August 01, 2002

Time to Cut Interest Rates Further?

Yet more reason that it is time to cut interest rates further...

With world stockmarkets--and political America--still reeling from a long list of corporate scandals which have destroyed some of the country's biggest companies, there seemed at least one comfort: America's economic recovery seemed strong. Now that reassurance, too, has been brushed aside. Figures issued by the government on July 31st showed that the economy grew much more slowly than expected in the second quarter of this year--by only 1.1% at an annual rate. Separately, survey data published by the Federal Reserve on the same day supported the impression of a slowing, and even faltering recovery...

Aug 1st 2002
From The Economist Global Agenda

New data suggest that America’s recession last year was worse, and its recovery this year is weaker than previously thought. Is there now a risk of another downturn?

THIS was definitely not what the doctor ordered. With world stockmarkets—and political America—still reeling from a long list of corporate scandals which have destroyed some of the country’s biggest companies, there seemed at least one comfort: America’s economic recovery seemed strong. Now that reassurance, too, has been brushed aside. Figures issued by the government on July 31st showed that the economy grew much more slowly than expected in the second quarter of this year—by only 1.1% at an annual rate. Separately, survey data published by the Federal Reserve on the same day supported the impression of a slowing, and even faltering recovery.

Almost as alarming are the revisions made by government statisticians to earlier figures. It now turns out that last year’s recession was significantly worse than previously estimated, and growth in the first three months of 2002 a bit less impressive than earlier statistics had indicated. The backward changes will mean a downward revision to America's spectacular productivity figures and cast further doubt on the “miracle” of the new economy.

The new figures are a blow to hopes that America’s economic recovery is well established. Suddenly, the recovery looks weak and the economy looks vulnerable to further shocks. The determination of American consumers to keep spending has bolstered the economy for so long. If consumers should now lose heart, as some recent surveys suggest they might, all bets will be off. Another downturn—a so-called “double-dip” recession—would then be highly likely. With Europe and Japan still in the doldrums, the forecasts of steady global growth this year could soon look overly optimistic.

The latest figures, though gloomy, are not all bad. Business investment is still falling, but at a slower pace than before. The one, very modestly encouraging sign is a small upturn in investment in computer equipment and software, though this comes after nearly two years of decline. Consumer spending grew more slowly in the second quarter than the first, though fortunately it is still growing, at an annual rate of 1.9%. And despite recent surveys showing a decline in consumer confidence, there are plenty of signs that consumers are still spending on cars and houses, as well as on smaller items. Retail sales in May, the latest month for which figures are available, were up nearly 5% on the previous year, in volume terms. With car makers reviving low and zero-interest deals, some analysts now expect July to be the best month of the year so far for vehicle sales. And one of the technical reasons for the weakness of the latest GDP figure is a boom in imports, which were up by 23.5%, the largest rise since 1984 (exports rose at only half that pace). The weaker dollar should encourage more Americans to buy home-produced goods in future.

So the picture remains mixed, but the risks of another downturn seem greater than most economists thought they were just a few weeks ago. The latest figures are, of course, a record of what has already happened to the economy, up to the end of June. They cannot offer a clear guide to what is happening now; and significantly they exclude the last few weeks which have seen near-panic in the stockmarkets and big falls in share prices. That is where the Fed's latest survey, or “beige book” can help fill in the picture. It comprises anecdotal evidence from the twelve district Federal Reserve banks spread across America. And it makes dismal reading, providing a significantly gloomier assessment of what's happening to the economy than the previous survey published seven weeks ago. Barely half the district banks, for example, reported an unambiguous expansion in manufacturing.

There is, though, still no clear evidence about the impact on consumers of the latest market volatility, which has itself posed a challenge for the authorities. After the latest setback, few economists expect to see a rise this year. Though American interest rates are now at their lowest level for the past 40 years, some economists have speculated that the Federal Reserve, America’s central bank, would cut them still further to try to calm the markets and stabilise the economy. The latest GDP data is likely to revive such speculation in the short term.

The Fed’s next scheduled meeting to review interest rates takes place on August 13th. A further cut still seems unlikely, for two main reasons: first, it might smack of panic, and thus be counter-productive by fuelling fear and uncertainty; and second, with interest rates already so low, the Fed will probably want to retain what ammunition it still has, in case the economy is faced with a further unexpected shock, such as that on September 11th last year. But it is difficult to predict with much certainty what the Fed will do next. Alan Greenspan, the powerful Fed chairman, plays his cards close to his chest.

One man likely to be especially concerned by the latest figures is President George Bush. His approval ratings have already taken a knock after the revelations of corporate malpractice and accounting fiddles at companies like Enron and WorldCom. Mr Bush has been struggling to regain the initiative for action from a Congress determined to clamp down on such activities; some voters perceive the president as having closer ties to big business than is desirable.

A sluggish economy is therefore a huge headache for Mr Bush, and his Republican Party. Control of both the Senate and the House of Representatives now look up for grabs in the mid-term elections in November. If the Democrats gain clear control of either, Mr Bush will find his ability to get much done in the second half of his presidency drastically reduced. If on top of this, America’s economy is weak, or in recession, his own re-election in 2004 could be threatened. Everyone in the Bush administration, not least the president himself, is painfully aware of his father’s failure to get re-elected, for which most blame the recession of the early 1990s.

