November 27, 2002


When Federal Reserve Chairman Alan Greenspan said that the United States hit a "slow patch," was this unusual or something that often happens in the early stages of an economic rebound?

Let us review the dimensions of this slowing. Employment is falling and so are weekly hours. Industrial production fell for the third consecutive month. Retail sales were unchanged following a deep drop in the previous month. Business sales and personal income less transfer payments are down when adjusted for modest price gains.

Furthermore, the leading indicators have a string of consecutive declines behind them. If the stock market had not begun to rally from its October 9 lows, most economists would worry about the onset of renewed weakness.

Frankly, the dimensions of this "slow patch" are unusual. My measures suggest that GDP actually declined in October and will show only modest gains for the fourth quarter. My estimate of Christmas sales is only 3.5 percent growth, well short of the 5.6 percent gains reported last year.

Nevertheless, a pause after the first burst of rebound is not unusual.

Whatever initiated a typical recession, falling paychecks ultimately push spending below production, and inventories jump. To remove those inventories, production lines are turned off while goods are sold from the warehouses.

Once the warehouses begin to empty, production slowly picks up. This normally leads to overtime hours and some renewed hiring. The result is rising purchasing power along with higher production. Indeed, this early phase of a rebound usually shows above normal rates of growth. (Five percent GDP growth in the first quarter of 2002 was the result of this process.)

At some point, the amount of inventory, current production, and sales are restored to some balance. This is normally where a rebound suffers a pause.

Also, recessions normally cause consumers to delay replacement of autos and appliances. Housing slows because falling paychecks more than offset falling mortgage rates. When the recovery begins, these deferred purchases reappear. Thus, housing and auto sales usually are still surging upward when inventories are restored to balance with sales.

Thus, the pause in industrial activity usually is not very long.

Because of aggressive interest rate reductions during the latest recession, however, autos and housing began rebounding even while paychecks were falling and inventories were spinning out of balance. By the time the pause caused by restoration of inventory balance occurred, housing and autos were stabilizing from their own rebounds.


Of course, the interest rate declines shortened and diminished the magnitude of the recession, but it also lengthened and intensified the pause after the inventory rebound. That is where this economy is now.

Can the pause undermine confidence and push the economy back into recession. This did occur in 1960 (following the 1958 recovery) and 1982 (after the 1980 plunge and rebound). However, both those "double dips" were accompanied by restrictive government spending policies and monetary restraint.

With government spending up 8 percent in the past year, money growth near double digit rates, interest rates at 40 year lows, and $130 billion of reduced tax liability facing households in the past year, this is not likely to develop into another "double dip."

Certainly, the Federal Reserve was concerned about just that prospect when they pushed their interest rate targets down another half point. Just like me, they must have found this "soft patch" too squishy for their tastes.


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