Revised Forecasts

Among economic forecasters, all bets were off as of September 11. (Side note: Many of the nation's professional economic forecasters were gathered for their annual convention literally next door to the World Trade Center when the attacks occurred). Nearly all forecasts have been downgraded sharply since then. The following is a brief summary of the outlook and rationale.

• The large majority of the National Association For Business Economics (NABE) forecasting panel believes the U.S. economy is now in a recession. About half of the panel believes it was triggered by the events of September 11. Four members of the 21-member panel believe we were already in a recession.

• The primary reason for the pessimism is "a drop in consumer confidence following the terrorist attacks that will prompt a consumption slowdown." In addition, panelists mentioned "the wave of lay-offs at transportation-related companies and the direct disruptions to businesses that will hit disposable income and pull down spending."

• The NABE panel now expects additional monetary easing by the Federal Reserve, with a Fed Funds rate of 2.25 percent before it is finished. The current rate is 3.0 percent (down 50 basis points as a result of the Fed's quick action following the terrorist attacks).

Economist Mark Zandi (Senior economist at Economy.com) offers some additional thoughts to accompany his firm's revised forecasts. They estimate that the direct economic costs (physical damage and economic disruption) associated with the attack on New York will total about $70 billion. Of that, the physical damage to the lower Manhattan infrastructure will top $20 billion. In addition, because the nation's air travel system and financial markets were shut down during the week of the attack, many industries have been impacted by the service disruption. The lost economic output will likely total about $50 billion, most of this in September alone. The air passenger and freight industries will be the hardest hit ($10 billion) followed by the hotel and securities industries. This will shave about one percentage point off the third quarter economic growth rate. Economy.com had previously forecast a 0.8 percent (annualized) gain in the third quarter, but this has been revised downward to a 0.3 percent decline in growth. Zandi notes that this would mark the first decline in quarterly GDP since early 1993.

By itself, this would not be enough to propel the economy into a full-blown recession, especially since the federal government has already pledged an additional $55 billion of spending to aid the stricken areas ($20 billion to New York), and industries ($15 billion to the airline industry), and to bolster security ($20 billion for military and airport security expenses). However, consumer, business and investor confidence has taken a nosedive in recent days. Despite quick action by the Federal Reserve and other central banks around the globe, equity markets were hammered in the first week of trading following the attacks. About $1.4 trillion of wealth evaporated as a result of the decline in U.S. equity markets during that week. The speed with which those markets recover remains to be seen. However, current economic wisdom regarding the magnitude of the wealth effect (in this case, the reverse wealth effect) suggests that the stock market declines will shave $30-50 billion off U.S. consumer spending. As a result, Economy.com expects that fourth quarter 2001 output will also drop by 0.6 percent.

If the Fed continues to lower interest rates (to 2.5 percent by Thanksgiving) and Congress approves a tax cut package (perhaps $30 billion), then the economy should stabilize by the first quarter of 2002 before accelerating toward the end of next year. Since much of this forecast is driven by expectations and confidence, another terrorist attack in the coming weeks would seriously downgrade the outlook. On the other hand, consumers may lay low for several weeks and then resume spending as the holiday season approaches, provided no further incidents or disruptions occur. As Zandi puts it, "increasingly dour expectations that the economy will suffer through a more severe downturn should be carefully considered as the downside risks are high, but it is important to note that the pessimism today is as dark as was the optimism bright not too long ago. The reality is somewhere in between."