Mr Bush has already presided over the disappearance of the huge budget surpluses projected when he first took office. For a time it looked as if he might narrowly escape being politically damaged by the economy, with the mildest recession on record and a swift and steady recovery. At the very least, the latest figures suggest that he can no longer count on either of these.

Posted by DeLong at August 1, 2002 04:57 AM | TrackBack


Is there any good reason why GDP growth is adjusted for inflation but not population growth other than the inability to monitor the latter too closely every 3 months? Because it seems to me that as population is growing at a roughly 1% annual rate, per capita real GDP (what we ought be concerned with) remains the same if the GDP grows by the same amount.

Relatedly -- what do people think of replacing GDP with NDP? "net domestic product (NDP) . . . excludes the portion of output that is used to replace worn out and obsolete equipment."

Posted by: Jeff Hauser on August 1, 2002 05:43 AM

What interests me the most is that for the past two years or so, I've seen a strong bias towards short-term optimism about the economy. I understand that we aren't in the Great Depression, but we have clearly been in a (common usage) recession since Fall 2000.

But what I kept reading was 'we're not in a recession' right up until the historical data said that we *had* been in one. Then the story switched to 'we're in a recession, but it was due to 9/11, and this is the last quarter of it'.

Where is the unbiased economic analysis? I'm using 'unbiased' in a strict sense - analysis which has a mean value equal to the truth. Right now we're seeing 99% biased estimators.

Posted by: Barry on August 1, 2002 06:32 AM

Has anybody wrung the GDP revisions out of Q1's reported 6.2% annualized productivity gain?

This always struck me as blippish ... a 1.5% quarter-over-quarterly gain could be skewed silly by minor errors of measurement in either real output or labor input, or by disarrayed reporting and other anomalies in the prior (9/11-affected) quarter.

Posted by: RonK, Seattle on August 1, 2002 07:50 AM

Remember the 1998 global economic crisis. We are again in a very fragile economic period globally. Also, when dividends are considered this bear market to 7/23 is the deepest and longest since the WWII. If a wealth effect occurs in America, there could be a ripple effect globally as American consumption slows.

Posted by: Anne on August 1, 2002 08:40 AM

1) Cost of capital to *credit-worthy* borrowers is not a problem now.2) Housing bubble risk would increase.3) Moral hazard/Greenspan put perception would be enhanced.4) Potential for "what does the Fed know that we don't" panic in markets.

Posted by: George Zachar on August 1, 2002 08:41 AM

George, what are you posting in reply to? I don't follow your arguments.



Posted by: Barry on August 1, 2002 09:23 AM

I believe Mr. George Zachar is giving reasons why an interest rate cut is a bad idea (that being the topic of the article being commented on). If I understand him, he is saying (1) a cut is not necessary because business investment is not being reduced by cost of capital, and (2) a cut would add to a real estate bubble, be damaging to Mr. Greenspan's reputation, and may itself cause a panic.

Posted by: David Margolies on August 1, 2002 09:43 AM

If the fed board believes the economy is slipping toward another negative quarter the need will be to lower rates again to try to stem the slide and worry about containing sceondary problems when the economy is clearly strengthening.

Posted by: Arthur on August 1, 2002 09:50 AM

Thanks to Mr. Margolies for his accurate English-English translation. :)

Posted by: George Zachar on August 1, 2002 10:19 AM

The investment grade and high yield corporate bond markets have lagged far behind the treasury and federal agency markets in recent months. The federal reserve will have to insure there is enough liquidity in the corporate bond markets to protect the economic recovery. The recession was not the typical stem inflation type, rather it was probably caused by the realization of excess production capacity created during the last years of the stock market bubble. The federal reserve has acted strongly to stem the deline and may have to do so again. We do not wish to risk deflation.


Posted by: JD on August 1, 2002 11:30 AM

Yes, the spectre of Japanese deflation haunts us all. But the problem with US corporate credit today is not solvable by simply supplying funds to the money markets. The problems tend to be company specific. A lender is not more likely to deem AOL, for example, worthy of a loan if its own cost of funds is 1.5% as opposed to 1.75%. The funds are far more likely to go into risk-free treasuries and the mortgage-market, with the housing bubble inflated still further. The good news is that the coporate debt hits, substantial in aggregate, have been spread widely within the US capital market, its banks, and institutions around the world. Unlike Japan, with its famously frozen centralized banking/credit allocation system, the diversity of US capital markets is serving to keep credit available to trustworthy borrowers. That is the key difference

between the US and Japanese experiences.

Posted by: George Zachar on August 1, 2002 12:12 PM

Thanks George

still - i reread krugman's reprint of "baby-sitting the economy" - the fed may need to

further prod the housing and auto markets to prevent another negative set of quarters - dangerous stuff - still if housing keep the economy healthy until industrial investment spending improves then spur housing - dangerous period

Posted by: on August 1, 2002 12:33 PM

Someone on this thread is emailing me directly without using a real name or a working response address.

I am trying to reply, but the mail consistently fails.

Will Mr./Ms. please use a "real" address so I can reply?

Sorry to waste blogsphere on this....

Posted by: George Zachar on August 1, 2002 12:53 PM

Iran & Iraq are long-time enemies, & Osama has major differences with both, given that Osama is a fundamentalist Sunni, the Iranians are Shiites, and Baathist Iraq's ideology is essentially atheistic socialism. North Korea has about as much to do with these guys as the Martians. The administration's strategy--push them together so we can deal with them all at once!

Posted by: on August 2, 2002 09:22 AM
Post a comment