TCS Daily


Sitting Pretty Through the New Economy's Recession

By Kevin Hassett - July 3, 2001 12:00 AM

Good news has been, as the old song goes, busting out all over. As mentioned in the previous Digital Green Book column, theory suggests that the economy should be nearing the bottom. The data, however, were not cooperating until very recently.

How bad was it? The day before the last Federal Reserve meeting, I was certain that the Fed would have to lower interest rates by a point. The bad news side of the economic scale was just too heavy. But the day of the Fed meeting, the sun began to shine again. The Advance Durables release for May was surprisingly upbeat. Durable goods orders jumped 2.9 percent, about five times the expected increase. Given such a large swing, the Fed was right to only cut rates a point. The recovery could well be on the way.

The news since then has been even more upbeat. Jobless claims dropped sharply, indicating that the labor market is no longer in free fall. Housing activity remained robust. Consumer confidence ticked up, and yesterday [July 2], we learned that consumer spending and income in May stayed healthy. As an economist who has been buried in the data during these troubled times, I now feel a little like I do after a hot sauna followed by an ice bath. Getting to this point was pretty painful, but I feel refreshed and optimistic.

Of course, we do not know that the good times are here again, but if they are, why did things feel so much worse than they were? The May data have been strong enough that it is likely that we have not even had one negative quarter.

What then explains the near universal, Chicken Little-style panic? The best theory I can think of is that the culprit is our old friend the new economy. Heres why. Last year at this time, the major developed nations were growing at an annual rate of about six percentage points. Today, they are growing at a rate that is close to zero. That decline in growth of six percentage points is about the sharpest growth decline on record for a post-WWII, developed-country economy! No wonder we feel so depressed.

In the past, the economy would hum along at about 3 percent growth near the end of an expansion, and then drop to 1 percent or 2 percent growth in a recession. This time around, the growth rate sank even more, but the economy did not contract because it started from such a high level. We are so used to a soaring economy that doldrums feel like catastrophe.

If the current scenario continues to play out, and the economy rebounds sharply in the second half, then our views about the new economy will solidify somewhat. The information technology revolution increased productivity and streamlined operations significantly, but not enough to stop fluctuations in the growth rate of the economy. When an oil shock hit, as it did last year, we experienced something like the normal level of economic distress. The level of growth, however, was so much higher that significant economic disruption was not enough to push the economy into a traditional recession. In other words, growth stayed positive.

So in one sense we have just lived through the worst of times. The growth rate of the world economy dropped more sharply than it has in the past. On the other hand, the lowest growth rate we reached was comfortably above the recession range. It was both the best and the worst of times.

There is pain when economic growth is lower than expected, and the new economy has raised our expectations so much that low positive growth induces near panic. But relative to the higher baseline, maybe we did just live through a new economy recession - a period when things stop being absolutely wonderful for a short while.

Which brings to mind a final thing to look for that will tell you that the new economy view has become the standard of the economics profession: when the National Bureau of Economics Research, the nonprofit research organization that calls recessions, revises the definition of recession in order to make this year look like one, even if growth stays positive. Then the new economy team has won the debate.
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