Special of the week; Issue 50-69

NDE are the national educational radio network presents special of the week Thursday November 20th 1969 one of the important economic forecasts of the economy was presented at the University of Michigan in Ann Arbor. A product of the University of Michigan's research some in our own quantitative economics. This is the 17th Annual Conference drawing businessmen government officials writers and economists from throughout the United States. The presentation includes a review of last year's forecast the current state of the economy and the forecast for 1970. The meeting is chaired by the former chairman of the president's Council of Economic Advisers now a professor at the University of Michigan. Gardner Ackley I'm certainly glad to return to these conferences myself after missing the last eight of them. But I had participated in the first date with much pleasure and found them all was one of the most exciting events of the fall season and then

Arbor rather than the highest state again. Indeed I guess I helped to organize the first of these conferences 17 years ago as I recall it was a committee consisting of Larry Klein and Dan suits and Dick Musgrave and George Capone and perhaps others who enlisted the enthusiastic support of our then chairman Leo Scharffen to initiate this series of conferences. I remember we were not at all sure there would be more than one that fall 17 years ago. Well we get right down to business with the forecast for 1917 as it is seen in the kind of metric models of our research seminar in quantitative economics. This model

has changed over the years. Those of you who have been following it for some years know that it always looks a little different and this year maybe this isn't the first time I don't know. There are two of them and we can even see how they compare. The presentation of this of the results of this these models and the forecast for 1070 is being made by two young very young members of the Department of Economics who have appeared on the scene during the time I've been away. It will be presented in two parts in the first part by Professor Shapiro Lester Shapiro is an associate professor of economics here and associate director of the research seminar in quantitative economics. He's a Canadian with his bachelor's degree from McGill but his Ph.D. from Princeton. He's been at Michigan since the fall of

1064. He's also associated with a number of other activities of a research character. A senior research associate of the Brookings Institution and research advisor to the Bank of Canada a research associate at M.I.T. a senior research consultant of the Economic Council of Canada. He's published which is somewhat like but also somewhat different from the Council of Economic Advisors with which some of us have had experience in the United States. He's published a great deal in the areas of monetary economics and the kind of metrics and economic problems of Canada. And very active in research in all these areas it's a great pleasure to present Harold Shapiro. Be. Well I'd like to turn now perhaps somewhat sheepishly to last year's

forecast. 969 was not a vintage years for econometric forecasts. A year ago based on the assumption that a tax surcharge would continue we forecasted a mere 6 billion dollar increase in real GNP measured in 1958 prices. You can take a look at Table 1 which has a review both of last year's forecasts. And forecasts of previous years. It now appears that the increase in cost in dollars GNP for calendar 69 will be in the neighborhood of twenty and one half billion dollars. That's rendering our November 1968 forecast a conservative by more than 50 more than 14 billion dollars. On the other hand our spring forecast which most of you received. Did much better it predicted an increase of 21 billion dollars in real

GNP for the year for the calendar year 69 and that seems to be just about on target. It now appears that not only did we predict the aggregate level of GNP very well last spring but that the model also predicted the growth from quarter to quarter pretty accurately and the components of GNP as well. So last spring forecast was one of our best. Now one could ask the question what made us so smart in April compared to how smart we were in November. Well basically the error we made last year the main addition to our knowledge you might say since the fall of 68 was that we had drastically underestimated the continuing strength of aggregate demand around the turn of the year in the first quarter. This error which amounted to cutting back at the Mandal to early resulted in the total downward bias in the forecast the spring forecast. Building on the

first quarter data and the April review with the federal budget avoided the earlier error and proved to be a much better forecast. Well let us turn now to the outlook for 1070. The RACQ a forecasting program is now centered around the development. And use of both an annual and quarterly econometric model. The annual model is well known to most members of this conference and result primarily of the work directed by Professor Daniel suits it was on a leave of absence in California this year. The quarterly model is a revised version of the DHL model first built in 1967 used by the Conference for the first by the seminar for the first time last year and the model in a modified and expanded form used by US this year and that is the so called DHL 3 model. During the past years we have become convinced that there is much to be said for maintaining both an annual and quarterly model. As part of our forecasting

