1. The 2001-2002 Recession

2. LECTURE TOPICS OUTLINE  Review of 2001  Prospects for 2002-2003  The global economy  Inflation

3. REVIEW OF 2001  My forecast of a year ago Almost exactly a year ago, at the MVEA meetings in Kansas City, I predicted that 2001 would see recession. While I am happy to be credited with calling a recession before it occurs, my forecast for 2001 was off the mark. The March 2001 peak identified by the NBER dating committee does not mark the beginning of the recession that I foresaw.

4. REVIEW OF 2001  The Strange Anatomy of the 2001 Recession The NBER looked at four indicators to determine the onset of recession Employment Industrial production Real manufacturing and trade sales Real personal income less transfers

5. REVIEW OF 2001  Employment Peaked in March 2001.  Industrial production Peaked in July 2000 and by March 2001 was 3 percent below its previous peak.  Real manufacturing and trade sales Too erratic to say what direction it is going in.  Real personal income less transfers Still climbing in March 2001. Peaked in October 2001.

6. REVIEW OF 2001  Labor Market The major sign of recession is in the labor market. Employment has fallen faster than average. Aggregate hours and unemployment rate on track with previous recessions. The next slides look at the labor market during 2001 and compare it with the previous six recessions.

7. REVIEW OF 2001

8.  Real GDP The NBER dating committee doesn’t look at real GDP when it identifies a turning point But another standard definition of recession looks for a two quarter decline in real GDP On this criterion, we’re still not in recession. And the slowdown is mild.

9. REVIEW OF 2001

10. PROSPECTS FOR 2002-2003  Four scenarios Recovery and resumption of rapid growth Recovery but slower growth Double dip recession—normal depth and length Double dip recession—deeper and longer than normal

11. PROSPECTS FOR 2002-2003  A quick overview Long-term prospects are very promising, but … We will have a double dip recession and it will probably be a serious one. Two major reasons: The saving problem The growth and profits problem

12. PROSPECTS FOR 2002-2003  The Saving Problem Well known that the private saving rate is low and has been falling. Fallen from 8 percent in 1991-1992 to around 1 percent in 2000-2001.

13. PROSPECTS FOR 2002-2003

14.  Measurement Issue Two measures of saving: Income minus consumption Change in net worth Argued during 1990s that the falling saving rate isn’t a problem because based on first measure, which ignores changes in stock and house prices. Figure on next slide looks at second measure.

15. PROSPECTS FOR 2002-2003

16.  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

17. PROSPECTS FOR 2002-2003  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

18. PROSPECTS FOR 2002-2003  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

19. PROSPECTS FOR 2002-2003  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

20. PROSPECTS FOR 2002-2003  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

21. PROSPECTS FOR 2002-2003  Measurement Issue Income minus consumption since 1996 is $6.7 trillion. Change in net worth since 1996 is $11.4 trillion. If the excess of $4.7 trillion were realized, it would be the equivalent of claiming 50 percent of 2001 GDP!

22. PROSPECTS FOR 2002-2003  Are stock prices too high? Based on the P/E ratio, the stock market looks overpriced. To sustain the current P/E ratio, profits must grow much faster than their historical growth rate. If profits don’t grow faster, stock prices must fall.

23. PROSPECTS FOR 2002-2003

24.  Stock prices correction? If stock market prices fall to restore long-term average P/E ratio, $3.3 trillion of the $4.7 trillion disappears. If stock market prices fall to achieve a low P/E ratio, all of the $4.7 trillion disappears.

25. PROSPECTS FOR 2002-2003  Bottom Line on Saving The saving rate is sustainable only if stock prices remain at historically high levels relative to earnings. The saving rate will rise and consumption expenditure will fall if stock prices fall to normal long term level. Most likely that consumption expenditure will fall sharply at some point during 2002 or 2003.

26. PROSPECTS FOR 2002-2003  The Growth and Profits Problem The growth rate and profits are being systematically overestimated by creative accounting “Enron style.” The extent and full implications of this problem are only beginning to be seen. A joke that is doing the rounds of the world’s financial centers makes the key point nicely

27. PROSPECTS FOR 2002-2003  Normal capitalism You have two cows. You buy a bull. Your herd multiplies and the economy grows.

28. PROSPECTS FOR 2002-2003  Enron capitalism You have two cows. You sell three of them to your publicly listed corporation, using letters of credit opened by your brother-in-law at the bank. You then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows.

29. PROSPECTS FOR 2002-2003  Enron capitalism The milk rights of the six cows are transferred via an intermediary to a Cayman Island company secretly owned by your chief financial officer who sells the rights to all seven cows back to your listed corporation. Your annual report states that your corporation owns eight cows, with an option on six more.

30. PROSPECTS FOR 2002-2003  Inflating Growth and Profit We know that practices similar to the ones in the joke are widespread. We know that growth and profits of the corporate sector are exaggerated. We don’t know whether these practices have contaminated the national accounts, but the matter needs investigating.

31. PROSPECTS FOR 2002-2003  Bottom Line on Growth and Profit As dubious accounting practices are revealed and corrected growth and profit will look less rosy than the current numbers suggest. The stock market will correct. Most likely, sometime during 2002 or 2003, a very large correction will come. Stock prices will fall by a large amount.

32. PROSPECTS FOR 2002-2003  Bottom Line on Prospects for 2002-2003 The stock market will correct. Consumption expenditure will fall. A deeper and longer than normal recession will occur.

33. THE GLOBAL ECONOMY

34.  Global growth outlook for 2002 Consensus US forecast: real GDP will grow between 0.3 percent and 1.8 percent, median at 1.2 percent Consensus forecasts for rest of advanced economies EU1.1 Canada1.4 Japan-1.3 Asia NICs3.6

35. THE GLOBAL ECONOMY  If the U.S. Economy stumbles EU and Canada will slow in line with US Japan will shrink even faster Asia NICs will slow to a near standstill

36. INFLATION OUTLOOK Current inflation numbers suggest low rate through 2002. Current money supply growth numbers point to higher inflation rate when economy eventually recovers.

37. The End