August 20, 2002

Falling Forecasts of Short-Run Growth

David Wessel and Thomas Sims of the Wall Street Journal report on how the consensus forecasts of near-term economic growth worldwide are being cut back. Former Fed Governor Larry Meyer provides context:


WSJ.com - Major Business News: ...In the U.S., the very slow growth in payrolls and the decelerating pace of wage gains threatens to pinch household income. Household wealth has been whacked by the weak stock market. And business investment spending is restrained by "a sense of pessimism and a reluctance to take risks," says Mr. Meyer, the former Fed governor. Consumer spending and housing have been impressively resilient, and another round of no-interest financing by auto makers will help the economy in the current quarter. "But," he says, "the only way to keep the economy going in the fourth quarter is to get a significant rebound in business fixed investment, and that doesn't seem to be in train."...

Global Economy Looks Fragile
As Optimism for Rebound Fades

New Data From U.S., Germany Add Strokes
To a Darker Picture of Recovery's Strength

By DAVID WESSEL and G. THOMAS SIMS
Staff Reporters of THE WALL STREET JOURNAL

The outlook for the global economy is deteriorating amid fading optimism that this year will see a smart rebound from the slowdown that began two years ago.

Monday brought more disappointing economic news, confirming that the U.S. recovery is still shaky and that the rest of the industrialized world isn't faring much better.

[Global Journal]

The U.S. index of leading indicators, a compilation of economic data that is designed to foreshadow the direction of the economy, fell 0.4%, the third decline in the past four months.

And Germany's central bank estimated that Germany, the world's third-largest economy, grew at an annual rate of just 1% in the second quarter. "As long as the economy hasn't gained strength and momentum, it remains vulnerable to new shocks, be they external or homemade," the Bundesbank warned. Second-quarter growth, which doesn't reflect the economic harm of recent flooding, was barely faster than the sluggish pace of the first quarter and only slightly better than slow second-quarter growth reported recently for Italy and the Netherlands. The U.S. economy grew at a 1.1% pace in the second quarter.

"There's a sense of disappointment that things haven't gotten better in the world economy," former Federal Reserve governor Laurence Meyer says. The U.S. economy "basically has been flat" since a surge at the very beginning of the year, he says. "You've got Latin America stressed out. You've got the euro area struggling to get back to trend growth, which is very low anyhow. The only bright spot is non-Japan Asia."

'Vicious Cycle'

No single development accounts for the darkening picture. Nearly everything that has occurred since the beginning of the summer has been an economic negative. "This is the vicious cycle," says Mr. Meyer, who is now at the Center for Strategic and International Studies, a Washington think tank. "The rest of the world needs us and we need them and neither one is helping each other."

"We were looking for some improvement in the second half," says David Hensley, an economist at J.P. Morgan Chase Bank in New York. But it isn't materializing. The pickup in global manufacturing that J.P. Morgan economists had been anticipating didn't show up. Stock markets have been weak and not just because of accounting scandals in the U.S. "All over the world," Glenn Hubbard, chairman of the White House Council of Economic Advisers, said recently, "money is flowing into safe assets."

Consumer spending in Europe continues to be disappointing. Japanese workers are being squeezed by corporate restructurings and Japanese exporters are being squeezed by the soaring yen. And oil prices, which usually fall when the economy weakens, instead are hovering around $30 a barrel because of uneasiness about a possible U.S. attack on Iraq.

Just seven weeks ago, at the beginning of the summer, economists at J.P. Morgan Chase were predicting that the world's other developed economies would expand at a 3.2% annual rate in the second half of this year. Now they are forecasting growth of 2.15% because of the bleaker outlook for the U.S. and Europe and renewed pessimism about Japan. The economies of the developed world grew at a 2.4% pace in this year's first half.

They have made similar changes to their forecast for developing countries, largely because of the deteriorating economies of Latin America. Instead of growth of nearly 4% in the second half -- the early summer prediction for the developing world -- the economists now expect just 2.6%. They think the economies of Latin America will grow at an annual rate of just 0.7% in the second half of the year. In contrast, the economies in Asia outside of Japan are expected to grow by better than 4%, but they will have difficulty sustaining that pace unless demand from the U.S., Europe and Japan strengthens.

