CURRENT ISSUE


Path to U.S. Economic Recovery Difficult to Determine

Is the U.S. economic slowdown over? If so, what path will the recovery take? Providing precise forecasts to answer these questions is difficult. An educated guess, however, can be made as to what the recovery will look like. In doing so, one must recognize that the current contraction is not like previous ones.

Not your father’s recession
In the past five recessions, inflation was accelerating or at high levels prior to the onset of the recession, and economic policy was typically in the process of becoming more restrictive. In terms of real economic activity, these slowdowns were generally led by a fall in housing followed by dips in consumption, employment and income.

Going into the recent economic contraction, policy had already begun to ease, nominal interest rates were low and inflation showed little sign of becoming a problem. The low-interest-rate environment provided a favorable climate for housing, and individuals also took advantage of the low rates to refinance their mortgages. In the process, they took substantial equity out of their homes, some of which was used to support further consumption.

Photo of Bob Eisenbies

Other important differences in this economic contraction included the collapse of the dot-com euphoria, the precipitous decline in corporate investment (both in structures and in equipment and software), the contraction in inventories and in manufacturing.

Also, what did not happen in this contraction was the usual decline in housing or slowdown in consumption. For this reason the U.S. economy is not likely to get a boost from either of these components as it begins to turn around.

The more likely scenario is that there first will be a rebound in business inventory investment. The reason is that, given the high level of demand, the contraction in inventories can’t continue forever without inventory-sales ratios — already near all-time lows — falling to unsustainably low levels. As a result, business will have to restock, and this effort will add a significant component to output.

The key question in looking forward is, will this increase in output be sufficient to increase corporate profits and stimulate investment, or is it simply a one-off event that will be followed by a double-dip slowdown as many economists have suggested?

The bottom line
In all likelihood, the U.S. economy bottomed out in the first quarter of 2002, and the expansion will soon be under way if it isn’t already. The keys to the economy’s recovery path will lie in the short-term outlook for inventories, the profit picture and corporate investment. It is important to understand that the recovery’s path is likely to be more gradual than in past recessions because of the prospects for consumption and residential investment described earlier.

Unfortunately, there was little information in the first quarter 2002 real gross domestic product estimate to provide a clearer understanding of the potential path of the expansion. Although April retail sales data released more recently were especially strong, consumption actually moderated slightly in the first quarter. Residential real estate was essentially flat, and subsequent data suggest that housing has slowed. Finally, while the pace of inventory liquidation slackened, there is still no sign that businesses have begun to accumulate stocks of goods.

At this point, one can only wait for signs that activity has increased and see whether forecasts hold up.

By Robert A. Eisenbeis, senior vice president and director of research
of the Federal Reserve Bank of Atlanta

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