May 21 , 2003

In the past three months, the U.S. economy has lost more than half a million jobs.  The average worker who still has a job has seen the weekly paycheck grow only enough to pay the higher prices for energy.  State and local governments remain about $38 billion short of balancing their collective budgets, although tax increases, wage freezes, and spending cuts have begun to close their constitutionally mandated gap between revenues and spending. 

If I did not know better, I would say this is a prescription for the beginning of a recession.  Yet very few economists, including myself, are willing to draw that conclusion.  There are two reasons for our optimism:  stimulative policies and inherent dynamics. 

The stimulative policies are easy to see.  Most homeowners have repeatedly lowered their monthly mortgage payments by refinancing their mortgages.   Furthermore, the lower cost of financing as a result of lower interest rate targets is beginning to create profit growth for corporations even if no revenue growth is to be seen. 

On the budgetary side, federal spending has been growing almost 9 percent after adjustment for inflation as home security, armed conflict, and new health and education initiatives have preserved strong spending growth.  At the same time, tax cuts have lowered the amount of each dollar earned that is kept by working households. 

To be sure, the timing of these tax initiatives has not been ideal.  The initial $130 billion annual reduction in tax liabilities did blunt the magnitude of the downturn, but an early rebate actually led to reduced tax stimulus as the recovery stalled.  Now, arguments about the form of tax cuts is preventing the reality of reduced taxes from pushing withholding down.  Most of the forecasts assumed that about $80 billion of further annual reductions in tax liability already would be aiding households by the end of June. 

Although any tax reductions probably will be retroactive to the first of this year, their form will not be known until right before Congress adjourns.  Moreover, most taxpayers wait until they see the reduced burdens before they begin to spend the proceeds.  Thus, stimulus from reduced tax liability may not begin surfacing until the spring of next year. 

Despite these timing difficulties, there will be economic stimulus from tax reductions, and they will be needed.  Therefore, the monetary and budgetary policies are largely supportive of economic growth.  This normally leads to some expansion of economic activity with the year that some positive policies are put into place. 

Even so, I would not be looking for strengthening growth in the second half of this year if the conditions were not right for such a rebound.  Too many inventories signal recessions.  When inventories are lean, as they are now, only the smallest improvement in sales can lead to strong gains in production.  Conversely, no inventory overhang is leading to order cancellations.   (A little bit of retail excess developed after weather removed the Presidents' Day sales, but that excess sales stock was quickly removed after the snows melted). 

There clearly is little need for a surge in housing activity.  Pent of demand has long since been met.  However, the low monthly payments for home ownership are pulling households out of rental units.  This will create some problems for apartments, but more resources are used to meet the housing need of the home buyer.  Housing will not fall until interest rates rise, and that requires significant economic strength elsewhere. 

Consumes clearly have little pent up demand either.  Credit has been available and auto and furniture sales have been strong.  Indeed, some economists believe that the consumer has been so responsive to incentives that they have too much debt to sustain current levels of spending.  If the size of debt was the most important factor, debt burdens would be a concern.  However, lower month payments mean that the percentage of the monthly paycheck needed to pay those credit bills has been falling;.  A smaller percentage of monthly is needed for bill repayment than last year or the year before that. 

While I have explained away forces that others have used to argue for further economic weakness, where do I find these inherent dynamics that lead to economic strength. 

While corporations were waiting for revenue growth , the capacilities of the computer softer, office equipment and production facilities  continued to improve.  Many IT officers know that they can lower their costs and hold their budgets at the same time. 

To be sure, there is too much capacity.  Also, weak performance has reduced the availability of capital for many companies.  But even here, inherent dynamics are working.  Falling interest charges are slowly lowering the finance charged need to maintain prevailing acitivty.  This is beginning to release resources for cost savings investment.  Much of this equipment pays for itself in cost containment in a year or less. 

Once the sales begin, then higher orders will add to credit opportunities.  Slowly but surely, spending will improve and so will the credit quality of corporate American. 

When capital spending si growing (unfilled orders began growing last month) some jobs will be generated.  This will push upon demand for other goods.  Only after growth becomes unsustainable, as it periodically does, will such spending support create any concern.  In the meantime, This economy is looking for opportunities to improve, not ones to dump people.  And even that suggests that strengthenng rather than weakening growth is likely in the second half of this year. 


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