U.S.: Once Again, This Economy Shows an Unexpected Resilience

Nevertheless, a shallow recession may beget a shallow recovery

The Jan. 30 report on fourth-quarter gross domestic product--with its unexpected gain in output--highlighted an interesting fact that could be easily missed: how quickly the U.S. economy has moved beyond the tragedies of September 11.

Immediately after the attacks, the feeling was that businesses would have to build up inventories as a hedge against supply disruptions: Just-in-time inventory management would become just-in-case. And consumers were so stunned that they would stop spending.

Instead, the fourth-quarter mix of shrinking inventories and soaring demand shows how fundamentally sound the economy is (chart). That view is supported by the latest monthly data which show that consumers are increasingly confident about the economy's future, and housing just finished its best year ever. Even orders for capital goods seem to have turned the corner, especially those for high-tech gear. Firm demand and the need to rebuild inventories after a year of unprecedented liquidation means this recession is over.

According to the Commerce Dept.'s report, real GDP edged up at a 0.2% annual rate in the fourth quarter. While the gain was small and could turn into a negative when Commerce revises the GDP data, economists had expected a drop in the neighborhood of 1% following the 1.3% contraction in the third quarter.

The surprise pop in GDP growth suggests that when the National Bureau of Economic Research sits down a few months from now to determine the economy's trough, the end date of the recession may well be this past December or January. The gain also explains why the Federal Reserve chose to hold interest rates steady at its Jan. 29-30 meeting. More interestingly, the yearend increase raises questions about whether the economy really slipped into recession in 2001.

AT THE VERY LEAST, the fourth-quarter gain means this downturn will probably turn out to be one of the most superficial slumps in the postwar era. From the first quarter of 2001 to the fourth quarter, the peak-to-trough decline in real GDP was a tiny 0.3%, vs. the 2.2% average for all postwar downturns. Only the 1969-1970 downturn, when output slipped just 0.1%, was more shallow.

Bear in mind, however, that shallow recessions beget mild recoveries. Although inventory growth is set to turn around, businesses and consumers are adjusting to the new realities of diminished expectations, compared with the high-flying days of the late 1990s. In particular, many service industries, such as advertising and financial services, will be slow to get back up to speed. Companies still have a lot of excess production capacity left over from past overinvestment. And households are not going to enjoy the same boosts from stock prices and house values that they had been.

Economists were downbeat on real GDP growth because the monthly data showed that inventories were being liquidated at a phenomenal rate. And in fact, inventories fell at a record $120-billion pace last quarter. But that was offset by increased spending by consumers, government, and businesses. Domestic demand grew at a 2.5% annual rate last quarter, boosted by a 3.6% surge in consumer spending, as shoppers flocked to car dealerships after Detroit introduced its generous financing deals.

That wasn't supposed to happen. Fear of terrorism was expected to keep shoppers at home. But consumers seemed to shrug off uncertainty. That was especially clear in the yearend trend in home sales. Consumers showed great willingness to take on the huge financial commitment of paying off a mortgage. December sales of new homes rose 5.7% to an annual rate of 946,000. Sales of new houses set a record of 901,000 for all of 2001.

THE QUESTION IS WHETHER consumers' resilience will continue in 2002. So far, the data are encouraging. Weekly surveys show that retail sales are rising sharply from their December level. And although Detroit scaled back its incentive plans, car sales are reported to be holding up well in January.

Even so, consumer spending is unlikely to match its fourth-quarter surge. At the very least, vehicle sales in the first quarter will likely be well below the 18.4 million annual rate for the fourth quarter. That drag will offset gains in other consumer buying. If large enough, the drop could even lead to a decline in quarterly household purchases for the first time in 10 years.

The Fed, however, has concluded the economy's prospects have picked up. That's why the Fed left the federal funds rate unchanged at 1.75% at its Jan. 29-30 meeting. In its statement, it said: "Signs that weakness in demand is abating and economic activity is beginning to firm have become more prevalent." The statement's upbeat tone paralleled a Jan. 24 speech by Fed Chairman Alan Greenspan in which he clarified his hopes for the outlook. With the recession's demise, this Fed policy-easing cycle appears to be over as well.

EVEN BEFORE THE GDP DATA, consumers were expressing a brighter view of the economy. The Conference Board's index of consumer confidence edged up in January to 97.3, from 94.6 in December. All of the gain was in expectations for the future. That index jumped from 92.4 to 96.9, the highest reading since December, 2000 (chart).

Better job prospects are driving sentiment. In January, 18.8% of consumers thought jobs will be more plentiful in the next six months, up from 16.5% in December. The recent trend in jobless claims supports that view. Filings for jobless benefits spiked after the September 11 attacks but are now down sharply.

Surprisingly, though, consumers aren't the only ones feeling better about the economy. Business executives are showing their confidence through their spending plans. Durable goods orders rose by a better-than-expected 2% in December, and new orders for nondefense capital goods--a proxy for business sentiment--increased 1.3%, their third consecutive advance.

Demand was particularly strong for computers and related electronics. The GDP report showed that outlays for information processing equipment posted the first increase in a year, and looking ahead, new bookings for high-tech gear grew at an annual rate of 20.1% in the fourth quarter, the first increase in 1 1/2 years (chart). A steady increase for computer demand suggests the tech meltdown is becoming less of a drag on the economy. And makers of computers, semiconductors, and peripherals may soon be gearing up production plans.

That's far different from what most economists expected only a few months ago. Indeed, the behavior of businesses and consumers is once again a testament to the new flexibility of the U.S. economy, a characteristic that it has shown many times in the face of adversity during the past decade.

By James C. Cooper & Kathleen Madigan

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