April 22, 1977
Page 11935
STAFF ECONOMIC ANALYSIS
Mr. MUSKIE. Mr. President, the Senate Budget Committee met this morning to reassess the status of the third budget resolution for fiscal year 1977 and the first budget resolution for fiscal year 1978. We undertook this reassessment as a result of the recent decision of the administration to withdraw its support for its original proposal for the $50 rebate and business tax credits, the actions of the Senate on the pending tax bill now under consideration, and the appearance of new economic information in recent weeks. These recent actions pose severe problems for both the maintenance of a steady congressional fiscal policy and for the future of the congressional budget processes.
The committee decided that it required more information before it could reach an informed and responsible decision on the desired revision, if any, of either of the two budget resolutions. We decided we needed more information from the administration on the economic circumstances which led to its abrupt reversal policy, since it did not see fit to discuss the matter with the Congress before hand. We decided we needed new information on estimated budgetary authority outlays and receipts, especially in light of recent statements that the budget deficit for fiscal year 1977 might be as much as $23 billion lower than that projected in the administration's original budget revisions.
We were assisted in our deliberations this morning by an analysis of the present economic situation and recent economic data by the economists from our staff. Both majority and minority staff economists indicated that, in their judgment, the current state of the economy and the economic information which has appeared during the first quarter of 1977 would not, in themselves, justify the change in fiscal policy which has been proposed.
Because much of the information on which this economic analysis was based has appeared very recently, and because the Members of the Senate are presently considering tax legislation which affects fiscal policy for both fiscal year 1977 and 1978, I ask unanimous consent that the economic analysis presented by the staff economists of the Budget Committee be printed in the RECORD so that it will be available for consideration by Members.
There being no objection, the staff analysis was ordered to be printed in the RECORD, as follows:
STAFF ANALYSIS
Chairman MUSKIE. Is this the proper time to get your total economic evaluation at this point before we hear the rest of it?
Senator McCLURE. Well, was the administration right ten days ago or were they right four days ago?
Chairman MUSKIE. I am sure those are the questions Van has prepared to address himself to.
Mr. Ooms. Thank you, Mr. Chairman. I am going to argue that the recent economic data does not support the kind of change which we have seen. Before doing that, however, I would like to make three very brief remarks with respect to the fact that I think the change was inappropriate even if the economic data for this brief period did suggest a very clear strengthening for this brief period.
I still think the change would have been inappropriate. I would like to indicate why that is so.
The first, Senator McClure has already said very eloquently and I simply want to underline, you should not try and fine tune the economy on the basis of a month's or even a quarter's worth of data. I think economists learned through the 1960's and early 1970's, and in a painful way, not to try to promise too much with respect to the ability of the economic policy to fine tune the economy.
I think most economists now recognize that we simply do not know enough to try to adjust policies on a short term basis in that way. Therefore, even if the first quarter did unambiguously show strengthening of the economy, fundamentally and over a longer term basis, which I don't think it did, I still think the policy would be inappropriate. I simply want to underline as many times as possible what Senator McClure said in this respect.
The second reason why I think it would have been inappropriate is that it is quite unclear to me what the administration means when it argues that the stimulus which it previously had argued was necessary is now "unnecessary." The only economic interpretation I could put on that remark would be that — that is to say, the only interpretation I could put on it with the unemployment rate still at 7.3 percent, is that the likelihood of inflation was increased or that there would be crowding out, that there would be some other unfortunate economic effects that would result from that.
The administration itself has indicated that it does not think the rebate was inflationary. So it is simply unclear to me, with about 7 million Americans out of work, what it means to say a stimulus proposal is not necessary. Put slightly differently, when we marked up the First Concurrent Resolution for fiscal 1978, we pointed out that the administration forecast, we thought, was slightly optimistic with respect to the amount of growth that they would get out of their budget and out of the stimulus package. But we said there was a possibility that they would get it because the economy might, as their forecast suggested, be somewhat stronger, stronger than we expected on a conservative basis that it would be.
We applauded that and we said that that is fine. If that is what results, that is well and good. That will create more employment.
Suddenly we have a situation in which the administration interprets the evidence as showing some strengthening is taking place and they turn around and they change the policy, the very policy they were hoping would produce that kind of strength. It simply doesn't make sense to me.
The third point I would like to make, which was dramatized in a headline in the Washington Post on Wednesday, which read,"U.S. Plan to Bolster Worldwide Economy Quietly Laid Aside,"is that we are not simply engaged in an attempt to fine tune the American economy. However inappropriate that would be, we were giving very clear signals to our trading partners and to the rest of the world of the determination of the administration in this country to undertake a worldwide leadership role with respect to reflation; not only that, we were leaning rather hard on some of our trading partners to get them to follow along in that direction.
