- The Washington Times - Friday, May 29, 2009

ANALYSIS/OPINION:

COMMENTARY:

The Great Recession is over. That’s a hard proposition to swallow when the gross domestic product is contracting at a rate of 6.1 percent and unemployment is still climbing. But that is old news. There are abundant signs that the economic bottom has been reached.

Take the GDP statistic, for example. Behind the headline number is a solid foundation for optimism: Consumer spending was up an impressive 2.2 percent. What dragged the GDP number down in this year’s first quarter was a sharp reduction in inventory and equipment investment and a 4 percent drop in government spending. We know we won’t see another drop in government spending anytime soon, thanks to the massive stimulus bill ($787 billion) and budget ($3.5 trillion) Congress has approved. Also, businesses can’t keep drawing down inventories if consumer spending - which accounts for 71 percent of GDP - keeps rising.

The end of a recession doesn’t mean GDP suddenly booms. It simply means GDP stops contracting. The math for the current quarter (April-June) looks extremely promising. If business investment (11 percent of GDP) declines by just another 20 percent (rather than 51 percent as last quarter) and government spending (20 percent of GDP) is merely flat, GDP registers positive growth. With increased government spending (a sure thing) and flat business investment (a good possibility), GDP growth begins to look very good.

Are these calculations fueled by false optimism? If you look back at the early stages of the Great Depression, there was lots of false optimism. In the wake of the stock-market crash, President Hoover asserted the U.S. economy was “on a sound and prosperous basis.” Merrill Lynch was touting “bargain” stocks. Such false optimism also was evident in early 2008, when Federal Reserve Chairman Ben S. Bernanke assured Congress there would be no recession that year. President Obama scoffed at such optimism. Indeed, he was the president of pessimism - warning of another Great Depression - until Congress passed his massive stimulus program.

The Great Recession of 2008-09 was never in the same league as the Great Depression, of course. In fact, the current recession was not even “great” by modern standards. There have been 12 recessions since World War II. In nine of those recessions, the GDP decline was steeper - often far steeper - than the 2008-09 contraction. Unemployment is still a full 2 percentage points below the 1981-82 peak. So the current recession hasn’t been markedly different from the norm, not withstanding Mr. Obama’s hyperbole.

What is different about this recession are the policy responses. At the outset of the Great Depression, the president was trying to balance the federal budget and the Fed was reining in the money supply. At the outset of the 1980-81 recession, the money supply was tight and the president-elect was railing against “massive” deficit spending.

We are in a dramatically different policy environment now. The Fed has opened the monetary floodgates and driven short-term interest rates down to nearly zero. And Congress has authorized a massive increase in government spending.

Will all this monetary and fiscal stimulus work? Absolutely. Former Fed Chairman Alan Greenspan had a nice formula for computing the spending response to interest-rate cuts. Every basis-point reduction in long-term rates triggers a $10 billion spending response. Rates have fallen by roughly 16 basis points since early 2008. So that’s $160 billion of additional spending.

The timing is critical. Economists have documented a 12- to 18-month lag between the start of monetary easing and the spending response.

When rates start falling, market participants don’t rush out to borrow and spend. They instead wait to see how far rates will fall. Only when they’re convinced that interest rates have bottomed out do they take on new debt. That’s what you’re seeing in the housing market now. It’s not a coincidence that home sales and refinance activity are showing signs of life 12 to 18 months after the monetary easing began.

Consumer spending also is being buoyed by the drop in oil prices. Remember the hysteria of last summer? With oil at nearly $150 a barrel, consumers were spending a lot of money on gasoline and energy. With oil down to the $50-per-barrel range, consumers have another $140 billion to spend on other products. Consumer incomes also have been sustained by November’s extension of unemployment benefits.

Notice that the pickup in consumer spending has nothing to do with the Obama stimulus package. The monetary stimulus was in the pipeline before Congress started debating a fiscal “rescue,” and the oil-price plunge had occurred already as well.

So, while Mr. Obama sees “glimmers of hope” in the post-stimulus economy, those glimmers are a reflection of past policy, not current policy. The Congressional Budget Office has observed that just 20 percent of Mr. Obama’s infrastructure “stimulus” will occur this year despite photo-ops of “shovel-ready” projects. And no one will make impulse purchases with “Making Work Pay” tax cuts dribbled out at $8 to $13 per week. The Obama stimulus package will boost spending, but not before the recession is over.

Aside from economic theory and GDP math, is there hard evidence that the recession is over? The first-quarter uptick in consumer spending is the most important signal. Encouraging data on first-quarter retail sales and recent pickups in consumer confidence point in the same direction. Then there is the significant reduction in initial jobless claims over the past month. There’s also the dramatic increase in pending home sales, accompanied by higher prices in California and other important areas. The April surge in the stock market also is a sign of heightened expectations that may translate into increased investment.

If the recession has ended, we still face economic problems. Unemployment will continue to rise for a while until businesses feel confident enough to start hiring again. With the labor force growing at 1 percent a year and productivity at 2 percent, GDP must grow by 3 percent before unemployment starts declining. Credit flows still will be restrained, too, especially for small businesses.

As GDP growth resumes, we’ll have to pay more attention to the risk of overstimulus and resurgent inflation. But at least we’ll be able to say we survived yet another short-term recession. Government statistics don’t reveal recessions until months after they begin, nor do they register a recession’s end until months after the fact. Clearly, the stock market isn’t that patient.

Oh, and if I’m wrong? We’ll have to reprint this column next quarter. Beyond that point, even the Obama team sees buoyant growth.

Brad Schiller is an economics professor at the University of Nevada at Reno and author of “The Economy Today” (McGraw-Hill, 2008).

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