April 25, 2003

This Is the Good News?

The Economist writes about the "good news for the world economy" that we received today: that U.S. GDP grew at a 1.6% annual rate in the first quarter of 2003. This is good news? It is lower than the forecasts I had seen (up until three weeks ago). At a GDP growth rate of 1.6% per year, the U.S. unemployment rate will rise at about 1 percentage point per year, and employment will fall by roughly a million jobs a year. Plus U.S. growth is markedly faster than growth in Europe and Japan.

To be fair, the Economist says that this is "only a bit" of good news. But my first reaction is that they are clearly taking too many Get-Happy Pills in the Economist's office.


Slow going

Apr 25th 2003
From The Economist Global Agenda

American economic growth speeded up only slightly in the first quarter of 2003. And there is still no sign of a strong global economic rebound, according to the latest assessment from the Organisation for Economic Co-operation and Development

FINALLY, a tiny bit of good news for the world economy. But it is only a bit. Figures published on April 25th showed that America's economy grew by 1.6% at an annual rate in the first quarter of this year. That is only slightly faster than the sluggish pace of growth at the tail end of 2002, and is lower than many economists had hoped for. It will certainly not be enough to cause anyone to revise their forecasts for the year as a whole. While the evidence on the American economy remains mixed, for the rest of the world there is little comfort in any recent data. Add to that the economic damage which the SARS virus is inflicting, especially in Asia, and it is hard to disagree with the conventional wisdom that global economic recovery is going to be a long, slow haul.

That is essentially the view of the Organisation for Economic Co-operation and Development (OECD), which published its latest assessment of global economic prospects on April 24th. Keen number-crunchers will make much of the fact that the forecasts from the OECD—a rich-country think-tank—are a tad more optimistic than those produced earlier in the month by the International Monetary Fund (IMF). But the underlying message is much the same: there is unlikely to be a sharp rebound in world growth this year, and the outlook for next year, while better, is not heart-stopping.

Several factors have combined to dampen economic confidence this year, forcing most economists to revise their expectations downwards yet again. Geopolitical uncertainty has hampered the previously anticipated upturn in business investment while depressing consumers’ confidence, and spending, in several of the world’s richest economies. And even though the war in Iraq has ended since the IMF issued its forecast, the OECD reckons that the improvement in the international political situation will not, by itself, be sufficient to boost recovery by much. What is needed is an underlying economic momentum, says the OECD.

To the extent that this momentum is absent—worryingly so in some countries—there is a hint in the OECD’s analysis that this reflects chickens coming home to roost. This is especially true of the European predicament. As the OECD points out, the gap between America and Europe is widening, with the euro area as a whole registering significantly poorer performance in the past few years. There is no prospect of an early reversal, at least in part because European economies have left themselves with very little room for manoeuvre—and because what scope they do have remains largely unused.

It does not help that the European Central Bank (ECB) has been slow to reduce interest rates. The OECD reckons that there is leeway to cut rates by another half a percentage point: the IMF also said further cuts should be considered. In Europe, monetary policy is the main instrument of economic stimulus because the European Union's much-derided stability and growth pact has left no scope for fiscal relaxation. The budget-deficit limits set by the pact were intended to underpin monetary union, but they have already been breached. For the euro area as a whole, the budget deficit should have fallen to 0.3% by last year, and be set to disappear altogether in 2003. Instead, the deficit across the zone reached 2.3% in 2002, and is not now expected to return to balance until 2006 or thereabouts. France and Germany are finding it particularly difficult to meet the pact’s targets.

The OECD does not share the view of those who argue that the stability pact is pointless because it is damaging short-term recovery. Instead, it points out that the medium-term outlook makes curbing fiscal deficits necessary—not just to preserve the pact’s credibility “but because of the age-related spending pressures that are about to intensify over the next few years”. Without new measures, the OECD reckons the three biggest euro-area economies—Germany, France and Italy—will make little headway in bringing down their deficits. The report makes little attempt to disguise the OECD’s view that governments have mainly themselves to blame, for squandering the surpluses in the boom years.

It’s a grim message for continental Europe, especially when contrasted with the somewhat better short-term outlook for America, where the OECD expects a modest but steady recovery this year, accelerating in 2004. The latest GDP figures appear to bear this out. But the OECD's view could turn out be optimistic in the light of the Federal Reserve’s latest survey of economic conditions across America, widely known as the “beige book”, published on April 23rd. This slightly more up-to-date evidence shows a “lacklustre” economy, with several parts of America growing even more slowly than earlier in the year.