Suddenly we turn around. But we cannot expect them, if we change signals on them in that way, to believe in the credibility of our steady fiscal policy. So there are international implications of this, some of which this committee addressed in hearings in January, which are very important.
We have only begun, I think, to understand what some of the implications of those are.
Chairman MUSKIE. Are you prepared to more explicitly discuss your view of what lies ahead for the economy?
Mr. Ooms. Yes, sir, and I would like to do that by remarking, first, on what I think the recent economic data in fact, mean.
As I said, I don't believe that what the data we have for the first quarter clearly indicate a stronger economy in any sort of permanent sense of that term, which would have important implications for 1977 and 1978.
There has been a lot of attention given to the fact that we were expecting a relatively low growth rate in the first quarter, for perhaps 3 percent revised upwards to 4 percent in real terms, and it suddenly came in at 5.2 percent. One would have thought all of our economic goals had been reached given the amount of attention given to that number.
The main thing to note about that number is that although it does represent a somewhat higher rate of GNP growth than we were expecting, final sales — that is to say, the sales that reflect the underlying strength of final demand in the economy — apart from inventory accumulation, in fact, fell from 5.7 percent rate of growth in the fourth quarter to 3.9 percent rate of growth in the first quarter.
Now, what that means is that you should not look just at single quarter growth rates because the changes in inventory accumulation tend to dominate the total growth rate of GNP. It means that inventory growth lopped 3 percent off the fourth quarter and added back a point to the growth rate in the first quarter.
This was true even though the rate of accumulation of inventories in the first quarter was only 60 percent of the 1976 average; in real 1972 dollars the inventory accumulation was $4.9 billion, where the 1976 average was $8.1 billion.
What does this mean? Well, I can summarize it perhaps in the easiest way by saying that it means that the fourth quarter was so bad that you had to look good in the first quarter. You could look good in the first quarter even by having a very moderate rate of inventory accumulation because it was zero in the fourth quarter. That is really what we are seeing in these numbers.
To underline that, I would like to look briefly at a couple of the components of it. We heard a lot about retail sales and how strong they were and how the administration had to change its policy because of the strength in retail sales.
Senator McCLURE. Wouldn't it be fair to say that the fourth quarter looked so bad because the second and third quarters looked so good relatively?
Mr. Ooms. Well, the slowdown tended to take place for GNP as a whole over a good part of the year. Really the first quarter was the only strong quarter as to the GNP growth.
Senator McCLURE. All right.
Mr. Ooms. As I said, we heard a lot about the administration changing its policy on the basis of retail sales. Consumption growth at 6.2 percent in real terms in the first quarter was again down from 7.0 in the fourth quarter. This was so in spite of the fact that the savings rate fell to 5.0 percent.
Now 5.0 percent savings rate is extremely low by recent historical experience. It means that it is very likely that consumption is not going to expand rapidly over the next couple of quarters because the savings rate is almost surely going to go back up. So there is nothing in the retail sales figures and the consumption figures that suggest that dramatic strengthening of the economy.
What we were seeing was a rebound from the very bad month of January and the effects thereof. If you look at the investment sector, take housing first of all. Now it is true there was a dramatic rebound in March in the housing start numbers and we saw thousands, but if you take the first quarter as a whole, housing starts were almost identical with the fourth quarter. There was no discernible difference between the two.
Again we ought to look at broader numbers. As Senator McClure said, you were trying to indicate that policy should be made on the basis of one month's set of numbers today.
If you look at expenditure on residential construction, its growth was lower in real terms in the first quarter than in the fourth quarter.
If we look at business investment, it is true that the rate of business investment growth was up in the first quarter over a very bad fourth quarter. However, again if you take the two quarters as a whole, you come out with a 7.5 percent real growth rate, which is not an investment boom by any stretch of the imagination.
Yesterday it was announced that nondefense capital goods orders in March fell for the second consecutive month, which is an indicator of relatively weak investment — what we can expect from the investment side. So the investment boom is still light at the end of the tunnel as far as I am concerned.
I don't see the clear indications that it is about to come off.
Real exports fell again in the first quarter after declining in the fourth quarter. Those are the fundamental underlying components of GNP.
Now, what does this really mean? What it means is if you take the last two quarters as a whole, GNP grew at 3.9 percent on the average. Final sales grew at 4.8 percent. Both of those numbers are well under the target of a 5% to 6 percent real growth rate which this committee addressed in the Third Concurrent Resolution for fiscal '77.
