Economic forecast: mostly cloudy with a chance of showers

by Dr. Dennis R. Murphy

The preliminary economic performance data are in for the second quarter of 2002 and the picture is, if not totally gloomy, at least seriously overcast. As you can see from the chart below, after a very robust first quarter, growth fell off significantly during the second quarter, giving rise to concerns about a so-called “double dip” recession.

Following the three successive negative quarters in 2001, the economy seemed to bounce back with some vigor in the last quarter, and even more so in the first quarter of the new year, giving us four positive quarters after the three negative periods. However, this past quarter, with only 1.1 percent growth, while still positive, can only be described as a disappointment.

The average recession since World War II has lasted 10 months, and the longest two have extended for some 16 months. In each of these two long recessions, domestic recovery was hampered by the fact that more or less all of the world economies had fallen into recession together, and there was no ameliorating effect from more robust areas as there had been in the average recession. During this recession, growth abroad, particularly in Europe, has been very slow.

Euroland had barely positive growth in the last three quarters of 2001, on the order of 0.1 percent. By comparison, the US growth rate for 2001, even with the three negative quarters, was 0.3 percent. PriceWaterhouseCoopers is forecasting only 1.25 percent growth for 2002 for all of Euroland. This will be clearly less then the US economy alone, and therefore we cannot expect any boost from that source. The situation in Asia is equally bleak.

However, the last three quarters for which we have data indicate that the US economy has some significant resilience that should not be overlooked. There are several reasons for this. Monetary policy, after being overly stringent for too long, lowered interest rates 11 times in one year to modern lows. Fiscal policy also gave a boost, and perhaps most importantly, unemployment, while rising, has not approached previous highs. The following chart illustrates the unemployment trends for the past several years.

It is clear that unemployment has increased, but it remains below 6 percent, which is well below the rate of our last recession in 1991. It is worth remembering that full employment in the US economy, given the way we measure, is probably somewhere around 5 percent unemployed for all practical purposes. As unemployment falls below that level, firms must settle for less and less qualified employees.

Other sources of strength have included the housing market, particularly housing starts, which have remained high, fueled by record low mortgage rates. Indeed, to date there has not been the usual decline in these data associated with a recession. Inflation has also been well in check, and is expected to remain low.

Consumer confidence continues to be mixed. In the most recent ABCNEWS/Money magazine poll, 36 percent of Americans say the economy’s getting worse, while only 20 percent think it is getting better. Some 44 percent think it is holding its own.

The same poll reports that 32 percent of Americans rate the national economy as excellent or good. But there is something of a dichotomy in these numbers. When asked about their own personal financial situation, 57 percent rate it as excellent or good. This seeming incongruity is probably the result of an information bias.

Our knowledge about the national economy is largely derived from the news media, which tends to report significantly more negative economic news than good news. However, information about one’s own financial situation is known with greater certainty. This disparity probably indicates that the response to the national economic well-being question is biased downward.

The stock market’s erratic performance continues to be a source if unease for a large number of Americans. Paper losses at least have been large, and period over period growth rates for the S&P have been negative for the past two years.

The NASDAQ performance has been even more devastating. The decrease in wealth represented by these declines influences consumer buying behavior in a negative fashion. The fact that unemployment has not increased more than it has, and that personal incomes continue to increase have so far largely offset the negative influence of decreasing wealth.

The State of Washington has not escaped, and in some sectors has been harder hit than the national economy. Unemployment, while modest compared to other recessionary periods, has increased more than the national average. Manufacturing, including aerospace, construction, transportation and utilities have all be hit rather hard. Aerospace in particular is unlikely to recover quickly.

 

Looking Forward:

As we noted above, consumer spending and housing markets have remained healthy. However, if equity values continue to erode, both consumer spending and investment in housing could come under a shadow. Interest rates are about as low as they can go, with the discount rate already at a mere 1.25 percent, and little stimulus could be expected from monetary policy. Given the excess capacity in the manufacturing sector, business investment, with the possible exception of inventory buildups, is unlikely to return to significant levels any time soon. Finally, fiscal policy stimulus, in the form of tax cuts is remote at best.

All of this is not to say that we will have a double dip recession, but rather that the continued recovery is likely to be slow paced over the next several quarters. Of course, the international situation may significantly change some of the parameters, but in general we should be prepared for slow and steady growth, and a rather prolonged period of recovery. If that leaves you disheartened, I commend to you the following verse by Dorothy Parker:

Razors pain you;

Rivers are damp;

Acids stain you;

And drugs cause cramp.

Guns aren’t lawful;

Nooses give;

Gas smells awful;

You might as well live.