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?
This recession will last a little longer than the post-war average of 11 months and be a little less severe than the average 2.2% peak to trough decline in real GDP. We expect this recession to last 12 months and be about as deep as the last recession, with a 1.5% peak-to-trough delcine in output. This is very much an business-investment-led recession, rather than a housing-market-led recession. Investment in equipment and software is now 12% of real GDP, compared to 6% in the last recession, while housing has remained close to 4% or output. Business investment tends to lag in a recovery, housing to lead. In this cycle, that is reversed. However, business investment will come back slowly, prolonging this recession. The housing market has held up remarkably well, helping to keep this a mild recession. The tax cuts and spending increases will also help make this a moderate recession.
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?
The housing market and consumer spending will lead the recovery, business investment will follow. Growth will only reach the robust rate of 4%, quarter-on-quarter annual rate, after business investment begins to grow in the second half of 2002. Corporate tax cuts and improved profitability from cost-cutting will provide the means to turn around business investment.
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?
Patience is required. In a business-investment-led recession, interest rate cuts are less effective because businesses are slow to respond to lower finance costs with increased investment. They are quick to respond to an improvement in demand. The rate cuts have helped to sustain housing investment in the face of rising unemployment, making this a mild recession so far. When housing responds and consumers stop cutting back on purchases in the middle of next year, business investment will turn around.
Copyright 2001, Bloomberg L.P.
