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U.S. economy to grow 2.6 percent in 1996, bit more in '97

ANN ARBOR—Despite the rhetoric, a compromise on the federal budget is likely to emerge that will resemble the budgets already passed by the Republicans in the House and the Senate, according to University of Michigan economists.

" The agreements aren't all signed yet, and the Congress has to get the president on board as well, but there's every reason to believe that a compromise looking very much like the budgets the House and Senate Republicans will emerge to dominate the next few fiscal years at least," said Prof. Saul H. Hymans, Joan P. Crary and Janet C. Wolfe.

Under such a scenario, the economy will grow 2.6 percent in 1996 and " a bit more in 1997," according to the U-M economists. Consequently, the economists expect " little change in the unemployment rate and subdued inflation." The " noticeably contractionary" federal budget over the next few years also will be " enough to take to about zero the chances that the Fed will feel like raising interest rates any time soon," they added.

Their forecast, which is based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics, was presented at the 43rd annual conference on the Economic Outlook on Thursday (Nov. 16) at the U-M.

The forecast, which incorporates " a path of spending reductions and tax cuts that we believe is consistent with a plausible compromise," also said that:

• Inflation will remain " distinctly moderate." Following a 2.2 percent increase in consumer prices in 1995, " consumer prices are forecast to increase by 2.1 percent in 1996 and 2.9 percent in 1997."

Core industrial prices will follow a similarly moderate course. " Following an extraordinarily low 1.3 percent increase in 1995, we expect industrial prices to rise by just 1.6 percent in 1996 and then to increase by 2.5 percent in 1997," the economists said.

• The unemployment rate is projected to average 5.6 percent in 1996 and 5.5 percent in 1997, " essentially unchanged from 1995 on a calendar year basis."

• Disposable personal income is forecast to grow by 3 percent in 1996 and by 2.4 percent in 1997, " following the 3.5 percent increase which we now project for 1995."

• Corporate profits, which rose above 8 percent of GDP are expected to hold at 8.1 percent of GDP in 1996 and 1997. These profit levels are " just slightly under the 8.3 percent we now estimate for 1995, and [are] still strong by recent standards."

• The federal deficit is forecast to slip to 2 percent of GDP in fiscal year 1996 and to edge down to 1.9 percent in 1997.

" More substantial improvement is expected in fiscal year 1998 and beyond," the U-M economists added, because the anticipated budget plan " implements a steady pace of tax cuts starting in 1996, while the lion's share of the spending reductions are back- loaded into the latter years of the seven- year plan" to balance the budget by 2002.

• The three-month Treasury bill rate is forecast to average 5.4 percent in both 1996 and '97 while the conventional mortgage rate averages 7.4 percent in 1996 and 7.6 percent in '97.

" The major point is that we expect Fed policy to deliver stable interest rates, with both short and long rates drifting up only slightly from current levels," they said.

• Light vehicle sales are forecast to rise a bit in each year of the forecast. " Light truck sales, which we now project will total 5.75 million units in calendar 1995, are forecast to climb to 6 million units in 1996 and to improve further to 6.2 million units in 1997.

" When steady car sales of 8.9 to 9 million units are added in, light vehicle sales are forecast to total 14.9 million units in 1996 and 15.1 million units in 1997," compared with 1995 sales, which are forecast at 14.7 million units.

• Housing starts are forecast to total 1.33 million in 1996 and 1.31 million in '97, " just slightly less than the 1.36 million starts we now project for 1995."

The economists concluded with an assessment of risks and uncertainties in the outlook for the economy, including the impact of the push to balance the budget in seven years.

" The first few years of the seven-year journey are...relatively easy to deal with. The Fed offsets the moderately contractionary effects of the budget with a policy of lower-than-otherwise-interest rates," they said.

But the real crunch comes a few years down the road when the federal budget becomes really restrictive. " And that's when the Fed may have to do some pretty fancy offsetting...Can the Fed engineer a reasonably smooth and effective transition from much tighter fiscal to sufficiently easier monetary policy? Will that be appropriate to the state of the international currency markets?" they asked.