Recoverv, inflation and interest rates in '82

By Dr. Herbert Runyon* Research Officer Federal Reserve Bank of San Francisco

rFHE ECONr OMY appears to have met the technical requirements necessary to qualify as a recession, two b ac k -to-back quarters of nega- tive economic growth, in the second and third quarters of 1981. There is a strong consensus that the economy may continue to languish in the doldrums at least through the end oftheyear before solid and lasting growth in output can be resumed.

But for those industries which are heavily affected by inflation and in- terest rates, l98l represents the second year of a severe deterioration in output. This is particularly true of housing and autos but no less true of producers' durable equipment. The one sector of the domestic economy to show consistent strength has been consumption spending. Of itself, consumption may sustain the economy but it is the dynamic components of housing, consumer durables, (particularly autos) and

Story at a Glance

The basic economy should turn around in the second half ol'82 .. . no pell-mell retreat of interest rates . . . short term rates in the medium to higher single digit range, long term rates of 11o/o-13o/o seem attainable.

producers equipment that must supply the lift to a recovery.

Looking at the "hills beyond the valley" in 1982, the results of policy actions taken in l98l will begin to make themselves felt. A consistently firm monetary policy in l98l is responsible for a declining trend in the inflation rate, although it is occasionally obscured by random monthto-month movements. As this decline becomes more readily observable, it will act to dampen inflationary exDectations for the future.

- The second stage of the personal income tax cut becomes effective in the second half of 1982. By then, the basic economy should have turned around. The combination of a lesser rate of inflation and the tax cut will have a salutory effect upon after-tax income and thence consumer confidence. Declining interest rates and the backlog of demand for homes

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