The Fed has consistently cut interest rates further and faster than the ECB. But the OECD now reckons enough is enough, and warns Alan Greenspan, the Fed’s chairman, that he should be thinking of raising rates as the recovery becomes firmly established next year (a warning issued to the Bank of England as well). If the beige book evidence is backed up by other data, Mr Greenspan might take a different view when he and his colleagues meet again next month: there is already speculation that the Fed will conclude that the risks of economic weakness outweigh those of inflation. Mr Greenspan will not want to make the wrong call at such a sensitive time: President George Bush said this week that he wanted to reappoint the Fed chairman to a fifth term next year. Mr Greenspan responded by saying he would serve if asked.

The OECD has a warning for Mr Bush, too. It shares the widely expressed concern about the impact of the president’s tax-cutting strategy on America’s long-term fiscal position. Already, the swing from surplus to deficit between 2000 and 2002 represents the biggest two-year fiscal expansion in decades, equal to about 3.8% of GDP. Now the president wants to do more, with a $726 billion tax cut he is now trying to get through Congress. The OECD acknowledges that some of Mr Bush’s measures should help boost domestic demand in the short term. In the longer term, though, the OECD is worried about the impact of such large deficits on the rest of the economy, especially now that there is no legally binding cap on the growth of government spending. As the recovery gathers pace, the OECD suspects that higher deficits might mean higher interest rates.

Drawing attention to medium- and long-term problems should certainly concentrate policymakers’ minds. Some are now paying the price for the poor economic discipline of their predecessors, and some, especially in Europe and Japan, continue to postpone difficult but necessary reforms. The OECD suggests it is no coincidence that the countries that worked hardest to reform during the 1990s—Australia, Canada and Spain, for example—are also those that found it easier to withstand the shock from the world economic downturn.

Posted by DeLong at April 25, 2003 02:57 PM | TrackBack


"Several factors have combined to dampen economic confidence this year, forcing most economists to revise their expectations downwards yet again. Geopolitical uncertainty has hampered the previously anticipated upturn in business investment while depressing consumers’ confidence, and spending, in several of the world’s richest economies."

My completely anecdotal evidence would suggest that the world was in a holding pattern during Q1 while waiting for resolution in Iraq. I would guess that Q2 can be written off as well. Hopefully the previous administration's disasterous foreign policy on the peninsula won't ruin the rest of the year.

Posted by: brian on April 25, 2003 04:01 PM

Are they suggesting at the end that Clinton showed poor economic discipline? They exempt three countries but not the USA. We certainly didn't have a deficit.

Posted by: John Isbell on April 25, 2003 07:59 PM

Dr. DeLong:

Why does a growth rate of 1.6% necessarily mean a loss of jobs of 1,000,000 and increase in the annual unemployment rate of 1 percentage point per year? I am not an economics student, but I thought that, as long as an economy is growing at a positive rate, unemployment will not likely grow. I thought that, common-sense-wise, a negative growth rate is needed for an area's unemployment rate to rise. Do I need a year of basic macroeconomics to understand why that is not so, or is there some simple information that I am missing? Thank you for your help.

--James S. W.

Posted by: J S W on April 25, 2003 10:14 PM

Worker productivity has been growing by at least 3-4% every year, so if the economy only grows by 1.5% then there is 1 or 2 percent less work to be done by the workforce. Plus the number of people looking for jobs grows with the population so there are more people going after a shrinking number of jobs. There may be some other factors, but those two jump out at me.

Posted by: Garyn Dunbar on April 26, 2003 12:14 AM

What about inflation? Inasmuch I understand this rate of GDP growth does not substract the effect of inflation, which for the last quarter was 2.6% in January, 2.98% in February and 3.02% in March ( http://inflationdata.com/Inflation/Inflation_Rate/CurrentInflation.asp ) So the real growth would in fact be negative, or else there something I do not know (Which would not surprise me: I do not know the extension of my ignorance)


Posted by: Antoni Jaume on April 26, 2003 04:47 AM

Dear Dr. DeLong,

Does this:

"...Because of a sharp drop in imports, the nation's trade deficit narrowed. The decline in the trade gap was responsible for more than half of the quarterly gain in gross domestic product...."

"Economy Grew Slightly in the First Quarter, Report Says", By KENNETH N. GILPIN (The New York Times) 25 April 2003 http://story.news.yahoo.com/news?tmpl=story&u=/nyt/20030425/ts_nyt/economy_grew_slightly_in_the_first_quarter__report_says

Make YOU "go hmmmmm" ;?)

Posted by: Mike on April 26, 2003 06:45 AM

The 1.6% figure is already adjusted for inflation...

Posted by: Brad DeLong on April 26, 2003 07:52 AM


I briefly worked at The Economist. There was always a liberal amount of Stella Artois lager, which if you can get it in America, you'll know (at least until next morning) has a similar effect to happy pills.


Posted by: Matthew on April 26, 2003 12:24 PM


Please explain what you are intimating. What is the significance of a reduction in imports adding to the scant growth in GDP?

Posted by: bill on April 26, 2003 03:11 PM
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