-: Welcome once again as MIT professor Paul Samuelson
discusses the current economic scene.
This series is produced
by Instructional Dynamics Incorporated.
Professor Samuelson, near the midpoint of the third quarter,
how does the recovery look?
-: This is a good time to take stock.
I have before me a series of the newest forecasts for the
next year and beyond by the usual consensus forecasters.
I have the brand new Wharton School forecast,
the Albert Summers private forecast from the conference
board, the new Chase Econometrics forecast,
the new DRI forecast, and they all tell pretty much
the same story, they all are fairly in agreement that
we reach bottom some time around May,
that we are now in the first year of a recovery.
And I would have to say that by and large, the new batch
of forecasts are a little bit more optimistic,
a little bit more expansionary in terms of real growth,
a little bit more sanguine with respect to the developments
of the unemployment rate than the last ones.
These consensus forecasters move, but they move like a
glacier pursuing a reality as it develops.
Now, you may ask are they, other than reacting to the
fact that their hopes that we would have a turn seem
now to have been confirmed?
And I guess I would reply to that leading question,
yes, they've taken courage, bottle courage you might say,
from the fact that what they thought was going to happen
has happened.
But I would hasten to point out that that is necessarily
irrational, that there is a great deal of momentum in any
business cycle situation, and if you do finally get
a peak at a turn in process, that should probably,
rationally, lift your conditional probabilities.
I used to say, you've heard me say it, that in the first
year of a recovery, the consensus forecasters are sort
of looking to six to seven percent real growth in the first
12 months after the middle of 1975, and for some policy
makers, this ought to be a little bit on the low side.
Of course, it's reassuring as against those who fear the
continuation of the slide, and it's also reassuring as
against those who thought that we were in for a very anemic
recovery.
I think if I were to take an average of all the different
variants of the forecasters who's names I've mentioned,
that the mean number now would
come to at least seven percent.
I testified before the joint economic committee not very
long ago, and I was asked what a good target would be,
and I this time chose the avenue of the moderation,
and said that the seven percent real growth was a suitable
target at this time.
You may say is seven percent really a moderate figure?
Well, let me simply reply that in the
locker rooms that I frequent, it's considered a fairly
modest thing and I've been berated if not reproached
by some of my peers and colleagues that I didn't
come out for eight percent and even nine percent.
Well, a number of the forecasters have quarters,
single quarters in the next four quarters, which
in real terms are in the ballpark figure of two digits.
Ten percent.
The Ray Fair Model, which is a non-judgmental model,
which compared to most of the names that I've mentioned,
is a model of a few variables, it has a 12% rate of real
growth in one of these last two quarters of the year,
mostly due to the inventory turn around, kind of a slingshot
effect, from the inventory deacumulation.
We ought to take off our hat to that model,
or we ought to take off our hat, because the model
is now dying, this was its last forecast, professor
Fair has I think been doing this more or less on his own,
and it isn't so much that he's gotten tired of doing it on
his own as that he is now working on a new model which he
thinks is a better model.
In his post-mortem, in his requiem eulogy of the Fair model,
He said that in terms of its X-post forecasting record,
that is if you put into the model, the correct exogenous
factors after you know what they're going to be,
and don't have to rely as he did on
forecasting the exogenous factors from the unknowable,
that it did pretty well.
That it does as well as the X-post non-judgmental use
of the more elaborate models.
Hope that's not true, because it seems to me, and I
say this in no spirit of criticism, that the Fair Model
has been an extremely interesting experiment,
but that it's been a disappointing experiment.
It has shown us that without judgment, you do very badly
in forecasting.
I don't know how good the formal models are of the consensus
forecasters, the Wharton model, the Chase model, the DRI
model, but I do know that the people who massage those
models, who adjust their constants, are quite well informed
on what is happening.
And there is serial, positive serial correlation and
momentum and drift, so that you can extrapolate from what's
happening, and so they do very much better.
I would, for example, be inclined not on this occasion,
but just in season and out of season to bet against
that 12% number.
It's just too big a shift in a short period of time.
I think the Fair Model tells us something, a little,
about the merits of big models versus small models.
