President's Message: Recession Fears May Be Overstated

William Poole

Every day I am struck by how quickly our Information Age society tends to jump to conclusions. I'm speaking of the recent predictions of economic recession.

While each of us has our own definition of recession, a popular rule of thumb is two consecutive quarters of negative real GDP growth. But since most everyone uses the business cycle chronology established by the National Bureau of Research (NBER), let's go with its definition: "a significant decline in activity spread across the economy, lasting more than a few months."

Such definitions, of course, don't sway the person who has recently been laid off, or whose 401(k) just plummeted. Indeed, if economic growth drops from a 4 percent rate to a 1 percent rate, we may all be excused for feeling like we're in a recession—even as the economy continues to grow.

Although economic conditions appeared to deteriorate quickly, some factors were already working to slow growth from its unsustainable pace of late 1999 and early 2000. One key factor was ballooning energy prices. In about one year's time, energy prices nearly tripled, causing consumers (and firms) to shift more of their expenditures toward home heating and gasoline. With the vibrancy of domestic demand sapped, sales waned and unwanted inventory buildups occurred, particularly in automobiles, leading firms to start slashing costs, including payrolls. As profit opportunities dwindled, stock market valuations, mainly in the information technology sector, headed downward. In response, firms cut back their capital investment spending significantly, especially in computer and other high-tech equipment, which had been an important driver in our record-setting expansion. Expenditures on computers and other high-tech equipment were further weakened by the shakeout.

Not all the news has been bad, however. Nonfarm payrolls actually rose 343,000 during the first quarter, and energy prices have abated recently. Based on this evidence, can I predict with certainty that our economy won't head into recession? The graveyards of economists who claimed they could predict the onset of recessions are numerous, and I'm not quite ready to join them. The NBER primarily looks at industrial production and employment in determining the beginning and end of economic expansions. In my book, though, two other things make me confident that recession fears are overstated: the housing market and monetary policy.

Monetary policy has been quite expansionary. The two aggregates I watch most closely, M2 and MZM, grew at estimated rates of 11.2 percent and 19.9 percent, respectively, in the first quarter. Meanwhile, the Federal Open Market Committee has reduced its target federal funds rate by 200 basis points since January. While falling interest rates should boost interest-sensitive sectors of the economy, some of these sectors, like housing, are already doing reasonably well. For example, sales of existing homes, as well as housing starts and permits, are all performing at or above fourth-quarter 2000 levels.

So if we're headed for recession, it's going to be one that breaks the mold.


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