August 17, 2001

Finally, some good economic news is beginning to surface.

The plunge in consumer installment debt for June suggested that the falling stock market and rising unemployment were beginning to exhaust the consumer. When the July auto sales fell by more than a million units at annual rates from June, it appeared that consumers were about to throw in the towel.

With inventories still correcting, capital spending plunging and the world economy slowing sharply, a plunge in consumer spending would certainly send the economy into recession.

Indeed, sharp downward revisions in consumer spending during the spring and in inventory investments may push GDP into negative territory when the spring data are revised later this month.

Fortunately, consumer spending is holding. Even with the dip in auto sales during July, retail sales were unchanged. Excluding autos, sales grew 0.2 percent.

While these do not appear to be stellar returns, about a half percentage point was knocked out of sales by declines in gasoline station activity. This was because of price declines, as the consumer price index clearly showed.

Because of the largest plunge in gasoline prices since 1986, consumers actually experienced deflation during July. Adjusted for these price declines, consumer spending probably will record more than a healthy 3 percent annual growth rate in July.

However, the good inflation news was not limited to plunging energy prices. Excluding a surge in cigarette prices, inflation other than food and energy grew less than 2 percent at annual rates during July. For the past three months, this core rate of inflation has averaged an annual gain of 2.4 percent, and that includes the surge in cigarette prices. This suggests that inflation will be subsiding for the remainder of this year.

Indeed, earnings after adjustment for price change showed their first meaningful gain in almost two years. Even before the tax rebate checks, the average consumer was leaving the gasoline station with a few more dollars in the pocket than earlier in the year.

It now appears that inflation will be less than 2.5 percent for the twelve months of this year and may be growing at even a slower rate than that as the year ends. Unless a whole bunch of people are dumped on the unemployment roles in the next few months, consumer purchasing power will support consumer spending of more than 3 percent.

Even the industrial production report had some good news. The smallest decline in industrial activity of the year developed in July, although seasonal distortions might have improved the report. A little back sliding is likely in August.

Of more significance was the slowing in capacity growth. Normally, stronger gains in capacity are desirable. However, with capital spending plunging, this economy needs to see some growth in capacity utilization before businesses will resume their purchases of new equipment. This slower growth in capacity along with the better consumer spending patterns shortens the time when capital spending may begin rebounding. (A rebound must wait until sometime late in 2002, but some capital spending recovery by that time now appears to be more likely).

None of this means that sluggish growth is over. The world economy continues to slow. Unexpected reductions in our sales abroad early next year are increasingly possible. Furthermore, one month does not make a trend.

The Federal Reserve should recognize that slower inflation provides further leeway to cut interest rates. I expect that they will make further rate reductions this week and probably leave the door open for more possible interest rate cuts if activity remains sluggish.

Still, a glimmer of hope for improved economic conditions has appeared. Even if investors remain skeptical, economic forecasters outside Wall Street (where earlier optimism was unfulfilled) may have seen the first signs to justify optimism for next year's economy.


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