You know, you can have a model which is so big it just
falls of its own weight.
There was the famous social science research council
Brookings model.
It had some of the best Lieutenant Colonels, Majors,
Generals, that we have in the econometrics army,
but it was so big you could hardly test for its own
consistency except for a run through the model.
It was not good for short run forecasting and it was not
good for long run forecasting.
So some people said, what you really need is a two or
three equation model.
The Fair model is in that direction, and it has not,
I think, done very well, certainly in X-anti forecasting.
Which is what its main use has been.
It's been discontinued.
It's the same thing that's happened to the St. Louis
Reduced Form Monatrist model.
It certainly is simple in terms of number of equations,
and it has done very poorly, even more poorly than the
Fair model, and it too I think is now discontinued as
far as published forecast.
There is a new version of the equations which has been
published by Dr. Lino Anderson, but I no longer get
forecasts that tell me from quarter to quarter what's gonna
happen to money GMP, what's gonna happen to real GMP,
what's going to happen to the rate of increase in
prices, and that's of course, what we would hope from
a monatrist model.
In the black book in which I keep all the forecasts that
I learn anything about, I think actually the federal reserve
bank of St. Louis has the largest squared error for the
last half of 75, 74.
The last half of 74 surprised everybody in its virulence.
I think there's no exception to that statement.
Nobody, even some of us who were on the pessimistic side
say at the summit in September of 1975, none of us could
foresee just how rapidly the economy would slide.
But some of us had bigger squared errors than others,
and it was from the federal reserve bank of St. Louis
that of all the forecasts in my collection, both was
respected a qualitative tone of the situation, and for
the quantitative detail that was the largest in error.
You can't prove anything by these simple little experiments,
maybe if you continue them over many lifetimes, there will
be, for the joy of judgment and eclectic discernment, a
moral that will gradually emerge, but for whatever it's
been worth, the experiment with the small models seems
to have suggested that in this season, I mean now, the last
three, four, five years, times when we certainly have been
very desirous of getting good forecasts,
they have done statistically, significantly worse than
the other models.
Well, we'll make of that what we can.
The fact that the consensus forecasters have got their
courage back and are looking for a fairly vigorous
recovery, that same news, and that same feeling has spread
through the country.
The various indicators of consumer sentiment have shown a
rapid rebound in consumers sentiment.
The concern which was very widespread at the turn of the
year, that the government wouldn't do anything about the
deepening depression, not just recession, and that we
would have a domino effect, slide into something like the
1930s maybe with some real epidemics of bankruptcy and
even of bank failures, that concern has been soft-peddled.
The pragmatic effect of all this of course, has been one of
the most rapid percentage rises in the United States stock
market that you can find in the history books, from the lows
of last December until recent times, and the stock market
seems almost like Moses, you remember that he could lead
god's chosen people for 40 years through the wastelands,
but when the promised land was in sight, it was not given
to Moses to lead his people in, and he had to turn that
job over to Joshua or Aaron or somebody or other.
Well the stock market seems to be able to sniff at
any impending recovery, and to make very substantial
progress.
But just as the fact of the recovery was confirming itself
to the rational eye, the market began to move sidewards,
and even to lose ground.
It is a possible explanation, it's so simple that I hesitate
to give it, but I think I can overcome my hesitation and
give it.
There is a view, a moralistic view, that in order to know
whether stocks will go up or down, all you have to do
is to know what's happening to interest rates.
Particularly volatile, short-term interest rates.
When interest rates go down, stocks will go up,
when interest rates go up, stocks will go down.
It's surprising how far in the last decade, that simplest
view would carry you.
You've heard me mention that I know some people in New
York who ask my advice at intervals, and they operate almost
exclusively in terms of this simple relationship.
And I keep telling them, it's too simple, there are more
factors involved than this one factor, and yet they so
to speak laugh all the way to and from the bank, because it
has done very well for them, and done very well for them
at a time when very few people are doing at all well.
Why did interest rates go down last fall?
They went down because the economy was going to hell
in a basket, at an unprecedented and unpredicted rate.
Strange for the stock market to go down, to go up,
when the economy is going down.
