Table: The Economy in Three Easy Letters
Picture a graph of the U.S. economy's performance in 2001. Which letter will it most resemble?
Growth picks up as quickly as it slid. The Fed cuts interest rates aggressively. Housing soars, and the stock market rebounds. The low jobless rate buttresses sagging consumer confidence. With inventories sharply trimmed, businesses need to increase output to satisfy demand. The perceived rate of return on investment remains high, so capital spending bounces back.
Bargain hunters pour into stocks. The rebound reassures consumers, hastening the economy's recovery and leading to market gains. The Standard & Poor's 500-stock index ends 2001 at 1,500, up 15% for the year. The Dow Jones industrial average climbs 17%, to 12,600. The Nasdaq Composite Index rises 20%, to 3,000.
Growth continues to slow through the second half, possibly even sending the U.S into its first recession since 1990-91. The unemployment rate rises. Consumers, burdened by debt, slash discretionary spending. Business cuts investment. Corporate profits wither, further discouraging investment. The economy eventually rebounds when the Fed lowers rates markedly.
Stocks trend downward, further shaking consumers' confidence and exacerbating the market downturn. But stocks begin to climb slowly by summer as investors look ahead to an eventual recovery. The S&P 500 ends 2001 at 1,400, up 5% for the year; the Dow rises 6%, to 11,400; the Nasdaq ends the year flat at 2,500.
Output falls sharply and stays low. The Fed's rate cuts don't work: Consumers and businesses are too cautious to borrow. The government turns to fiscal spending but fails to stimulate the private sector. Foreign investors lose faith in the dollar, causing the currency to plummet and raising the cost of imports. Stagflation sets in. With prices rising, the Fed is afraid to cut rates enough to get the economy moving.
Stocks slump as investors begin to fear that the U.S. may be catching the stagnation disease that has plagued Japan. Every rally is quickly extinguished by a wave of selling. The S&P 500 ends 2001 at 1050, down 15% for the year; the Dow falls 12%, to 9500; and the Nasdaq Composite falls 25%, to 1850.