IS THAT SOMETHING IN THE AIR A RECESSION?

By Richard Lacayo

It was just their routine Tuesday strategy session that brought House Republican leaders to the offices of Newt Gingrich last week. But from the way majority leader Dick Armey was talking, it could have been one of the economics classes he used to teach. His subject: Recent Signs of Recession in the U.S. Economy. One by one he ticked off the signals: payrolls falling, investments soft, inventories high. "The economic indicators suggest to me that I may be living with my worst fears,'' he told them. "If you have a recession in 1995 or '96, the voters are likely to connect that economic event to the most notable political event in their recent life. Quite frankly, that is the new Republican majority.''

There may be no American enterprise so sensitive to the ups and downs of the economy as the business of politics. When times are bad, incumbents don't sell. That was the lesson George Bush learned hard in 1992, when his re-election chances were sunk by the recession that began in 1990. But in the current fractious political realities, there are two kinds of incumbents: the Democrat in the White House and the uniquely and loudly powerful Republicans in Congress. Sometimes it doesn't pay to win too big.

Especially if the economy starts producing too many losers. After four years of economic growth, the U.S. either is in the midst of a necessary cooling off-the "soft landing" that Fed Chairman Alan Greenspan was aiming to foster by raising the Federal Funds rate seven times since February 1994-or it's heading for something more painful. No one is certain yet which it is, but anyone disposed toward pessimism has plenty of supporting data.

For one thing, the Federal Reserve last week reported that American industries cut production in May for the third consecutive month. Though the 0.2% drop was less than half the drop of the month before, it still marks the longest consecutive decline since the 1991 recession. That followed news that after 21U2 years of steady and sometimes spectacular growth, the U.S. economy lost 101,000 jobs in May. The month before witnessed the third decline in a row in the index of leading economic indicators, which is used to forecast economic conditions six to nine months from now-when Campaign '96 will be well under way. "This is a pretty sizable slowdown," observes economist Victor Zarnowitz of Columbia University. "In many ways it resembles past slowdowns that have become recessions.''

At the White House they are nervously counting the ways. In response, some Administration officials have begun to signal to Greenspan how strongly -- how very strongly -- they hope he will come to the rescue soon by cutting interest rates. Meanwhile, Democrats have been framing the Republican budget and tax-cutting plan as a too much, too soon shock to the economy. In the televised address in which he presented his own budget plan, the President warned that deficit reduction must not "put the brakes on so fast that we risk our economic prosperity.''

While Greenspan has been surprised by how hard his soft landing is turning out to be, he and his supporters at the Fed are convinced the slump is a temporary "inventory correction'' -- a pause while businesses draw down inventories they overbuilt during the rapid growth of the past two years. "We're not as surprised as some outsiders to see some weak numbers,'' insists Fed governor Janet Yellen, a Clinton appointee. "These are actually consistent with the [soft landing] scenario.''

One factor that will spell the difference between slowdown and recession is sustained consumer confidence and spending. A decline could prompt businesses to cut back production even more, leading to more cuts in the work force and a further fall in consumer spending -- the vicious cycle that drives a recession. In surveys, confidence still looks solid, but beneath is an enduring anxiety about wage stagnation and job security. With any additional sign of a serious downturn, consumer confidence could collapse like a nervous smile.

It has also not been lost on the Clinton White House that the Bush-era recession and frail recovery were blamed on rate hikes engineered by Greenspan. In the next nine months, Clinton must decide whether to appoint him to a third consecutive term as chairman. Greenspan might like that. Enough to soften his reluctance to reduce rates? If not, there are others on the Fed who are less reluctant. "I don't think there is going to be a recession,'' says vice chairman Alan Blinder, a Clinton nominee who thinks job creation is as important a mandate as Greenspan's focus on inflation fighting. "But I am worried about it.''

Meanwhile, Republicans in Congress are casting their own budget plans in recession-busting terms. Armey, a confirmed supply-sider, says a potential recession is more reason for the House to stand firm on big tax cuts. Republicans in the Senate, where they are skeptical about the House's tax-cut arithmetic, say it's more important to deliver on deficit cutting. Wall Street would like that too. And those crucial consumers-also known as voters? Ask them in November '96.

--Reported by Bernard Baumohl/New York, William McWhirter/Detroit, Suneel Ratan and Karen Tumulty/Washington

With reporting by BERNARD BAUMOHL/NEW YORK, WILLIAM MCWHIRTER/DETROIT, SUNEEL RATAN AND KAREN TUMULTY/WASHINGTON