Comments: Kevin Logan
Senior Market Economist, Dresdner Kleinwort Wasserstein
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?
It lasts four quarters. It will not be as deep as most recessions due to the more rapid and forceful monetary and fiscal policy changes designed to stimulate demand. It will be broad, affecting most industries (with the possible exception of health care). Unlike many recent recessions, this one has been caused not so much by restrictive monetary policy, but by a massive drop in profits and in investment spending. Growth in investment spending ran well ahead of the growth in profits in the late 1990s and up until 2000. The decline in corporate profits since mid-2000 is now leading to a very sharp decline in desired and actual levels of investment spending. Since profits will rebound modestly, at best in 2002, investment spending is likely to contract for several quarters before stabilizing. This means that the recovery form recession is apt to be slow.
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?
It's not likely that a strong recovery will take place without some pickup in investment spending. The most important influence on investment spending should be the level of and the change in corporate profits. Since the level of profits in 2002 is likely to be lower than it was in 2000, and since the growth of profits is likely to be anemic in 2002, aggregate investment spending is likely to decline. Other important factors include the dollar's exchange rate (a negative), capacity utilization (a negative) and interest rates (neutral).
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?
We should be patient. Lower interest rates have already lowered financing costs for most businesses and prevented an even greater decline in profits. There is no structural blockage, just a lack of growth in profits. Businesses were, by and large, too optimistic about the expected growth in profits. They over-invested in new capital equipment. Now the capital stock has to be adjusted down to fit the likely future growth in demand. That implies a period of reduced investment spending and the elimination of some existing capital through depreciation (and closure of some capacity). The headwinds are low capacity utilization and slow growth in corporate profits.
Copyright 2001, Bloomberg L.P.