Similar rethinking about the near-term prospects is under way at the International Monetary Fund, which is preparing a new semiannual forecast to be released at the end of next month. Back in April, the International Monetary Fund marked up its post-Sept. 11 forecast for the world economy and pointed hopefully to "increasing signs that the global economic slowdown, which began in the middle of 2000, has bottomed out, most clearly in the U.S. and to a lesser extent in Europe." In its semiannual World Economic Outlook, it said, "Growing expectations of recovery have been particularly apparent in financial markets."

The tone of the new IMF forecast is almost certain to be gloomier.

[Graph]

The new German data underscore the weakness of the global economy outside the U.S. Strikes at auto makers, rising unemployment and stingy corporate investment spending hindered growth and the recovery from last year's recession, the Bundesbank said. Consumer spending helped growth in the second quarter, but the central bank warned that sagging stock markets may undermine confidence. And exports, one of the drivers of what little growth Germany enjoyed in the second quarter, depend on the elusive rebound in the U.S. and elsewhere.

The Bundesbank, using the European conventions for reporting economic data, said the German economy grew by 0.25% in the second quarter, compared with the first, marginally faster than the 0.2% growth in the first quarter. In the U.S., quarterly changes are usually converted to annual rates. Germany's government statistics office will publish the official growth estimate Thursday.

The German Banking Federation said that it is cutting its growth forecast for 2002 for the 12 countries that share the euro to 1% from 1.4%. The trade association marked down its forecast for German growth for the year to a meager 0.5% from 1.0%.

The European Central Bank, meanwhile, appears even more reluctant than the Federal Reserve in the U.S. to cut interest rates further to stimulate the economy. The Bush administration is flirting with new tax cuts that would be crafted to offset some of the damage done by the stock market's drop. But the German government, already under pressure from the European Commission in Brussels to limit the size of its budget deficit, Monday delayed €6.9 billion ($6.8 billion) of income-tax cuts planned for 2003 to finance flood repairs in eastern Germany.

In the U.S., the very slow growth in payrolls and the decelerating pace of wage gains threatens to pinch household income. Household wealth has been whacked by the weak stock market. And business investment spending is restrained by "a sense of pessimism and a reluctance to take risks," says Mr. Meyer, the former Fed governor. Consumer spending and housing have been impressively resilient, and another round of no-interest financing by auto makers will help the economy in the current quarter. "But," he says, "the only way to keep the economy going in the fourth quarter is to get a significant rebound in business fixed investment, and that doesn't seem to be in train."

Compounding all this are recent revisions of history by the economic scorekeepers at the Commerce Department. Their new numbers describe a recession that was longer and deeper than the earlier numbers suggest. That doesn't show much about the economy's future direction, of course, but it underscores the vulnerability of the U.S. economy.

"The boom," Mr. Meyer says, "was unique. And the downturn was unique. We're in a post-bubble economy. The lesson from Japan is that it's very difficult to figure out the forces that interact with each other."

Write to David Wessel at david.wessel@wsj.com5 and G. Thomas Sims at tom.sims@wsj.com6

Posted by DeLong at August 20, 2002 06:57 AM | TrackBack

Comments

Former Fed Governor Alice Rivlin on PBS remarked that there is no need for the Fed to further stimulate housing or auto sales and there is no evidence as yet of a dangerous slowing of the economy. Rivlin gave no hint of how long it might be before we began to grow again at a healthy rate. Rivlin may well reflect the Fed belief that we can muddle along at growth well below 4 percent. I believe that such muddling will be a problem for workers and may produce deflation. There is much to worry about if we continue 1 percent growth many more quarters.

Posted by: on August 20, 2002 09:30 AM

there is no reason to believe the fed is worried about slow economic growth rather than an economic reversal to recession - if the economy simply continues to grow slowly the fed will likely not lower rates - if slow growth does result in deflation the fed may have waited until an especially serious problem developed - we not be japan but we should attend to the lesson the japanese central bank taught by its overly conservative monetary stance this last decade

we should now be quite worried about the prospect of continued slow growth

Posted by: on August 20, 2002 09:58 AM
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