Originally published in The Boston Globe
Tuesday, December 4, 2001
From Recession to Recovery
By Martin and Kathleen Feldstein
"The history of previous recessions provides clues to what we might expect looking ahead some months."
All good things must come to an end, including good economic times. It's now official that the longest economic expansion in U.S. records has ended after ten years of rising incomes and employment. The National Bureau of Economic Research (NBER), the private non-profit research organization that is the official arbiter for dating economic cycles, recently declared that the latest expansion ended and a recession began in March.
It comes as little surprise that the economy is in recession, but the NBER typically waits for some time after the economy begins to contract before determining both whether and when there is an actual recession. The NBER has no fixed rule for making its determination, such as a two quarter decline in GDP, but weighs a number of economic indicators, in particular industrial production, employment, real income, and sales. For an economic downturn to be declared a recession, there must be a significant decline in economic activity that is spread broadly across the economy and that lasts for more than a few months.
While industrial production has been declining for over a year, until now it wasn't clear that the current downturn would be broad enough and deep enough to qualify as a recession. But the decline in services and employment following the September 11 attack made it clear to the NBER's business cycle dating committee that a recession is underway.
To pick the peak of the business cycle, the NBER committee looks at monthly measures of production, sales, employment, and income. Generally these measures rise and fall together. If they all turned down in the same month, it would be easy to date the expansion's end. But, of course, the measures never are that much in step.
A decline in manufacturing activity frequently is the first indicator of a coming recession, but in this cycle the lead time was much greater than usual. Industrial production peaked more than a year ago, in September of 2000, at about the same time that sales in the manufacturing and retail sectors reached their peak. Employment, however, continued to rise until March, and personal incomes have not yet stopped rising. The committee emphasizes employment as the broadest measure of economic activity and selected March, when employment peaked, as the end of the expansion and beginning of the recession. They also put the start of the recession in the first quarter of 2001 even though real GDP didn't turn down until the third quarter.
Speculation now turns to the likely length of the downturn and the factors that will bring the economy back onto a growth path.
Although the NBER assiduously avoids making forecasts, the history of previous recessions provides clues to what we might expect looking ahead some months. Most recessions don't last very long. The nine recessions since WWII ranged from 6 to 16 months with an average of 11 months.
Many factors are already in place to help the economy recover from its current downturn. Monetary policy, the primary policy source of past recoveries, has been increasingly expansionary all year. The Fed lowered the overnight interest rate from 6.5 percent a year ago to 5.3 percent in March and 2.0 percent now.
The lower interest rates have helped to maintain construction and have allowed home owners to refinance mortgages, taking out some cash to spend on other things. Lower interest rates have also boosted share prices, keeping up consumer spending. And the low interest costs have allowed auto companies to offer the zero interest rate credit that have made this a record time for auto sales. Consumption has also been encouraged by lower energy prices that mean lower bills to be paid for gas and home heating.
The Bush tax cut that was enacted earlier this year will also increase consumer spending in 2002. Traditionally, tax cuts are not helpful in turning around a recession because of long delays in legislation and in the implementation of the tax cut. By the time a tax cut starts to raise spending, the economy is already past the recession. But this time, the tax cut package that President Bush proposed early this year and that Congress approved in the spring is coming just when it is most needed. And while the tax plan was designed to improve long-term incentives, the substantial personal income tax cut should give consumers an incentive to boost spending now.
There will be increased government spending as well this year as part of the rebuilding activities to recover from the September 11 attack. The overall economic effect of September 11 on the pace of the recovery is difficult to assess, as the negative short term impact will be offset to some extent through rebuilding in the months ahead.
Consumer psychology is key to the timing of the recovery. Despite the lower interest rates and higher personal incomes, consumer confidence about the current economy as measured by the Conference Board continues to decline. But in a very positive sign, consumers show optimism about economic prospects six months from now. If consumers back this up with an increase in spending, the current recession may follow the recent average pattern and become history by spring.
Martin Feldstein, the former chairman of the Council of Economic Advisers, is President of the National Bureau of Economic Research and a member of its Business Cycle Dating Committee. He and his wife, Kathleen, also an economist, write frequently together on economics.