Recession is Here for a While

The National Bureau of Economic Research (NBER) made it official: the U.S. economy slid into its first recession in a decade in March, 2001, ending the longest expansion since 1854. The NBER's business-cycle dating committee consisting of six academic economists made the call. NBER defines a recession as a widespread decline in economic activity lasting more than a few months. Closely watched indicators include industrial production, employment, real incomes minus government benefits, and real wholesale and retail sales.

The delay in calling the recession stems from this one's unusual characteristics. Industrial production has fallen 6 percent since its peak in the fall of 2000, significantly more than the 4.6 percent average decline during the last six recessions. However, employment is down only 0.7 percent and real incomes have continued to rise. Although the committee agreed that a recession had arrived, it was split sharply on the causes. For example, Harvard economist Martin Feldstein told The Wall Street Journal that this recession was caused mostly by "rising energy prices and Federal Reserve tightening." In contrast, Princeton economist Ben Bernanke said the Fed was less a factor this time, and that "in this case, recession came from a change in business expectations about the near-term profitability of the Internet and related technologies, which caused the drop in investment spending." Without the terrorist attack of September 11, Bernanke thought the economy might have dodged the recession altogether. He also remarked that the Fed can't pull us out of recession by itself. "A pickup in business demand, perhaps driven by the upgrade cycle in technology, is probably also needed."

Economists expect a slow recovery will begin in 2002, but differ on the timing. Goldman Sachs economists William Dudley and Ed McKelvey have downgraded their forecasts in recent weeks, having witnessed the start of a "vicious cycle" in which "firms caught in an intense profit margin squeeze have begun to slash payrolls, creating further job loss, falling confidence and further demand and profit weakness." In the November issue of The Pocket Chartroom (Goldman Sachs Economic Research), Dudley and McKelvey write "the recession is likely to be deeper and to last longer than generally anticipated. That is because the dynamic underway now is powerful relative to the policy stimulus that is being applied to break it." They forecast a recovery beginning in the second half of 2002.

A large part of the continuing problem is that consumer spending will likely remain weak for several reasons. The declines in confidence this fall are only part of the problem. Households are likely to try and save more out of current income. The sharp decline in household net worth resulting from the plunge in stock prices (beginning in the second quarter of 2000) has not yet been accompanied by the "reverse wealth effect" which economists believe will surely occur. The S&P 500 index has fallen by 15 percent in 2001 and is down 27 percent from its peak in March 2000. Consumers have not yet adjusted to their reduced wealth with a higher savings rate. The Goldman Sachs econometric models suggest that the personal savings rate currently is about 3 percentage points too low relative to historical experience. This means consumers will be retrenching for some months to come, unless the stock markets rebound sharply to levels last seen in late 1999/early 2000.