The recession ended more than two years ago, the unemployment rate has fallen 0.7 percent from its recent high, interest rates are at 20-year lows, stock prices are rising nicely, the Cold War is over, inflation is around 3 percent, personal income is rising. Sound like good news?
Apparently not. According to consumer sentiment surveys, the nation is still in a recessionary funk. Unfortunately, the survey becomes a self-fulfilling prophecy. Unless and until consumers feel more willing and able to spend, the economy will be moving at a moderate pace that falls well short of the booming 1980s.
The chart shows the two major consumer sentiment surveys conducted by the University of Michigan and the Conference Board. The term "consumer sentiment" might suggest that researchers ask consumers how they feel about themselves. Actually, the surveys are made up of specific questions about buying plans, such as for automobiles, and about specific financial and economic variables, such as whether income is rising or whether jobs are plentiful. Toting up the answers, analysts then compare today's readings with a baseline arbitrarily set at 100.
In the late 1980s, consumer sentiment was about as robust as it gets. The longest peacetime expansion in history led householders to conclude that prosperity would last forever, or at least until all the bills were paid. The 1987 stock market crash may have prompted apocalyptic analysis on the evening news, but it barely fazed consumers. Sentiment dropped briefly, only to move on to new highs in 1988 and 1989 as the economy boomed along.
This is not as remarkable as it may seem at first glance. When the unemployment rate is perceived as low or falling and when income growth is seen to be rising ahead of inflation, consumers are willing and able to spend. It is not too complicated a process. The events on Wall Street in late 1987 were all very interesting, but consumers correctly concluded they would have little impact on either the job market or on their own income. Life went on.
The Gloomy 1990s
If the 1987 stock market crash did only fleeting damage to sentiment, the uncertainties created by Iraq's invasion of Kuwait and the subsequent surge in oil prices had a more powerful impact. In late 1990, consumers decided that things had become considerably more worrisome. Buying plans plunged even as inflation jumped up over 6 percent. Suddenly, the debt accumulated during the 1980s did not look like such a good idea. With consumer spending drying up, the economy started to contract, and in July 1990 we entered a recession.
The combination of war and recession understandably drove sentiment down to levels not seen since the double-digit unemployment rates of the early 1980s. Worse, the moderate economic expansion that began in the spring of 1991 was not enough to bolster sentiment, which has fluctuated slightly but continued in the doldrums.
The last readings in April put the University of Michigan survey about where it was when the stock market crashed in 1987, and the Conference Board survey is in the range it occupied during the recession of 1990-1991. You would never know from looking at these numbers that the economy grew more rapidly in 1992 than it did in 1989 when sentiment was sky-high.
The New Administration
Every time it looks like consumer sentiment is coming out of the doldrums, it falters and falls back. The most recent episode was the improvement following the elections in November. Elections do not customarily cause people to change buying plans. Who goes out to buy a car to celebrate a winning candidate? Still, there was a sense that President Bill Clinton would focus more aggressively than President George Bush on speeding up economic growth.
However, sentiment has receded as the administration's detailed plans started coming out. Laura Tyson, who chairs the President's Council of Economic Advisers, said last week the administration may have unwittingly slowed the economy. "There are big uncertainties. That may have made the recovery a little more modest."
The "uncertainties" to which Dr. Tyson was gingerly referring are taxes. The Clinton administration, which won the election in part by condemning George Bush for reneging on his promise not to raise taxes, now wants to raise income taxes, taxes on Social Security benefits, excise taxes, probably payroll taxes, and it wants to invent some new taxes on energy.
Consumers might be forgiven for being a bit confused and more than a little skittish about their financial future. When consumers fear that their disposable income is in danger of falling, they definitely become cautious.
Conversely, when the uncertainties become certainties about when and by how much taxes are going to rise, the news will probably not be as grim as feared, and consumer uneasiness will likely recede.
Meanwhile, after a burst of spending in the fourth quarter of 1992 (partly to replace goods damaged by catastrophic hurricanes), consumer expenditures have softened. Retail sales last month still had not climbed back up to the pace set in December on a seasonally adjusted basis. In the first quarter, inventory build-ups accounted for all the growth in real Gross Domestic Product.
But this is not a recipe for a recession. The rise in inventories in the first quarter still left inventory/sales ratios at historic lows. Though consumer spending has ebbed and flowed in recent quarters, the trend rate of about 2 1/2 percent growth in real terms is well established. Business spending on equipment continues to boom along, homebuilding is on a upward track, and domestically-produced automobiles are selling well.
On balance, the outlook for the economy is for more of the same: moderate growth, moderate inflation, no boom, no bust.
Paul Boltz is vice president and financial economist for T. Rowe ++ Price Associates, Inc.