Hopeful Economic Signals
The Beginning of the End for a Relatively Mild Recession
Article by: Alan Levenson, Chief Economist, T.
Rowe Price
T. Rowe Price Report, Winter 2002
The National Bureau of Economic Research (NBER) in November confirmed what
had been suspected for months: the 10th recession since World War II began
in March 2001, ending a decade long-expansion, the longest in NBER's
chronology. In making its declaration, the NBER pointed out that before
the attacks of September 11, "it is possible that the decline in the
economy would have been too mild to qualify as a recession. The attacks
clearly deepened the contraction and may have been an important factor in
turning the episode into a recession."
The NBER, generally accepted as the official arbiter of recession dating,
rejects the popular definition of a recession - two consecutive quarters
of declining gross domestic product (GDP). Instead, the group looks at the
peaks and troughs of the business cycle and defines recession as, "a
recurring period of decline in total output, income, employment, and
trade, usually lasting from six months to a year, and marked by widespread
contractions in many sectors of the economy."
These four broad measures of economic activity are combined in the
Conference Board's Index of Coincident Indicators, which depicts a clear,
though relatively shallow, recession emerging last year.
THE ROOT CAUSES
Recessions can generally be traced to a combination of excessive Fed
tightening (judged excessive only after the fact) and external "shocks"
which in this case likely included the pricking of the equity bubble and
the outbreak of the war on terrorism. In each of the three recessions
preceding the current downturn, the shock was an increase in the price of
imported oil.
Changes in perceptions and expectations can also generate cyclical
movement, as in the current downturn. The "new economy" of the mid-to-late
1990's, characterized by the rapid pace of technological innovation,
accelerating productivity, and low inflation, promised (and to a
substantial extent, delivered) a higher sustainable economic growth rate
with less cyclical volatility around that elevated trend. This higher
return, lower risk environment encouraged (and, at least to some extent,
justified) higher equity valuations. The resulting surge in share prices
rewarded debt-financed business investments in information technology and
gave consumers the financial wherewithal to spend an increasing share of
current income while continuing to meet wealth accumulation objectives.
The result was growth in private sector demand that outstripped the
economy's sustainable supply capacity. As the unemployment rate fell and
industrial utilization rates rose, cost pressures began to mount.
The Fed rate hikes of 1999-2000, which aimed to head off incipient
inflation, contributed to the bursting of the equity bubble and set off a
correction in imbalances accumulated during the previous strong growth
period. Business investment screeched to a halt as companies began to
rethink the potential returns to investments in technology. Consumer
spending growth aligned more closely with income growth as the equity
wealth engine sputtered. Manufacturers, wholesalers, and retailers
responded with the most aggressive inventory liquidation on record. As the
process gained momentum, GDP growth slowed from 5.7% in the second quarter
of 2000 to -1.1% in the third quarter 2001.
HOW LONG WILL IT LAST?
This question cannot be answered with percussion under the best of
circumstances, and certainly not in light of the uncertainty introduced by
the tragic events of September 11. Yet, questions persist as to whether
this will be a "deep" or "shallow" recession.
The other nine post-World War II recessions range from six to 16 months in
length, averaging 11 months. The 16-month downturns or 1973-75 and 1979-82
are the deep recessions, while the eight-month 1990-1991 slide exemplifies
a shallow recession. The deep recessions featured GDP declines of 3.4% and
2.8%, respectively and private payroll contraction of 3.3% in each. The
shallow 1990-1991 recession registered peak-to-trough decline in GDP and
employment of 1.5% and 1.6% respectively, over eight months.
With GDP down just 0.2% during the first two quarters and employment down
1.1%, the current recession will more likely resemble the 1990-01 downturn
than the more severe1973-75 or 1979-82 contractions. In addition, there is
no structural impediment to recovery.
As in past recessions, personal income growth (and customer spending
growth, in turn) has slowed in response to falling employment, which
reduces the number of wage earners. But for the 110 million people who
still have jobs, the purchasing power of the average hourly wage has
accelerated by 0.7 percentage points since March's business cycle peak,
offering a backstop for consumer spending that is without precedent in
previous recessions. And consumer wealth accumulation since the end of
1994 still remains ahead of reasonable expectations, even after the
2000-2001 equity markets sell-off. Also in contrast to other recessions,
productivity, the amount of goods and services produced for each hour
worked, has continued to rise.
WHAT SHAPE THE RECOVERY?
While recession conditions are likely to prevail through the first quarter
of this year, growth should resume in the spring, with real GDP growth
approaching 4% by year-end. This is a relatively restrained outlook
compared to the 5% to 6% GDP growth rates typical in the early phase of
recovery. Interest-sensitive vehicle, housing, and housing-related durable
goods purchases may not enjoy a typical post-recession boom, since the
recent low inflation, low interest rate setting has staunched the typical
recession bust. Business investment retrenchment may run well into 2002,
particularly if capacity targets were adjusted downward to reflect
sustained increase in underlying uncertainty post-9/11. But with the
U-bottom phase of the recession beginning to take shape and substantial
monetary and fiscal stimulus in the pipeline, a sustained recovery becomes
increasingly inevitable.