program. While the annual model of course cannot provide the richness of detail that you find the chord in the corny model in the sense of the intro your movements of various parts various pieces of economic activity. The models can act as a very good check on one another. It was our feeling that unless we could produce forecasts that were broadly consistent with both models that we couldn't trust either forecasts. Of course it will always be differences in detail in any given forecast between the quarterly forecast. And the one brought out by the annual model. But unless the patterns were similar less we could understand these differences. We felt we couldn't have much confidence in either forecasts now. Table 6 at the very end of the tables that you got passed out there. Contain some comparisons of 970 forecasts. With the annual quarterly model. But we'll get to discussing these figures and details in detail in a few moments. Now what

about the current state of the economy. In preparation for our 1970 forecast we use our new quarterly model together with Department of Commerce estimates for the first three quarters to produce a forecast for the fourth quarter and the 1969 calendar year. The results are presented in table 2 which you have before you. And exhibit really only minor differences from our spring forecast. Just to look at one or two of the main aggregates we're now projecting GNP for the calendar year 1969 to be at nine hundred and thirty three billion dollars which represents a seven point eight percent increase over nine hundred sixty eight. This is composed of a 2.9 percent increase in real GNP and a 4.7 percent increase in prices. The unemployment rate for the year will run on the average of about 3.6 cents for the county or 69 as we projected.

Now the year will close with constant dollar GNP growing at an annual rate of just 1 percent. This represents a decline from the 2 percent rate of growth which characterized the first three quarters of the year the fourth quarter unemployment rate is now projected to be just under 4 percent while the overall rate of price inflation should be about four and three quarters percent. In the last quarter all the weakness in the fourth quarter extends primarily from the lack of normal growth in expenditures on consumer durables and business plant equipment and natural declines in residential building activity and inventory accumulation in our view this is the result of the joint restricting this monetary and fiscal policy. Aside from the current state of the economy or a jumping off point for 1970 the outlook of course is critically dependent on the stance of fiscal and monetary policy. We have therefore and never to undertake a careful analysis of the federal budget

including the probable effects of impending tax reform legislation removal of both the investment tax credit and the tax surcharge table 3 which you have before you contains the breakdown of federal expenditures in the national income accounts for not fiscal 1970 as shown in the mid-year budget review and as revised by the research seminar for use the 970 forecast. As you can see from that table we project total federal expenditures for the fiscal year 1970 to be a hundred ninety seven point four billion dollars and the breakdown the detail breakdown is also there in the table. Our figures differ from the mid-year review primarily in the area of defense spending. Where we have shaved the much heralded 3 billion dollar cut back in the fence expenditures by three quarters of a billion dollars. That is we are not counting on the full 3 billion dollar cutback in defense expenditure for the

last two quarters of the calendar 70 beyond the 70 to school year. We continued a modest decline in defense purchases but allowing for a federal pay increase of about three billion dollars in the third quarter. As you all know there's an automatic review of federal salary scales and we have project we have projected three million dollar increase in federal pay in the middle of next year. On the revenue side we have assumed that the tax surcharge will be reduced by 50 percent in January the 1st 1070 and will expire at made here. Consistent with the probable facts of the impending tax reform legislation we have assume that the 7 percent investment tax credit will be repealed by the beginning of 1970 and retroactive to the spring of 69. When the president made the speech the tax reform proposals if passed substantially as in the Senate bill. Should have minimal effect on economic activity during calendar

1970. The effects won't be nil but they should be very small 1970 most of the effect. We have allies that will most the effects of legislation on the Paisley Timoney will come in later years. Now consistent with our view concerning monetary policy and federal grants and aid. You can see from Table 3 that federal grants and aid are still continue to rise in the federal budget. We have projected an increase of nearly 11 percent in state and local government purchases. This represents a slight reduction from recent growth patterns. Now regarding monetary policy for 1970 we expect some easing of monetary conditions. We have projected an increase of about six point two percent in the monetary Reserve Base which almost doubles the rate of growth of reserves experienced during 1969. This is consistent with a moderate rate of decline from

current levels. In the short term interest rate. Now this puts into focus what I hope does put into focus for you. The situation as we see it right now where the economy is operating right at this moment we have projected a saw somewhat of a decline in growth rate of real GNP during this last quarter. And we have before you know the estimates for calendar 69. Also you have at least our view of how the fiscal policy and monetary policy are likely to influence the pace of economic activity. And I hope this provides a good framework within which to interpret our forecast. Thank you. Thank you. Professor Hyman also an associate professor of economics and associate director of the research seminar in quantitative economics also joined the University of Michigan faculty in