I find nothing in those numbers that indicates that a change in fiscal policy was necessary, and desirable at this time.
I would like to close by referring to a remark which the Director of the Congressional Budget Office, Alice Rivlin, made in her testimony on March 2 before this committee.
This was referred to in an April 5th forecast update by the CBO which I should point out was before the change in the administration's policy and before some of the most very recent economic data had come in.
But Dr. Rivlin said the following, "A rebound from the weather caused reductions and a move towards rapid inventory accumulation are very likely with double digit rates of growth in real GNP or industrial production in the spring, a distinct possibility. Last year many forecasters including those at CBO were misled by a similar inventory spring in the late winter and spring and failed to anticipate the return to a slower rate of recovery later in the year. We may need to guard against making this similar error this year."
I would argue that the administration was so misled and the administration has changed its policy in a way which invites a similar result.
Thank you.
Senator CRANSTON. Your conclusion would be that we should keep the same stimulation we had in the First Concurrent Resolution, I gather.
Mr. Ooms. In the Third Concurrent Resolution.
Senator CRANSTON. In the third? What about the first for 1978?
Mr. Ooms. As I argued at the time of the markup for the 78 budget, I felt that if there was any appropriate adjustment in the 1978 budget it would appropriately be in a degree towards modestly more stimulus, but very modest. It does not appear that any revision in the 1978 budget would be required at this time. As Sid Brown pointed out before, the economic effects of the policy changes take place largely in 1977 rather than in 1978 although there are some 1978 effects.
I don't believe that the revision of the '78 budget would be in order on economic grounds.
Senator CRANSTON. Thank you.
Mr. Ooms. I could perhaps just indicate very briefly and the figures are only quite crude as to what one might expect if the administration's change in policy were to be implemented and we had both the rebate and the business tax cuts removed.
You would expect as far as the change in GNP is concerned — that is to say the change in total product and income to our society — you lose about $9 billion in 1977 and about $7 billion in 1978. Those are not trivial numbers; they are not large in terms of total GNP, but when we think in terms of what we could in fact do with $9 billion worth of resources this year and another $7 billion next year, it seems a shame to throw them away.
With respect to unemployment, we could expect a rising unemployment rate in the fourth quarter of '77 of about .2 percent, a loss of something on the order of 200,000 to 250,000 jobs. By 1978 the effects are less strong, as we said, by the end of '78 we would expect an increase of .1 percent which would be on the order of 100,000 jobs.
The update of the estimates that I have made and those made by CBO suggest that the effects on inflation and the effects on the interest rate would be essentially negligible. You might get a change on the inflation rate or interest rate of a tenth of one percent in ‘77 and '78, but that sort of change is so small in relation to the estimating difficulties and the way in which those numbers bounce around that you have to argue that it was economically negligible.
Chairman MUSKIE. Can I ask both you and Sid to address the budget implications, budgetwise and economywise of the President's energy proposals with respect to, I assume — I would doubt if it would affect '77; are you far enough along in. your evaluation to give us those?
Mr. Ooms. Senator, I am really not. I think it is going to be a lengthy process to get any sound estimates of the President's proposals. I think we can develop crude estimates in a few days when we have had time to look over them but I don't think it would be responsible to try to comment off the wall on those at this time from the economic point of view.
Senator BELLMON. Mr. Chairman, would it be in order to ask Ted Haggart if he has any comments?
Chairman MUSKIE. Yes.
Mr. HAGGART. Thank you. I think Van has very clearly represented what the first quarter data means and I think all of it is such that we expect to be looking at this as an averaging of the two quarters which is very useful. I agree fully that there is no reason to change our underlying forecasts. One perspective that I think is useful for the committee is when we look at the Third Concurrent Resolution in January and February,we were talking about economic policy over a two-year span, 1977 and 1978.
It looked at that time that if we continued the Second Resolution current policies we would have real growth in the 4% to 5 percent range on the average over that two-year period.
I don't think that the underlying forecast is changed any based on the recent data. We fully anticipated at that time that as compared to the very poor performance, reasonably poor performance in the latter part of '76 that the first quarter of '77 and probably the second quarter would be fairly strong.
The 5.2 percent real growth may be a little stronger than we had expected especially in light of the weather effects, but still I don't think it is justification for a major revision in the estimates, especially when you look at the period 1978. The policies that we considered were in the context of a stimulus package for a two year period and much of the concern was with the necessity of continuing the recovery through the latter part of '77 and on into '78.
The scenario that we foresaw without a stimulus package was that a fairly good first and second quarter of '77 with real growth tapering off thereafter.
The latter part of '77 and '78 is still a very real concern and I think that the general dimension of the policies that the committee adopted are still appropriate.