Nigh impossible to provide an explanation, but at first
blush, it would seem a little bit pickwickian or ironical.
Similarly, why are interest rates now going up?
That's a subject which I want to discuss in some detail.
But certainly an important aspect of the picture is the fact
that everybody now believes that the economy has made its
recovery, that the slide is over.
We're no longer sliding downward.
And therefore, given the way the federal reserve maintains
its posture with respect to the money market,
this tends to create conditions which I'll describe in a
second, which tend to tighten interest rates.
Never the less, do you want to be smart?
Do you want to be deep?
Do you want to be understanding and perceptive?
Or do you want to be rich?
I'm of course, suggesting, because I really don't
believe that the new formula, the new philosopher's stone
has been found, that you can just blindly watch to see
what interest rates do and then do the opposite with respect
to stocks.
But it is interesting that the stock market has not been
able to make headway since the Dow Jones' peaked out
at about 880, just at a time when the money market has
convinced itself that the federal reserve is tightening up.
The money market does believe this, and let me just read
from the Salomon brothers weekly comments on credit.
This one is written by Henry Kaufman, a name respected
and revered in the money market.
It comes at the end of July, and it's therefore not out
of season yet.
Comments on credit, Vigorous Monatrism is the title.
"Through a dramatic series of actions, and the congressional
testimony of its chairman this week," that's Burns, "the
federal reserve gave notice to the market that it intends
to pursue a much stricter monatrist policy than in the
past."
I think that adjective, monatrist is regrettable,
because its a stricter policy with respect to the interest
rates as well as with respect to just the money aggregates.
"This means their attempt to hold relatively short-term
trends in the monetary aggregates within moderate bounds,
even if that means typing money market conditions in the
earliest stages of economic recovery.
Successive fed open market interventions this week confirm
resoundingly that the authorities were raising their
target for the fed fund's rate, which for some time had
centered around 6%.
On Monday," this is the last week in July, "the fed sold
a substantial volume of treasury bills for cash, when
fed funds were quoted 16% on Tuesday, they consummated
reverse repos with funds at six-and-a-sixth percent.
On Wednesday, authorities entered the market to provide
reserves only after the funds hit six-and-a-half percent."
Well, why is the fed moving its interest rate target upward?
Undoubtedly, it's doing so because it has been somewhat
frightened by what maintaining its previous lower targets
seemed to be doing to the rate of growth of money supply.
We had a rates of growth of money supply in short periods
of time, which were 14%, in shorter periods of time which
were 20% annual rate, and since the fed has given as its
goal, under pressure of congress, congressional committees
to get a goal that the money supply, M1 say, is to grow
from five to seven-and-a-half percent in the period,
or first they said for March to March, but now from the
second quarter of 1975 to the second quarter of 1976,
and since they were, as the economy was making its turn,
and as the federal government was pumping money into the
economy, at its peak rate, in the second quarter of the
year, the annual rate of the fiscal deficit, if you use
that as a rough measure of fiscal stimulus, fiscal
deficit on the national income account, it peaked out
at the second quarter at 100 billion dollars.
It will be, would be a lesson then on a year's basis,
and it's no coincidence that the turn of the economy was
confirmed, the fiscal stimulus had something to do with
confirming that in the face of an unprecedentedly large
inventory deaccumulation.
Well, the fed had realized that this would be a situation
which would probably, unless interest rates were allowed
or forced sky-high, cause a monatrist to have his
hair curl, that it would be a very rapid short-term
rates of growth in M1, and so they were prepared, as
I remember it, for a number above their target of seven-
and-a-half percent, the upper interval.
But they weren't prepared for twice that amount,
or even more, and so it kinda scared them, particularly
since they know the monatrists are gonna be on their tail
very soon, once those numbers get out, and nothing is new,
everybody is on the federal reserve's tail, the economists
who want a vigorous expansion complain when the
federal reserve lets interest rates, short-term interest
rates go up, the monatrists complain when they don't let
them go up if the price of not letting them go up is to have
increase in the money supply, and congress, now, is looking
over if not the day-to-day activities of the federal
reserve, certainly the month-to-month activities.
