Recessions aren't built to last

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The Independent Online

Recessions are a lot more exciting than expansions. After all, what economies normally do is grow steadily year after year. The US economy did just that for 10 years until March 2001, the date just decreed to have been the peak of the cycle by the National Bureau of Economic Research, and the longest expansion recorded.

The very word we use to describe the pattern of expansion and contraction in every economy is misleading. "Cycle" sounds regular, but every cycle is different, and recessions are always shorter than the expansionary phase. In the seven business cycles since 1945, the average US recession has lasted 11 months (though some have been as short as six months) and the average expansion has lasted 43 months (though the latest was 120 months). As the NBER puts it: "Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades."

Boring, isn't it? If the current recession in the US lasts as long as the previous longest post-war downturn, it will be over by the middle of next year.

It isn't that recessions are insignificant. On the contrary, they can be very painful. But the statistics should give us a sense of perspective. A Great Depression (which lasted almost four years from the previous peak to its trough) is a once-in-a-century event. So it is of course possible that this time we are in for a repeat, and that is what some commentators seem psychologically ready for, but it isn't likely.

The report of the NBER's business-cycle dating committee explains that they look for evidence of a significant decline in activity spread across the economy and lasting for more than a few months. In their judgement, the call was impossible to make until figures for October showed a drop in employment and a big fall in industrial production. In other words, despite all the recession warnings earlier in the year, the evidence was not there before the 11 Septem- ber attacks. These "may have been an important factor in turning the episode into a recession", the committee comments.

Comparing this recession with previous ones, it is manufacturing output that is leading the economy down. As the chart shows, the slide in output began earlier and has been steeper than is typical. On the other hand, personal incomes (in real terms) are holding up better than usual, mainly because sharp drops in the price of imports are boosting consumers' purchasing power.

Economists are unanimous in expecting a second quarterly drop in GDP in the final quarter of this year. But other indicators are important for predicting further ahead.

Pessimists tend to base their forecasts of a deep downturn on analytical considerations. Some think the stock market is still overvalued, based on how far away it still lies from historical averages for the risk premium or the replacement cost of capital. Others believe growth in consumer spending will have to be curtailed sharply because of the low savings rate and high debt levels of American households.

It is also possible, as it has been for years, that the dollar will plunge and at last start to turn around the yawning trade deficit, which has required the US to suck in capital from the rest of the world. In that case, higher import prices would undermine purchasing power and perhaps force the Federal Reserve to raise interest rates if the result was increased inflationary pressure.

Those who are less pessimistic have to admit these are all valid concerns. Like any economy, the US has its imbalances, and it does them bigger than anywhere else. So eventually harmony will surely be restored by a smaller trade deficit, lower consumer borrowing and a smaller govern- ment budget surplus. But as the old econo- mists' joke goes, this might be right in theory but it doesn't work in practice. For it is possible to spot rays of hope in the gloom.

One is the huge turnaround in monetary and fiscal policy compared to last year, which is being supplemented by the helpful drop in oil prices. Given that bad monetary policy is now believed to have been the main reason a recession in the 1930s turned into the Great Depression, this is important. The Fed has reacted impeccably to events in the past year, and even though the collapse of Enron has unveiled some terrible lending decisions, the banking system is not showing signs of strain.

Manufacturers have cut their inventory levels every month since January – destocking was a large part of the reason for the fall in third-quarter GDP – so while the ratio of inventories to sales will need to fall further, businesses are clearly trying hard to get into a position from which they can expand again.

Consumers will eventually reduce their debt mountain, but their housing wealth is intact, their stock-market wealth is no longer falling, and low prices mean their buying power is buoyant. Unemployment is rising, and will for some time after the trough of the business cycle. But even so, the correction can happen slowly.

That the recent evidence has been mixed is itself a sign that the US economy is not in freefall. In the early stages of a recession, and given the horror of recent events, this is rather encouraging.

These are not times to be downright optimistic. Being at war is never fundamen-tally good for an economy, and only a brave person would put aside all fears of future terrorist attacks. But things could be a lot worse, and it is possible to see a day when they start getting better. For, as the NBER's records show, recessions might be dramatic and interesting but they are not the natural state of the economy.

Diane@enlightenmenteconomics.com

For details of the NBER's business-cycle dates, see www.nber.org/cycles.html

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