And The Beat Slows Down

It'

s ba-a-a-ck! The business cycle, that economic beast from 20,000 fathoms, is poking up its head again. The rushing tides of the new economy kept it submerged for almost a decade, but they could not drown it for good. It lives! Only it now looks like a pretty tame beast. A little slower growth in U.S. production, a little more inflation before the slowdown takes effect, a bit more unemployment, eventually, maybe...that's about the worst damage that the cycle is expected to inflict. Unless...

Such was the consensus of TIME's Board of Economists, which gathered in late May in Manhattan to assess a rapidly changing business outlook. For the first time in at least two years, members concurred, not all economic systems are go. Imbalances are showing up, notably a worsening labor shortage and excessive consumer spending; signs of renewed inflation are real; stock markets have turned turbulent, to say the least. Allen Sinai, chief global economist of Primark Decision Economics, long contended that rising productivity in the new economy enables the U.S. to enjoy noninflationary increases in production much greater than once imagined. He now concedes that this picture has been temporarily pushed aside. "For the first time in over a decade," he says, "a standard business-cycle pattern is moving front and center."

Why? Most important, of course, because the Federal Reserve under Chairman Alan Greenspan has been raising interest rates for just short of a year to slow a runaway boom. Members of TIME's board differ considerably on how soon and how hard those rate hikes will bite. But all agree on two predictions: 1) there will indeed be a slowdown; 2) the chance that it will turn into a recession is, in Sinai's word, "zero." Diane Swonk, chief economist of Bank One and president of the National Association for Business Economics, declares, "I expect this expansion to last until 2004"--which is as far as she will predict.

At present there are signs a slowdown may be under way, but the economy's overall momentum is still quite powerful. Total production of goods and services rocketed ahead at an annual rate of 5.4% in the first quarter. That was below the superheated 7.3% pace in the previous three months yet still well above what the wildest optimists would consider a sustainable pace. However, Chris Varvares, president of Macroeconomic Advisers, a consulting firm with headquarters in St. Louis, Mo., expects a "fairly abrupt" slowing in the second half of the year to below 3%, which will hold gross-domestic-product growth for the year to 5%. Ed Yardeni, chief economist of Deutsche Bank, agrees, largely because he believes the skyrocketing rise of stock prices in late 1999 and early this year "most likely did contribute to boosting car sales and housing-related sales." With the NASDAQ index by late May down roughly a third from its March peak, he says, "within the next couple of months we'll find weaker car sales, weaker retail sales, weaker housing activity." Varvares expects a further slowdown to about 2 1/2% growth in 2001, though he thinks the pace will pick up again by next year's end.

Swonk looks for a more prolonged slowing. The boom has been powered lately by consumer spending, she says, and that spending is less sensitive to interest-rate boosts than it was in the past and not as sensitive to stock-market gyrations as many would suggest. She figures that real wage increases--that is, pay raises minus price boosts--will be "nipping up into the 4% range" by year-end. Her conclusion: "You never bet against U.S. consumers when they've got money in their pockets to spend, and these consumers have a lot of money to burn." Swonk expects GDP growth to slow from more than 5% in the first quarter to about 4% for the rest of 2000. She adds, though, that "the economy will slow more dramatically in 2001, but still not enough to derail the upward pressure on inflation that has taken root in labor markets."

Would the Fed then raise interest rates further still? Maybe--but just how much and how long it will continue to crack down is the biggest uncertainty in the outlook. Since June 30 of last year, the Federal Reserve system has pushed up the so-called Fed funds rate (a very short-term rate that it effectively controls) 1.75 points, to 6.5%. Yardeni thinks it will stop there, but he is a minority of one. All the other members of TIME's Board of Economists expect it to go up to 7% or 7.5% by year's end; Swonk and Varvares believe it may rise to 8% next year. And Swonk thinks even that may not be the peak. The reason: Fed Chairman Greenspan seems dead serious about reducing the annual growth rate to around 3.5% to 4% and the inflation rate to somewhere around 2%. Most members of TIME's board think the rate boosts so far are not enough to do that job.

Lawrence Kudlow, chief economist of , is an exception. Though he expects the Fed to boost rates to 7.5%, he thinks that will be an error reflecting "buggy-whip" thinking. Even the increases so far, he believes, were unnecessary. In his view the Fed itself caused the surge in output in late 1999 and early this year by pouring money and credit into the economy to guard against any disruptions that might result from Y2K computer breakdowns. No such breakdowns occurred, of course, so the Fed is now throttling back the growth of money supply. That, says Kudlow, will be enough to slow production growth to a sustainable, noninflationary rate, which he expects to be achieved by year-end, after a brief "wiggle wobble."