I wouldn't say by the way, that congress are doing it in
a particularly informed way, but we have only one democracy
and we have to work with the democracy that we do have.
Well, it'll be interesting to see how the recovery actually
does develop in comparison with the average of all post-war
recoveries and with the special features looked forward
to by the forecasters with the best betting average.
Let me just turn from the future, to mention something
extremely interesting, the unemployment numbers as reported
for July came in with a pleasant surprise.
Let me just review, in May, the unemployment rate leaped
up to 9.1%, and it was thought that that number had a bad
seasonal correction in it, and was a little higher than
it ought to be, so the punitive, genuine rate, if you had
a good seasonal correction, was expected by experts
to be in the ballpark of 8.9%.
Mr. Julius Shiskin, the commissioner of labor statistics,
who I must say has been conducting himself well among other
things, very cautiously, at this stage of the game,
he hasn't even to admit that there has been an upturn.
Well, Mr. Shiskin warned us to expect that the June number
would fall, and that wouldn't represent all that much of
an improvement, it would just represent a correction of a
correction, of something that needed to be corrected.
While the June number did fall, and it fell perhaps a little
bit more than he had warned us of, it fell from 9.1%
as I remember, to 8.6%, but we could all say to ourself,
aha, it's still consistent with 8.8, 8.9%, and people like
me as when I testified before congress, said the
unemployment has probably been lagging, so it's going
to peak out a little bit above nine percent.
But then, just a week or so ago, we got the July number,
and the July number showed a further drop, not a rise,
a further drop from 8.6% to I guess it was 8.4% in the
rate of unemployment, and it was also a drop that in part
was due to an increase in employment, not just an increment
of discouraged workers, et cetera, et cetera.
Now, the evidence is by no means all conclusive,
because we have two ways of estimating employment from the
sample of asking people and also from establishment data,
and they show some disagreement.
Nevertheless, it looks, now, as if it's a plausible
hypothesis that the 9.1% number in May was the aberration,
and maybe that'll be the peak of unemployment, and maybe
unemployment is almost already on its way down.
And of course, I think that's very good news, because
one of the worst aspects of all the forecasts including the
optimistic ones, has been that only very slowly do we bring
the rate of unemployment down to eight percent, say some
time next spring, and very slowly down to seven-and-a-half
percent, say about the time of the election, November, 1976,
and it'll be a long, long day on that scenario, until we
get the unemployment rate even down six percent.
But, you see now, it looks as if we have gained maybe
as much as a half a percent in comparison with what were
reasonably dire forecasts before, and I have to regard
that as good news, after all, it is the unemployment
which is the greatest human cost of the way we've chosen
to fight inflation.
I mustn't conclude without using the last minute to discuss
inflation.
Here, the consensus forecasters are really, fairly far
apart.
The hardest thing in the world for economists to forecast
is prices.
It's ironical.
Chase is very pessimistic.
Chase thinks that the rate of increase in prices will
be eight percent, even nine percent, that this will
feed into short-term interest rates and even into
long-term interest rates, and is doing so already.
On the other hand, there are students of the labor
market, like Robert Gordon in Northwestern University,
and Robert Hall, my own colleague here at MIT, who think
with all this slack, that it is bringing down the rate
of increase in wages and in prices, and I have heard
from such people, I don't recall either of those
two gentlemen, 'cause I haven't checked with them recently,
that by the last quarter of the year, we might well see
a three-and-a-half percent, four percent rate of price
inflation.
Along comes the drought in the middle west,
along comes the bad crop prospects in Russia, and
we're again, off to the races with respect to
grain prices and with respect to food prices generally.
So I think I will maintain my agnosticism that the
rate of inflation will continuously abate, and that
the recession has all been for good purpose and
is achieving that good purpose.
I think that we will do well over the next year,
if we're able to keep the rate of price inflation,
as measured by the GMP deflator or the consumer price
index, in the ballpark range of five or six percent, not
three, four percent, and I think there's a chance that
it might well be that seven or eight percent, particularly
if oil is decontrolled.
-: If you have any comments or questions for Professor
Samuelson, address them to Instructional Dynamics
Incorporated, 450 East Ohio St. Chicago, Illinois,
60611.