Investors greeted the news that the U.S. is officially in recession with a shrug and a yawn. After all, the National Bureau of Economic Research's announcement that the downturn began in March was too backward-looking for most stock and bondholders. They are much more interested in where we go from here than where we have been.
Yet an analysis of the NBER's Nov. 26 declaration provides some insight into the shape of both the recession and the coming recovery. The first lesson is that, if history is any guide, the recession is almost over. Second, the downturn may well turn out to be the mildest since World War II (charts). And third, the unusual nature of the recession means that the recovery will develop only gradually.
These three ideas mean the outlook is a mixed bag. On the plus side, the economy won't experience the hit-a-brick-wall cessation of business activity that has been the norm in other recessions. Indeed, housing and autos, as well as many service industries, are still holding up. But when the upturn arrives, demand will not shoot out of the cannon as in past experiences. That means the economy could start growing again, but the pace will be too slow to lower the jobless rate or improve investor sentiment.
TO UNDERSTAND THE COMING RECOVERY, it's important to grasp the nature of the current downturn. Let's start with the recession's length. The downturns since World War II have ranged between 6 and 18 months, with an average of 11. This one is now nine months old. The recession would have to be the longest in the postwar era for a recovery to be delayed past the middle of 2002.
That's unlikely because the policy response during this slump has been far faster and larger than average. In fact, this is the first recession in which the Federal Reserve began cutting interest rates aggressively before the downturn even began. So far, the Fed's rate cuts have totaled 450 basis points, while cuts during the comparable period in the past 6 recessions have averaged only 180 points. Plus, the NBER's announcement should help to break the deadlock in Congress over further significant fiscal stimulus. That's likely to total anywhere between $65 billion and $100 billion, and it will kick in early next year.
Perhaps more important than the downturn's length will be its depth, or the degree to which economic activity contracts and the jobless rate rises. The NBER's admission that before the September 11 terrorist attacks, "it is possible that the decline in the economy would have been too mild to qualify as a recession," strongly suggests that this episode could turn out to be the most shallow of all postwar downturns.
Contrary to popular belief, the NBER does not use gross domestic product to determine turning points in the business cycle. Instead, it looks at four monthly data series: industrial production; private-sector employment; sales by manufacturers, wholesalers, and retailers; and personal income minus various government transfers of income to individuals, such as unemployment benefits. Both sales and income are adjusted for inflation.
The Conference Board's index of coincident indicators is a composite of these four monthly measures. Since March, the coincident index has declined 0.3%. In the comparable time period of the past six recessions, the index fell by 1.6%. That means this recession is running far behind the average experience of the past six, and once the shock effects of September 11 have passed, the economy's prior resilience will very likely reassert itself.
THAT MAY ALREADY BE HAPPENING. Consumer spending bounced back strongly in October. Weekly sales reports from the Instinet Research Redbook show continued strength in November, and early reports of post-Thanksgiving shopping, while mixed as usual, are generally more encouraging than feared. Surprisingly, overall consumer spending is set to show a gain for the fourth quarter, which means that the forecasts of a 2%-or-greater decline in fourth-quarter GDP, made only a few weeks ago, already look far too bearish.
Moreover, measures of consumer confidence in November did not show any significant additional deterioration from the September and October drops. The University of Michigan's measure rose slightly in November, while the Conference Board's gauge dipped to 82.5 from 85.3, amid job worries (chart). Still, even though households surveyed by the Conference Board noted that current conditions are worsening, they expressed increased faith that future conditions in the next six months would improve.
Plus, households seem willing and able to grab a good deal when they see one, including buying a home. October sales of existing homes recovered much of September's shock-related plunge, rising 5.5%, to an annual rate of 5.17 million. Since March, sales have averaged 5.27 million, far sturdier than in past recessions. Low mortgage rates and record refinancings are supporting both housing and consumer spending generally.
BUT THEREIN LIES A PROBLEM for the recovery. The NBER's four key indicators highlight an important atypical pattern of this recession. The bureau noted that "continuing fast growth in productivity and sharp declines in the prices of imports, especially oil, raised purchasing power while employment was falling." This rise in household buying power--even as the three other NBER indicators fall--will continue to sustain spending in coming months.
However, because consumer outlays, especially for cars and homes, have remained strong, they will not provide the large push they have supplied in past recoveries. Also, past wealth losses and skimpy household savings will further limit any consumer surge in 2002.
Car sales alone in the first quarter will likely drag down overall spending. The fourth-quarter boom in car buying, which continued into November, was fueled by rich incentive programs. It is sure to go bust in the first quarter when the incentives end. Nonetheless, the average level of sales for the two quarters combined should be unusually good for a recession period.
The NBER admitted that the committee considered earlier dates for the recession's start in order to reflect the industrial sector's decline since last autumn. The factory downturn, the sector's worst recession in the postwar era, has been driven by the tech-related bust in capital spending.
The tech wreck points out another big obstacle for the recovery. The economy will not enjoy a strong rebound until companies see business improving enough to shell out more money for investments in machinery and high-tech gear. Only that can ensure a solid upturn in the industrial sector. So while consumers will be able to lead a modest recovery in 2002, their pull won't be great enough to offset the drags left over from 2001.
By James C. Cooper & Kathleen Madigan