A Recession in Name Only
To counter the first economic downturn of the millennium, politicians have put forth a spate of proposals to jump-start the economy. In a bit of revisionist history, President Bush defended his huge tax cut as stimulative. Then he claimed in his budget proposal, also laden with tax-cut ideas, that “further fiscal stimulus was needed to prevent a worsening of the recession.” After bemoaning a raid on the Social Security lock-box, Democrats quickly geared up to pile on their own spending measures. And on March 9, the bipartisan fiscal-stimulus package was signed into law.
Here’s the dirty little secret: It appears there wasn’t a recession after all. The six economists who make up the dismally named but highly influential business-cycle dating committee, working out of the National Bureau of Economic Research and charged with calling a recession when they see one, may have gotten it wrong. Theirs could prove to be an extremely costly mistake, because there are hundreds of billions of dollars in the pipeline to rev up an economy that may not need revving.
The standard definition of a recession is two consecutive quarters of negative economic growth. In November 2001, when the committee declared that the economy had slipped into recession last March, things did look bleak. Gross domestic product had shrunk by 1.1% in the third quarter. In the wake of Sept. 11, consumer confidence was down, the stock market exhibited few signs of life and personal savings rates hovered near zero.
But despite all the appearances, the economy was actually moving. Data from the Commerce Department show that in the final quarter of 2001, the economy grew at an annualized rate of 1.4%. While the recession-dating economists don’t rely on GDP to make their calls since the numbers come out quarterly and are subject to large revisions, the single quarter decline is noteworthy. Furthermore, productivity growth in the quarter was quite impressive.
Indeed, with the exception of industrial production, all the major indicators that the recession-dating committee relies on tell a different story than that of your standard recession. While 1.2 million jobs have melted away, the percentage decline in the workforce is modest by historical standards. Also, the unemployment rate may have peaked at 5.8%, a level not uncommon for non-recessionary periods. Since the committee views employment as the single most reliable indicator, these numbers alone should cause it to reconsider its earlier assessment.
Even more unusual, the decline in retail sales has been just 4.1%, compared with an average drop in the past five recessions of 7.4%, and almost all that occurred in September. Since then, sales have rebounded strongly. Most confounding is that income has risen steadily throughout the downturn.
But the act of labeling the economy “in recession” may itself have endangered the recovery because politicians have used it to justify policies that under normal circumstances would be considered an outright assault on fiscal discipline. Just take the startling deterioration in the federal budget, which has abruptly gone from projected surplus to projected deficit.
On repeated occasions, President Bush said he was committed to saving Social Security’s surpluses, except in the instance of war or recession. Now, he’s got both, and he’s no longer afraid of red ink.
Had the recession never been so labeled, perhaps Democrats would have been more forceful in opposing the return to deficits. Instead, not wanting to appear unsympathetic to the hardships recessions can cause, they have shed the pretense of being the guardians of responsible budgeting and are advocating a host of new spending initiatives, uttering not a word on how to pay for them. All this under the guise of further fiscal stimulus to revive the economy.
Then there is the fiscal stimulus package itself. Had the recession ever materialized, this package would probably have been deemed “too little, too late.” But given what we now know, it is better labeled “too much, not needed.” The package, which will infuse $51 billion into the economy this year and as much as $75 billion over the following three, primarily through corporate tax cuts, will drain the U.S. Treasury for years.
The result of the growing deficit is likely to be higher interest rates, which will dampen a number of economic sectors, including business investment and housing, not to mention higher taxes to repay the debt and balance the budget in the future. Certainly, spending the Social Security surpluses will make dealing with the program’s woes all the harder. And if these measures have their desired stimulative effect, they may stoke inflation, causing the Federal Reserve Board to raise interest rates more quickly than it otherwise would.
The federal government is not the only sector to have overspent in response to the recession call. Articles, commentators and politicians repeatedly reminded consumers--reprimanded them almost--that since consumer spending constitutes two-thirds of GDP, they had better spend if a deeper recession was to be avoided--and they did. As a result, consumers’ financial situations look precarious. Personal saving rates have not improved, total consumer credit stands at $1.7 trillion and there were nearly 1.5 million bankruptcies in 2001, a record that may be surpassed this year. When consumers do retrench, as they must, the change may be more destabilizing to the economy than if they had ignored the calls to spend more.
Yes, to the six recession watchers, it must have seemed virtually inconceivable that the correction in business over-investment in the late 1990s would not have spilled over into the economy as a whole. In the past, such drops in production have correlated with similar declines in employment, personal income and retail sales. Also, it seemed a sure bet that consumers would stop spending after Sept. 11. High levels of uncertainty, not to mention outright fear, normally don’t precede consumption binges.
Nonetheless, in possibly calling the recession prematurely, the recession-dating committee broke its own rules. Typically, members wait until hard data confirm a significant and widespread downturn. Never before have they declared a recession when declines in employment, sales and income were so small. The first recession of the millennium may go down in history as the recession that never was, but the consequence of that mistake--deficits--will not be imaginary.
