion tax cut (adjusting for lost export sales), with the major beneficiaries in GNP terms being those countries which currently have the tightest fiscal policies, Germany and Japan.''
The US has contended that other industrial countries have not been doing enough to increase their growth rates (a point not necessarily accepted by these other countries).
But the oil price collapse should be similar to fiscal stimulus for these countries, and the growth rates of the major industrial nations should surge. It is even better than fiscal stimulus, of course, since it doesn't come out of the pocketbooks of the governments involved.
The nations ``paying'' for this new economic stimulus are the members of OPEC, which are paying in the sense that they are getting less revenue to fill their own bank accounts.
Thus 1986, which began as a year that would see steady but unexciting growth, is looking better. All of which also shows why each economic cycle has to be examined on its own merits.