1964. He is an Easterner comes from Boston. That's his degree at Harvard but went to the Far West for his graduate where he received Ph.D. in economics at the University of California Berkeley and taught there briefly before coming to the university in 1064. Hughes best known to me because he served as a member of the senior staff of the Council of Economic Advisors in 1967 68 where he was one of the leading member of the small team which was responsible for the forecasts that the council and the federal government was making for the guidance of fiscal policy decisions. It's a great pleasure to introduce to you Professor Saul Hines. Thank you very much Gardner. Let me get right into the question of the forecast for 1070. The broad sweep of our

forecast for 1070 is already contained in table for which you have a table for displays the forecast the changes for several key macroeconomic variables. Based on the policy assumptions which we have already discussed we forecast that nominal GNP current dollar GNP will increase by about fifty seven billion dollars for the year 1070 as a whole. This increase amounts to a bit more than 6 percent compared to an increase from one thousand sixty nine projected at seven and three quarters percent. This 6 percent rise in current dollars GNP is composed of a price rise totaling nearly four and a quarter percent and a rise in the volume of output constant dollar GNP amounting to just a little over one and three quarters percent corresponding to an output growth of only one and three quarters percent. We project the rate of unemployment

of nearly 4 and a half percent for the year as a whole. That four and a half percent rate of unemployment represents an increase of about three quarters of a percentage point from the 1069 level. There's general weakness of the economy will be accompanied in our forecast by a drop of nearly three and a half percent in the level of corporate profits before tax. That represents roughly 3 billion dollars. It should be noted that the forecasted rate of price increase of about 4 a quarter percent for the GNP deflator the overall rate of price increase in the economy. It's fourth quarter percent represents a meaningful cut back from the nearly 4 and 3 quarters percent increase experienced for 169. If we look at the private nonfarm sector of the economy where we have some figures for costs prices and wages we expect an increase in unit labor cost of about five and a half percent for 1070 as a whole. This is more than

a full percentage point below the rate of increase in 1069 and stems largely from the combination of a modest improvement in productivity performance and a very slight shading of the rate of increase of compensation per minute hour. The annual forecast which I have highlighted for you and which is in Table 4 fails to provide sufficient information on the evolution of economic activity through the year. Full quarterly detail as we project it is contained in Table 5. The slow pace of economic activity which we have already forecasted for you for the final quarter of one thousand sixty nine continues through the first half of 1970. Despite the 50 percent reduction in the tax surcharge the consumer sector bolstered by the cut in the personal tax surcharge at the turn of the year boasted by the effects of the projected tax reform legislation and bolstered

by an increase in Social Security receipts beginning in March. Is not the source of weakness for the first half of 1970. If we look in the private sector to try and detect the source of weakness it turns out that we have to attribute the pace the slow pace of growth to continued declines in building activity residential building activity and continued decline in the rate of inventory accumulation along with a mild decline in real expenditures for business plant equipment. Further after correction for price change we project almost no growth in total government purchases of goods and services from the fourth quarter of one thousand sixty nine through mid-year 1070. It's really represents an aggregate result on the state and local side we do project some real increase. But on the federal side we have defense spending coming down and

therefore at the crease in real terms which comes out to essentially zero change in real terms for the aggregate of the government sector. It is our view that the period of one year ending in the second quarter of 1070 is an extremely critical period in terms of the resolution of the economic problems of the past several years. Over this year ending in one thousand seventy second quarter we project the rate of growth of real GNP at only one and one third percent. That is far below what it takes to hold the unemployment rate fixed. Therefore over the same period we have the aggregate unemployment rate rising from about three and a half percent in mid 69 to nearly four and a half percent in mid 1070. Over this period in which we experience very little growth one and a third

percent in real terms and an increase in the unemployment rate of approximately a full percentage point the overall rate of price increase slows substantially at the beginning of this period of one year. The rate of price increase was over 5 percent at an annual rate that's about mid 169. At the end of this period of the year the short period of two quarters happy year ending in the second quarter one hundred seventy. We project an annual rate price increase of three and three quarters percent. That's a decline from somewhat over 5 percent beginning in the period to somewhat over three and three quarters percent both at annual rates in the latter half of that period. For the second half of 1070 we foresee the beginnings of a return to the full capacity growth rate in

