October 27, 2003

Business Cycle Optimism

Morgan Stanley's Richard Berner believes that we can finally see a sustainable rapid-growth recovery ahead. He thinks real GDP growth over the next year and a half is as likely to be above 4 percent per year as below it.

If he is right, we might finally see the unemployment rate start to drop below 6 percent...

Morgan Stanley: ...It was fun while it lasted, but US final demand is cooling from a sizzling 7% summer pace, and many believe that this deceleration is the prelude to a more lasting slowdown in growth. After all, the pessimists believe, massive summer tax cuts and a record mortgage refinancing boom largely fueled the advance; with both of these sources of stimulus fading and scant job gains to recharge income, the payback could be significant and lasting. I disagree. To be sure, the summer demand surge ran at an unsustainable clip, but in my view the inevitable deceleration will be short-lived. That's because production is finally scrambling to catch up with demand in time-honored cyclical fashion. In turn, rising production will begin to generate jobs, and the acceleration in output will lift growth in capital spending. If anything, I see the risks to our prognosis of solid, 4%-plus growth as evenly balanced in both directions. Here's why.

That private domestic demand is decelerating is hardly surprising: Consumer and housing outlays rose at unsustainable rates in the summer, and some consolidation was likely. We estimate that real consumer outlays soared at a 6.6% annual rate in the third quarter -- the strongest quarterly rise in six years. Regardless of income gains, with more than half this surge coming from big-ticket durable goods, a payback was inevitable and it apparently began in September. Similarly, housing outlays probably jumped by nearly 10% at an annual rate in the summer quarter, capping a year of nearly 9% growth. Notwithstanding the strong demographics underpinning housing demand and still-low mortgage rates, some slowing would seem unavoidable. The resulting demand deceleration will keep alive the debate over just how strong and sustainable is the budding economic revival. In my view, however, this deceleration in domestic demand will prove temporary.  That's partly because the capital-spending overhang of the past three years has evaporated, and some pent-up demand is setting the stage for an acceleration from the current "maintenance and repair"? capex recovery, at least in equipment...

Posted by DeLong at October 27, 2003 10:51 AM | TrackBack

Comments

In this version of Berner's happy look into the future, he give mention to the view of his colleague, Roach, that the recent rapid pace of consumer demand for durables will lead to a downturn, but then walks right past it. He asserts that "the capital-spending overhang of the past three years has evaporated" while Brad's summary of the Berry piece on the Fed notes that "the gap between the economy's sustainable productive potential and actual output continues to grow." The context suggests Berry/Brad have more in mind the state of the labor market than of the capital stock, but still, Berner seems to be giving shoving aside contrary arguments without addressing them. He has 4% as his central estimate of GDP growth, same as the Berry piece, which notes that may not be enough to pull down the jobless rate. His assertion of coming rapid growth may well be defensible, but he doesn't really defend them in this piece. In fact, when he addresses the "three common objections" to the happy outlook, he ignores labor market weakness altogether.

I am not a die-hard pessimist about the economy, but Berner's piece just seems to willing to ignore risks to the economy, to willing to see good news - the dollar and better foreign demand will take care of export leakage - GE orders' lack of correlation with ISM explains lack of good news from the corporate sector (???). I'll grant him his cash flow point.

By the way, look at them there home sales!!!

Posted by: K Harris on October 27, 2003 11:48 AM

I am just as optimistic about economic growth, and optimistic about the stock market, but the labor market continues to worry. So, I am generally optimistic for the near term and more than just worried about the budget bind we are in for the long term and the pressures that will mean for middle class families.

Bob Herbert:

Jared Bernstein, a senior economist at the Economic Policy Institute, has taken a look at the hours being worked by families, rather than individuals. It's a calculation that gets to the heart of a family's standard of living.

The declines he found were "of a magnitude that's historically been commensurate with double-digit unemployment rates," he said. It was not just that there were fewer family members working. The ones who were employed were working fewer hours.

http://www.nytimes.com/2003/10/27/opinion/27HERB.html

Posted by: Anne on October 27, 2003 12:37 PM

Re:

Business Cycle Optimism

Even a stopped clock ...

The following exercise is derivative but still worth a chuckle (for more reasons than may be initially obvious). Google the phrase

Second Half Recovery

and click on "I'm Feeling Lucky"

Posted by: paul on October 27, 2003 12:45 PM

Berner's prognostications over the last year have certainly been better, in hindsight, than Steve (Doctor of Deflation Doom) Roach's. I'll stick with Berner's optimism. He's a heckuva good economist.

I wish we could get past the "economic growth creates jobs and therefore lowers unemployment" argument. It just doesn't seem to explain anything anymore, and how can we pretend the rest of the labor market dynamics are somehow irrelevant?

Posted by: Jim Harris on October 27, 2003 01:24 PM

What about "confidence" and "demand"?
Is "demand" a function of "confidence"?

The Economist:
"The magisterial William Donaldson, chairman of the securities and Exchange Commission (SEC), speaking to a roomful of bosses at a meeting of the Business Roundtable" in WDC, last month, declared that the view of American business "is as low as it has never been", and added apoliptically that the system could not continue to operate "if so muich of the population thinks that business leadership has failed them".Jack Welch still a hero to many in spite of some embaerrassing scrutiny of his retirement package from GE, talks of a "crisis of confidence" in corporate leadership."