Now, that does span the Third and First Concurrent Resolutions which is embedded in both of those. I think there was good agreement at the time as to the approximate magnitude of the stimulus needed from our witnesses and among the committee discussions. Of course, there were differences of opinion as to the timing and expenditure and outlay components but the basic judgment about a policy that expands that spans that two year period has not changed, I don't think, on the basis of recent data.
Chairman MUSKIE. Is there significant disagreement in your analysis among other economists?
Mr. HAGGART. I have not heard any feedback just based on a two or three day period to indicate there are major revisions of the two year forecasts by the major econometric forecasting services. I am sure on a month-to-month basis they tend to feed in a little more data and it does affect the quarter by quarter statistics that they are predicting, marginally. But I think it's unlikely that you will see a significant change from any of the major forecasting services. That is speculation but I have not seen any revisions at this point.
For instance, Data Resources was anticipating 4.5 real growth in the first quarter. It turns out to be 5.2. They may go back and reestimate some of the future anticipations in light of that.
One further thing I think should be mentioned, an afterthought, if you look at the release from the Commerce Department they point out that in the back that these data are revised in subsequent months and what we can really say based on the numbers we have now which are preliminary and incomplete is that with about 50 percent surety, we can say real growth in the first quarter was between 4.2 and 6.2, and it remains to be seen for several months to see how those numbers are revised. There is uncertainty at this point.
Mr. Ooms. Mr. Chairman, I would like to make two points. First of all, I think the point that Ted made is fundamental and again underlines what Senator McClure said earlier, given the enormous forecasting difficulties that we have and also given the uncertainty about the statistics themselves in the preliminary estimates when we don't have complete data for March in several areas, to make a broad policy change on the basis of that kind of evidence really doesn't make sense.
In response to your question, economists that I have talked to I think are in agreement that an abrupt policy change of the magnitude that was made with that kind of information simply does not make sense.. We should have learned our lesson by this time.
With respect to the forecasts, I would like to make one point which Dr. Okun made when he testified before the committee on the First Concurrent Resolution for 1978.
He pointed out at that time that a critical factor in the forecast for 1978 in particular was business investment. Now there could be disagreement about what the factors are which eventually will bring on strong business investment. But he pointed out that it was his analysis that you stimulate business investment by business in 1978 by having a stronger economy in 1977. It wasn't until, as he said it, you sent customers to the people that were not investing that they were going to begin to raise their investment plans and you get the business investment expenditure.
Econometric models are not very good at picking up the relationship between the strong economy one year and investment in the next year. There have been instances in which they have clearly underestimated that relationship. Therefore, when the econometric models tell us that removal of the President's stimulus package will have some fairly important, not enormous but fairly important economic effects in 1977, but that these tend to fade out so that they are smaller by the end of '78 and they disappear by 1979, those econometric models are not picking up the exact thing that the administration was hoping for in hoping for a stronger economy. They were hoping for a stronger 1977 consumption behavior and a stronger 1977 economy which would kick off an investment boom by 1978 and which would give that optimistic forecast validity.
This is precisely the sequence of economic change, it seems to me, which the change in administration policy has now made less likely to take place.
Senator McCLURE. Could I. ask a question on that, Mr. Chairman?
Chairman MUSKIE. Yes, Jim.
Senator McCLURE. It seems to me that one other thing the econometric models don't really reflect and find very difficult to reflect, and that is the psychological effect of political estimates, the psychological effects of the climate, climate of confidence or whether they lack confidence.
While the President may have reduced stimulus by reducing certain portions of the spending package, he may have increased stimulus by increasing confidence by telling people and persuading them that things are going to be good. So there may be an offsetting effect in what he has done by convincing people that indeed things are going to be better, they are better now and they will go right out and spend more money and go right out and invest more money, as a matter of fact the reduction in spending may be offset by an increase in confidence.
How is that measured and how sure are we of its effect?
Mr. Ooms We are sure that its effects are important and we really do not know very well how to measure them except that there are some attempts made as you know in the consumer surveys and we have referred previously to some of those done at the University of Michigan by the survey research institute there.
One of the interesting things they show in the February survey was that consumer confidence was much stronger among people that expected that there would be a tax rebate than among those who expected there would not be a tax rebate. It is through that part of the business community and the financial community indicated some skepticism about the rebate. I think one could argue about whether that was justified or not. But I am not sure how comprehensive a survey was taken of the opinion of lower and middle income Americans who were expecting their $50 or indeed many of whom had already spent their $50 for heating bills — I don't know how much of a survey was taken of those people to see what happened to their confidence in economic policy when the change of this sort was made.