Shape of the downturn: V or U?

Alan Greenspan sounds less gloomy about slowdown, but hints at further easing of interest rates nonetheless.

After months of gloom about the US economy, a growing number of economists are now saying the downturn could be relatively short and quick.

Call them members of the "V" school. They believe the swing may turn out to be as sharp on the upside as it has been the past few months on the downside.

While others continue to adhere to the "U" theory - that the recovery will be slow in coming - the optimists have gotten a boost from a significant source: Alan Greenspan.

The Federal Reserve chairman, who in recent months has been sounding like a Cassandra, told the Senate Banking Committee yesterday that the "exceptional weakness" so evident in a number of economic indicators late last year apparently didn't continue in January.

Even so, Mr. Greenspan hinted that a further cut in short-term interest rates is coming. This would follow two half-percentage point cuts in January. "Downside risks predominate," he said.

In total, his remarks were relatively cheerful. And he forecast that over the entire year, inflation-adjusted Gross Domestic Product would grow 2 to 2.5 percent.

That is about the same as the consensus forecast of some 50 economists polled earlier this month by Blue Chip Economic Indicators. Their average growth forecast was 2.1 percent.

Like the Fed, economists, financial markets, and even politicians are watching with some suspense to see if the present slump in the economy is merely a slowdown, or a full-fledged recession with national output actually shrinking for six months or so. And they are debating the shape of the recovery.

"Issue du jour," notes Stephen Roach, chief economist of Morgan Stanley & Co., a large investment banking firm based in New York.

The "V" team made some ground yesterday when the Commerce Department reported a strong 0.7 percent jump in retail sales in January, the biggest gain in four months. Consumers were apparently lured into stores by bargains and better weather. Many analysts had been expecting a gain of 0.5 percent.

There is another small team of economists who subscribe to the "L" school. Because of "structural" problems in the economy, such as high consumer and business debt levels, and a huge international payments deficit, they figure the recovery will take a long time to come - though not as long as in Japan, where the economy has been stalled for a decade.

Worries of recession fade

Most economists, though, don't even see a recession.

One reason for this relatively cheery view is the assumption that the Fed under Greenspan's guidance will continue to lower interest rates to stimulate the economy. The Fed cut interest rates by half a percentage point twice in January. Fed watchers expect another cut at or before the next meeting of Fed policymakers in Washington March 20.

At the moment, financial markets are anticipating a V-shaped upturn. They are also hoping for some tax relief this year as the Bush administration's proposal builds up a head of steam. If payroll withholding rates are cut, it could put money into the pocket of consumers fairly rapidly.

Greenspan shares the view of some other economists that just-in-time technologies in recent years have enabled firms to adjust production levels more rapidly to changes in demand. Thus inventory-sales ratios rose only moderately in this business downturn compared to the past. And "a round of inventory rebalancing appears to be in progress," he said.

Those economists who fear a U-shaped recovery argue that an upswing involves more than a reduction in business inventories. They are concerned about a rising unemployment rate, the collapse in business capital spending and software, a lack of household savings, trade imbalances, and so on.

Greenspan talked of how advanced inventory management and flexible manufacturing technologies have quickened the pace of adjustment on the factory floor: Both production and payroll cuts now come quicker, increasing the stress on business and consumer confidence.

"It is difficult for economic policy to deal with the abruptness of a break in confidence," he admitted. He likened that risk to water backing up against a dam that is finally breached. "The torrent carries with it most remnants of certainty and euphoria that built up in earlier periods," he cautioned. But so far consumer confidence "remains at a level consistent with economic growth."

Greenspan offered some reassurance that technology advances have enhanced the Fed's capacity for "real-time surveillance," that is, seeing a problem and adjusting monetary policy quickly.

'It will all be OK'

Paul Kasriel, an economist at Northern Trust Co. in Chicago, saw Greenspan as saying, in effect, "Things look a little rough, but trust me. Things will work out fine."

Greenspan, Mr. Kasriel adds, would like to emerge from the present slowdown with his reputation as a central bank "hero" intact.

He has the 1990-91 recession on his record. He doesn't want another recession to mar his status in history.

Kasriel sees a recovery in the second half, largely because the Fed has kept the nation's money supply - the fuel for economic activity - growing at a reasonable pace.

(c) Copyright 2001. The Christian Science Publishing Society

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