September 14, 2001
In the end, economics is about the well being of individuals and economies. This week's dastardly terrorist attacks have destroyed a lot of laughs, hugs, warm moments, and periods of joy that many of our fellow Americans no longer can enjoy. I cannot begin to value the significance of that loss.
As an economist, however, it is my responsibility to determine what the attacks mean to the economic environment in the months ahead. Is recession now inevitable? Will stock values plunge, destroying consumer confidence and investment initiative? Was the World Trade Center the elusive ball bearing plant of our economy that Osama bin Laden's operatives believed eight years ago when they tried to blow it up?
(In World War II, the strategic bombing planners believed that if a certain ball bearing plant could be destroyed, Nazi Germany's economic machine would grind to a halt? Bin Laden has been reputed to believe the same thing about the now destroyed World Trade Center.)
Those economists who have declared that nothing has changed must be overlooking the tens of billions in assets and even more in the economic value of human talent that were destroyed by the attacks. Our economy has been damaged.
Not only are there fewer productive resources, but the efficiency of our economy will be impaired by these losses. A decline in stock market values would be appropriate to reflect this loss.
However, electronic communications, off site storage, contingency planning, and the resilience of our economic system all suggest that the loss will be contained and eventually overcome. There is no critical asset whose destruction will cripple our economy. That ball bearing plant does not exist.
We have lost consumer sales as people have been glued to their TV sets. This happened in 1991 when the attack began against Iraq. Most of those sales were recovered in the following quarter.
We have lost the use of airplane seats, hotel rooms, restaurant places, convention services, as air transportation has been grounded to discover the security lapse that allowed terrorists to use our system as their weapons. Some of that loss will not come back quickly.
We will need to pay more for security, either in actual expenditures or in time costs and air cabin convenience. This will raise the cost of travel, probably impairing its growth.
There will be some subsequent economic gains as we rebuild the assets that were destroyed and add to our defenses and responses to terrorism. However, until we know what must be done and get it done, uncertainty will persist.
Fewer assets, less efficiency, more security costs, transportation disruptions followed by rebuilding and defense spending suggest that our economy will weaken more than expected in the third quarter and into the fall. Then we should rebound more than originally expected early next year.
Unfortunately, the lost efficiency also means higher inflation, but the magnitudes should not be large. This means that long term interest rates will drift upward next year. However, fears that economic weakness could spread around the world will spawn substantial liquidity. Thus, short term rates probably will be lower than originally expected, at least early into 2002.
When I put all the pieces together, my forecasts of inflation adjusted GDP have changed from a gain of 0.7 percent in this quarter to a decline of 0.5 percent. My fourth quarter forecast is less than 2 percent growth, down from about 2.5 percent. However, growth in excess of 3 percent could develop as early as the spring of 2002, earlier than originally expected.
Consumer prices might grow almost 3 percent next year instead of the 2.5 percent I originally thought. The Federal Reserve probably will lower short term rates another half point very soon and then stop their declines.
I would be more worried that the disruptions could undermine our economy if the banking system was struggling. Certainly, the asset losses will tax the insurance industry, but few financial failures are expected.
We probably will never forget these latest terrorist acts, but any economic havoc that they spawn will be a rapidly fading memory before the middle of next year