Comments: William C. Dudley
Chief US Economist, Goldman Sachs
How bad will the recession be in terms of its depth, breadth, and duration? Importantly, how does this downturn differ from those in the past, and how will those differences affect how this recession will play out?
The recession is l ikely to be mild, but about average duration in terms of length. It differs considerably from the past in that it is a "business-led" recession., generated mainly by the consequences of an investment boom/bust cycle and the accompanying decline in equity prices. The profit squeeze for business has been intense. This has led to aggressive cost-cutting that has contributed to rising job layoffs. The recovery is likely to be moderate in intensity, given still significant imbalances in the private sector (low household saving rate and still-wide corporate financing gap) and the fact that the interest-rate sensitive sectors are already at high levels of activity.
Capital spending has borne the brunt of this slowdown/recession. Can the economy mount any meaningful recovery without a significant pick up in capital spending? What are the influences underlying your outlook for business investment next year?
We would not expect capital spending to revive quickly or powerfully for two reasons. First, the contraction in investment is appropriate as it corrects an overshooting that occurred in 1999 and early 2000, especially in the tech sector. Second, capital spending is rarely an early-cycle sector. With profits depressed and capacity utilization rates very low, capital spending is likely to stage only a mediocre recovery in the second half of 2002.
The Fed has lopped off 450 basis points in 11 months. What are the signs that easier policy is working its way through to the real economy? Is there some structural blockage, or should we just be patient? What kind of headwinds are policymakers up against?
Monetary policy is not as powerful as usual for two reasons. First, when the Fed started to ease, the interest rate sensitive sectors of the economic were not depressed. Thus, the Fed is getting less lift from this source. Second, and more importantly, despite aggressive Fed easing, financial conditions have not eased much. For example, the Goldman Sachs Financial Conditions Index has eased by only about _ point since the Fed began easing. This is much less than typical. The problem is that financial markets have not been cooperating with the Fed and this is blunting the transmission mechanisms of monetary policy. Stock prices have declined this year and the dollar has appreciated slightly. Moreover, long-term rates have barely budged as the yield curve has steepened sharply.
Copyright 2001, Bloomberg L.P.
