U.S.: A Slump and a Recovery in Internet Time
At his semiannual monetary policy report to Congress a year ago, Federal Reserve Chairman Alan Greenspan made a point of explaining how unusually quick reaction times by businesses and policymakers shaped the economic slowdown. When Greenspan travels to Capitol Hill for this year's testimony on Feb. 27, it will be interesting to see if, in forecasting the shape of the recovery, he cites that same time compression as a factor.
As Greenspan has noted, rapid response times are a result of technological advances. Increased use of real-time information, such as computerized order tracking, enables business to know when demand is shifting and to instantly change output schedules, workshifts, inventory levels, and capital spending plans. Like increased productivity and greater labor flexibility, quick reflexes became a key characteristic of the U.S. economy during the 1990s.
These New Economy phenomena will affect this year's upturn, too. Already, capital spending is showing signs of stabilizing as companies invest in high-tech equipment in order to keep productivity growing. Also, unemployment will rise this year even as real-income gains amid low inflation give many households greater buying power and keep consumer spending on the rise.
Most important, shorter reaction times will play a big role in this year's inventory cycle. With demand growing at least at a modest pace, businesses in early 2002 will not continue to cut their stock levels as drastically as they did in late 2001. Tech inventories in particular have fallen far enough so that they are better aligned with the drop-off in tech sales (chart). This slowdown in inventory liquidation may mean that economic growth in the first half of 2002 could be much stronger than most economists now anticipate.
TO SEE HOW rapid responses have changed the way the economy works, you need only look at last year's recession. The quick availability of information on slowing demand caused businesses to cut their inventory levels at an unprecedented rate in 2001. The drawdown in business inventories accounted for all of the contraction in real gross domestic product last year.
At the same time, officials at the Fed and the White House reacted in record time to supply the economy with stimulus in the form of lower short-term interest rates and tax rebates. St. Louis Fed President William Poole noted in a Feb. 13 speech that the Fed began reacting before the recession began, partly because of anecdotal reports of falling loan demand. He said such reports allow the Fed "to see what is going on in the economy almost as it is happening."
The rate cuts helped to push down mortgage rates, which fueled record home sales last year--a pickup that never occurred in any previous recession. The tax rebates gave consumers the money to keep spending in each quarter of this recession: another unprecedented occurrence. All told, the quicker response times were crucial in making this recession unlike any other in the postwar era.
That alacrity should likewise make for a unique recovery. Its influence will be felt most keenly in inventories. Thanks to real-time information, companies can quickly refigure the appropriate levels of merchandise and supplies to have on hand. And companies don't have to rebuild inventories to contribute to economic growth in 2002: In GDP arithmetic, even a slower rate of liquidation means a big plus for economic growth.
For example, if inventory liquidation slows from its $121-billion fourth-quarter pace to zero by the second quarter, as some forecasters expect, that swing would add, on average, a huge 2.5 percentage points to GDP growth in both the first and second quarters.
OF COURSE, COMPANIES will only realign their inventories if they believe that demand prospects have improved. So far, demand, especially from consumers, has remained steady. The end of lucrative financing deals caused a drop in car sales in January, which pulled down total retail sales by 0.2% for the month. But excluding vehicles, retail buying jumped 1.2% in January. Outside of the recent ups and downs in sales of cars and gasoline, buying began the first quarter far above its fourth-quarter average (chart).
Although consumers have increased their shopping during this recession, they have also cut back on their credit-card use. Installment credit slipped by $5.1 billion in December. The drop-off has been concentrated in revolving debt, mostly on credit cards (chart). Installment debt peaked last summer, suggesting that consumers used part of their tax rebates and general increase in purchasing power to pay off existing debts at a quicker rate than they have in past recessions.
THE TIME SQUEEZE may also be widening the divide between business spending on high-tech equipment and outlays for more traditional capital goods. That gap showed up in the fourth quarter, when investment in tech equipment edged up slightly for the first time in a year, while spending on old-line investments--such as turbines and rail cars--fell. Outlays for industrial equipment dropped at an 11.6% annual rate, with spending on transportation equipment down 5%.
The gap may get bigger in 2002. New orders for computers and electronic products grew at a 20.1% annual rate from the third quarter to the fourth. But noncomputer, nondefense capital goods dropped at a 28.7% pace. The divergence may reflect fresh reasons for investing in today's economy: Instead of adding capacity, companies are buying tech goods in order to increase productivity and lower costs. That's the only profit-building strategy that will work this year, when pricing power again will be a no-show. Moreover, faster depreciation for most tech equipment compresses the buy-and-replace cycle for this category of capital spending.
Historically, capital spending has lagged the rest of the economy. But like everything else in this business cycle, that old rule of thumb may not apply in 2002, at least not where tech is concerned. Business investment for computer equipment slowed before the rest of the economy did, and it may well pick up before other sectors because of the different imperatives that underlie the spending plans of today's companies.
How much Chairman Greenspan uses his upcoming congressional visit to contrast this business cycle with others remains to be seen. He may well spend the bulk of his testimony explaining the possible economic consequences of the Enron debacle and questionable accounting practices. But the economy's 1990s metamorphosis played a part in the recession, and it will influence this year's recovery. Whether the Fed chief mentions it or not, one key aspect of the recovery will be quicker responses made by businesses, consumers, and policymakers to shifts in the economy.
By James C. Cooper & Kathleen Madigan