The Economy: Why the Recovery is Finally Real
from
November/December 2003
by Rob Norton
News about the economy has been so glum for so long that sometimes it’s hard to imagine times will ever be good again. Nevertheless, the news in the summer of 2003 was both reassuring and hopeful.
The reassurance came from the National Bureau of Economic Research (NBER), the official arbiter of U.S. economic history. It declared in July that the recession that began in March 2001 came to an end in November of the same year, and that the subsequent expansion, although sluggish, is for real. The seven academic economists who make up the NBER’s “business cycle dating committee” are sometimes ridiculed for taking so long to make up their minds, but they are more concerned with accuracy than timeliness and like to see solid evidence before saying anything. Their reasoning, therefore, helps dismiss fears that the recession never ended. While allowing that both jobs and industrial production are lagging, the NBER notes that real GDP not only has risen 4% from its trough in the third quarter of 2001 but also is 3.3% above its pre-recession peak in the fourth quarter of 2000. Two other indicators that the NBER watches—personal income and sales volume—have also surpassed their pre-recession peaks.
The hopefulness is in the economic data, which show that the recovery finally has traction. Manufacturing production and revenues have been growing, notes Sophia Koropeckyj, an economist at the economic-data provider Economy.com, and capital spending is recovering as corporate profits rise and capital markets perk up. Real GDP grew 2.4% in the second quarter of 2003, well above forecasts, and many economists are confident that the growth rate will reach 4% by early 2004. And the rise of long-term interest rates, after a lengthy decline, indicates that the bond market is finally betting on stronger economic growth.
The business cycle that ended in 2001 contains three lessons that help show why the current expansion can continue to gain strength.
First, recent business cycles have become both longer and less volatile than earlier ones. The 1990-91 recession was one of the mildest in the post-World War II era, and the 10-year expansion that followed was the longest. The 2001 recession was milder still. Many economists give the credit to improved monetary policymaking. The Federal Reserve’s longstanding commitment to price stability has helped avoid the inflationary ups and downs that nipped expansions in the past. The absence of inflation this time has allowed the Fed to cut rates aggressively to counter the recession and will give it leeway to keep rates low as growth accelerates.
Second, although job losses have been the most unfortunate markers of the 2001 recession, the apparent unemployment peak of 6.5% is well below the 7.8% rate of the 1990-91 recession and far below the 10.8% rate of 1981-82. The economy’s ability to expand despite underemployment in the labor force reflects continued productivity growth. When the job market does improve, it should fuel a continued expansion. William Poole, president of the Federal Reserve Bank of St. Louis, said in May that as the slack in the labor force is taken up, the increase in worker hours will provide “the potential for real-GDP growth of 4% to 4.5% per year.”
Third, the pursuit of “lean and mean” in the 1980s and 1990s has allowed U.S. businesses to adjust quickly to changing economic conditions. Throughout the 2001 recession, according to a study by Federal Reserve Bank of New York economists, U.S. companies sold off inventories at an extraordinarily rapid pace, showing the same kind of improved inventory control they first employed in the 1990-91 recession. “Unlike businesses in recessions prior to 1984,” the study found, “firms anticipated the slowdown in sales well before the recession began” and thus were able to avoid the kind of inventory buildup that worsened recessions in the past. Inventories have remained lean so far during the expansion, paving the way for further sustainable increases in production.
All in all, it’s a safe bet that the current expansion will continue—and strengthen.
