National economy to steadily improve in next two years

August 15, 2001
Contact:
  • umichnews@umich.edu

ANN ARBOR—Although there is little doubt that the American economy has been and continues to be weak, it appears to have entered just a low-growth phase, rather than a full-blown recession, say University of Michigan economists.

While sharply rising energy prices, a sliding stock market, higher interest rates and business overinvestment have been the main culprits for this past year’s economic slowdown, the economy should begin to strengthen before the end of this year and continue to grow throughout the next two years, they say.

“It’s remarkable that all of these contractionary factors have failed to produce a full-fledged economic contraction—so far, at any rate,” says Saul H. Hymans, U-M professor of economics. “The pessimistic perspective would be that the very slow growth of the first half of this year will yet degenerate into a classical recession—a pervasive and sustained decline in the level of output.

“Our perspective is a good deal more optimistic, that there’s a greater likelihood that the U.S. economy will avoid a true recession in the near term, though it will have been a close call.”

In their annual forecast update of the national economy, Hymans and colleagues Joan P. Crary and Janet C. Wolfe say that they have plenty of reasons to be confident that the economy will back away from the brink of recession.

First, with nearly $300 billion in personal tax cuts over the first four years of President Bush’s tax cut plan, the tight fiscal policy of the Clinton years are no more. The U-M researchers estimate that the tax-cut package will add about 0.75 percent to the annualized economic growth rate during the second half of this year, and another 0.4 percent to next year’s growth rate.

Second, once the seriousness of the economic slowdown became clear, the Federal Reserve wasted little time in moving to a stimulative monetary policy by cutting short-term interest rates (by 250 basis points already this year with another 25-basis-point cut expected next week).

Finally, as business inventories have declined in response to the economic slowdown—and, in the process, have intensified the economy’s slowing—inventory stocks are now well under control. As a result, Hymans and colleagues predict that increased stock-building will soon add to economic growth.

While their forecast calls for real Gross Domestic Product (GDP) growth of just 1.6 percent for this year, down from last year’s 4.1 percent, the U-M researchers say that the economy should expand by 2.4 percent in 2002 and by 3 percent in 2003, as private investment and net exports improve.

With the Fed sticking to its supportive monetary policy at least into early next year, interest rates should remain low. The conventional mortgage rate is expected to continue to drop from last year’s 8.1 percent to 7 percent this year and to 6.6 percent in 2002, before edging up slightly to 6.8 percent in 2003.

The Aaa corporate bond rate will fall from 7.6 percent in 2000 to 7 percent this year and hold steady at 6.5 percent in the next two years, while the rate for three-month Treasury bills will decline from last year’s 5.8 percent to 3.8 this year and to 3.5 percent next year, before moving back up to 4.4 percent in 2003.

Although unemployment will be higher than last year’s mark of 4 percent—jumping to 4.6 percent in 2001 and then rising to 5 percent in the next two years—consumer price inflation through 2003 will be lower than last year’s 3.4 percent, falling to 3 percent this year and to 2 percent next year, before rising to 2.9 percent in 2003.

“As slack develops in the labor market, diminishing wage pressures help keep a lid on inflation, which is also moderated by lower energy and raw materials prices,” Hymans says. “As the economy picks up steam in 2003 and energy prices are no longer falling, inflation notches upward.”

The U-M forecast (which is based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics) also predicts that:

  • Real disposable income will rise by 3.9 percent this year and 3.7 percent in 2002, but only by 2.7 percent in 2003, due to higher inflation.
  • Annual sales of light vehicles will back off from last year’s record-setting mark of 17.2 million units to a still-strong 16.4 million units this year, 16 million units next year and 15.9 million units in 2003.
  • Private housing starts will increase from 1.58 million units in 2000 to 1.61 million this year and then settle at about 1.57 million units in each of the next two years.
  • Oil prices, which averaged about $30 per barrel last year, will remain in the $26-$27 per barrel range through 2003.
  • The federal budget surplus will drop sharply from nearly $199 billion in 2000 to $153 billion this year to $64 billion next year and to $42 billion in 2003—primarily due to the phase-in of additional parts of the Bush tax-cut package.

 

 

Related Links: