August 6, 2003

Policy mix boosts growth but not jobs

By James W. Coons

The second-half has finally arrived.

Since late 2001, forecasters have been predicting an economic revival starting in six months. After more than a year and a half, the elusive rebound finally appears to be at hand. The powerful policy mix of low interest rates, a large federal budget deficit, and a weaker dollar will promote much faster economic growth starting in the current quarter. The lift in employment that we have been waiting for will take longer.

This is, of course, yet another forecast that things will be better in the future. But after being singled out by the Wall Street Journal in January 2002 for having an especially gloomy economic forecast and being vindicated by the subsequent course of events, I feel free to preach revival now that the future has arrived.

In fact, the recovery from the 2001 recession technically has been underway for some time. The economy has increased in size each of the last seven quarters by a total of 4.6%. That’s a measly 2.6% at an annual pace – well below the long-run potential of close to 3½% and not enough to cause firms to expand employment. Yet it is a distinct reversal from the cumulative decline of recession.

In response to the sustained, if still disappointing, growth in output, the National Bureau of Economic Research proclaimed last month that the recession officially ended in November 2001. The Business Cycle Dating Committee of the NBER is widely recognized as the authority on recessions. The Committee also cited growth in personal income and industrial production as indicating the end of recession.

It still feels like recession to many, though, because businesses continue to cut jobs faster than they create them. Total employment has decreased in each of the last six months by a total of almost a half million workers. In Ohio, the number of jobs is down by more than 150,000 from two years ago and the unemployment rate roughly matches the elevated rate at the national level.

In both cases, manufacturing is ground-zero. The imperative to cut costs leads to productivity-enhancing investments and outsourcing overseas. Both actions reduce manufacturing jobs in the U.S.

According to Anirvan Banerji, director of research at the Economic Cycle Research Institute in New York, the extended period of job loss is due to an unprecedented shift of manufacturing jobs from around the world to China. And as Bruce Springsteen put it, “They ain’t comin’ back.”

But at the same time, broad leading economic indicators point to faster economic growth. Stock prices are more than 20% higher than in March and are headed for the first calendar year gain since 1999. The spread between long-term and short-term interest rates – the single most reliable leading economic indicator – remains very positive by historical standards. Commodity prices are rising rapidly almost across the board and corporate profits are improving.

In Ohio, the leading index for the state economy compiled by the Bureau of Labor Market Information has managed a small gain during the past six months, following a two and a half year decline.

Most impressively, ECRI’s weekly composite leading index for the national economy has posted its biggest increase since the beginning of the 1990s economic expansion. The index is the combination of seven indicators, such as mortgage loan applications, bond yields, and jobless claims, that move in advance of overall business conditions.

The reason for believing the signs this time is the stunning mix of economic policy stimulus from tax cuts, federal government spending increases, low interest rates, and a weakening dollar.

The budget deficit will approach 5% of gross domestic product this year – the largest since the beginning of the long, strong economic expansion of the 1980s. Short-term interest rates are effectively zero after inflation, and Federal Reserve officials have pledged to keep them down for an extended period. Finally, the 15% to 20% declines in the value of the dollar against major currencies are tilting the playing field ever so slightly in favor of domestic production instead of imports.

Policy makers have concocted a powerful mix of economic stimulus that is finally taking hold twenty months after the end of the recession. Unfortunately, labor markets might not revive as quickly as is widely expected.

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