Posted by: A demand-side economics supporter on October 27, 2003 01:30 PM

J and K Harris

I agree with each of you. We do have a different sort of employment market now that will likely respond tepidly to 4% sustained growth. But, what do you suspect is happening to income distribution now. How much reason is there to worry about an increase in income inequality from 2001 to now and beyond? The nature of this recovery leads me to believe it is accentuating inequality.

Posted by: Anne on October 27, 2003 01:39 PM

How can we deficit spend by 4% of GNP ($400 billion) and not recover??

Meanwhile lots of manufacturing jobs have been lost to globalization and steel tariffs. This administration is simply not addressing the unemployment issue. Where are the worker training / retraining programs? Where is the investment in infrastructure? Spending increases by this administration have mostly been shoving money down the rat hole of Iraq, shoving money down the rat hole of farm subsidies and obligating the economy to spend money to support the steel dinosaurs at the expense of domestic steel manufacturing jobs.

Posted by: bakho on October 27, 2003 02:01 PM

Re:

What about "demand" and "confidence"?
Isn't "demand-policy" a function of "confidence", is it?

The Economist:
"The magisterial William Donaldson, chairman of the Securities and Exchange Commission (SEC), speaking to a roomful of bosses at a meeting of the Business Roundtable in WDC, last month, declared that the view of American business "is as low as it has ever been", and added apoliptically that the system could not continue to operate "if so much of the population thinks that business leadership has failed them".Jack Welch, still a hero to many in spite of some emabarassing scrutinity of his retirement package from GE, talks of a "crisis of confidence" in corporate leadership.

Hmmmm?

Posted by: Demand-side supporter on October 27, 2003 02:02 PM

RE: ... but in my view the inevitable deceleration will be short-lived. That's because production is finally scrambling to catch up with demand ...

okey dokey ... so which is it? Keynesian demand is more important than supply or supply as a driver of demand is the more significant economic force?

Inquiring supply-side skeptics want to know.

Posted by: SSS on October 27, 2003 05:30 PM

bakho asks, "How can we deficit spend by 4% of GNP ($400 billion) and not recover??"

Precisely. The question is not whether there will or will not be economic growth. Of course there will be.

The question is what it will cost.

Among Republican presidents, Ronald Reagan's Administration shows the best growth rate. It also shows some of the largest growth in national debt (even so, Democratic Administrations consistently outperform Republican ones). So, when Republicans point to the respectable Reagan growth rates, one can agree-- merely adding, "But how much did it cost?"

Every growth point/year under Bush is costing roughly $100B. In other words, a deficit of magnitude of 1% GDP creates 1% growth. There is absolutely no bang for the buck: for a buck, you get a buck with no bang.

Personally, I like Republicans. I just can't afford them.

Posted by: Charles on October 27, 2003 07:33 PM

The Federal Debt has increased by $1.2 trillion since Mr. Bush took office. I did not think it possible given the fiscal situation at the end of 2000, that any new administration could increase the deficit more in 4 years that it increased in the 8 years under Mr. Clinton. Mr. Bush seems certain to accumulate a larger debt in 4 years than Clintonomics accumulated in 8. Charles is correct. There is no bang for the buck. Someone stole the national credit card.

Posted by: bakho on October 27, 2003 08:45 PM

Somebody with a decent box of multipliers and accelerators needs to jump in here. Such a presence might not please supply-side non-skeptics, but I think a more thoroughgoing examination of where the stimulus is going would answer my, Jim's, Anne's, Bakho's, SSS's (sorry, had to do that), and Charles' issues. Anybody?

Posted by: K Harris on October 28, 2003 06:42 AM

K Harris, I think bakho or Zizka had pointed out the potential that much of the tax cuts could be invested outside the U.S. It wouldn't take much of that for the bang to buck ratio to decline. Pure speculation though.

Posted by: Stan on October 28, 2003 07:30 AM

Stan,

Could be. The war-fighting expenditures end up largely being spent in the US. Nation-building expenditures less so, but still a good bit of it goes to Bechtel and such like. I'd still be interested in seeing a more rigorous treatment of the popular notion that the Bush stimulus package isn't stimulative. Krugman's argument about the high cost of jobs in the Bush "jobs" package seems well taken - General Clark seems to be putting that argument to good use - but that is about as far as I have seen the argument pushed.

Posted by: K Harris on October 28, 2003 08:08 AM

K. Harris says, "I'd still be interested in seeing a more rigorous treatment of the popular notion that the Bush stimulus package isn't stimulative."

Amen.

Unfortunately, we're probably going to have to wait 5-10 years to get it.

I would add to the discussion the following point. The issue is not so much where the money is spent. That affects the timing of growth. What matters is how the money is spent. If it is all spent on killing people and blowing things up, it will normally depress the economy. If it is spent on education, environmental remediation and so on, it will stimulate the economy.

The exception is when blowing things up and killing people actually makes the human situation better. Such examples are very, very rare.

Posted by: Charles on October 28, 2003 12:09 PM

Spend enough money, get stimulus. But not as much stimulus if the money had been spent better. Bush has spent his stimulus in the least stimulative way possible. Nonetheless it is in Bush's interest to get an economic bounce in 2004 and we may well get one.

It won't last, though. The structural reasons for being pessimistic have not gone away.

Number one economic indicator in 2004? Whether Bush is re-elected or not.

Posted by: Ian Welsh on October 28, 2003 09:44 PM
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