real terms GNP is projected to grow at an annual rate somewhat over 4 percent in the second half of the year. That's real GNP annual rate somewhat over 4 percent. There are several elements which contribute to this resurgence of growth. First of course we project the remainder of the tax surcharge to expire at maid year. In addition the moderate easing of credit conditions in early 1970 which Professor Shapiro discussed begins to spark a revival of housing expenditures in the second half of 1070 and at the same time this easing of credit conditions early in 1070 acts to moderate the mild decline in real expenditures which we foresee in plant equipment spending. Finally by the second half of the year inventory investment is no longer offsetting increases in final sales. We have a declining rate of

inventory accumulation in the first half of the year but not in the second half of the year consistent with the second half pattern. The unemployment rate levels off after mid year and begins to decline by year end. The rate of price increase drops to about three and a quarter percent in our forecast annual rate of three and a quarter percent for the second half of 1070. The process of mild slowdown in the year ending in the middle of 1970 and smooth resumption of growth beginning in mid 1970s permits productivity bonuses to accrue in the second half of the year resulting in mild increases in unit labor costs despite a five and a half percent annual rate increase in compensation per man hour in the second half of the year. Taking all this together it is our judgment that by the end of 1970 significant progress will have

been made in unwinding the inflationary pressures built into the economy over the past several years. This situation would call for economic policy consistent with an orderly return to the full employment path by the end of 1071. I would like not to spend a few moments discussing some alternatives to the forecast. As I've presented you're no doubt aware that the recent McGraw-Hill survey of corporate investment plans implies a rise in business fixed investment of 1 percent after correction for anticipated price increases. Our model differs marginally in this respect and in fact forecasts a small real decline of nearly 1 percent. That's a swing of not too many billions of dollars. In the past year investment realisations have consistently been below prior anticipation. We believe this process will continue and have therefore based our forecasts on the

output of our model. We did however generate an alternative forecast incorporating the results of the McGraw-Hill investment survey. The effect of this alternative forecast which is to have GTE real investment running a bit stronger is to raise real GNP forty year one half of one percent above the real GNP level that is in our preferred forecast. This has this does not however change the nature of the pattern within the year. Let me turn to one more topic in recent weeks there has been some discussion of the possibility that the administration or the Congress might seek to retain the tax surcharge beyond the original schedule which is embodied in our forecast. Apparently this is being contemplated in order to stem a potential federal deficit to evaluate such a policy. We

generated a forecast. In which the surcharge remained at full 10 percent until mid year till July 1st 1070 and then dropped to 5 percent for the remainder of the year. Monetary policy was unchanged from the mild easing that we had given it in the original forecast. The failure to reduce the surcharge at the beginning of 1970 resulted in our forecast in this alternative forecast in a slight decline in real output in the first quarter of 1970 and essentially no growth at all through the first half of the year. Indeed essentially no growth at all from the fourth quarter through the second quarter of 170. The subsequent mid year tax reduction did generate a resumption of growth for the second half of the year but at a somewhat slower rate than our preferred forecast relative to our forecast. The cost of such a policy change change

in policy which retains a surcharge longer than originally scheduled. The cost of such a policy change was lower output a higher unemployment rate four point eight percent by the fourth quarter of one hundred seventy. And no further reduction in the rate of inflation. When I say no further reduction I mean no additional reduction over what we have in our basic forecast the inability of such a policy change to make further headway against inflation stems primarily from the fact that it restricts the improvement in productivity by enough to negate the price effects of smaller increases in wages and lower aggregate demand. It seems to us that such a policy would generate substantial risk of a real recession. A policy which leads to the expectation of a zero real growth rate over a three quarter period carries with it little margin for error it seems to us that in such a case the

risks are heavily weighted on the downside and further it seems to us that there is little reason to accept such risks at the present time. Thank you. Thank you. Thank you thank you. That was Seoul hymens of the University of Michigan Department of Economics. The forecast for 1970 as seen by the University of Michigan's research seminar in quantitative economics presented in an Alberta November 20th 1969 at the 17th annual conference on the economic outlook. This has been special of the week from any of our of the national educational radio network.