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Con: U.S. likely coming out of mild economic slump unless Fed’s intervention makes it worse

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Kerry Lynch
May 24, 2008
EDITOR’S NOTE: The writer is addressing the question, Is the United States facing a prolonged recession?

The economic data have been pointing toward recession for nearly a year. Though the Commerce Department on April 30 reported a slight 0.6 percent increase in the gross domestic product for the first quarter of 2008, other data suggest a recession is here.


The National Bureau of Economic Research, official arbiter of such matters, has yet to make the call, but employment, industrial production, real income, and wholesale-retail sales—the key data the NBER looks at—have all decreased in recent months. The Commerce Department’s first-quarter GDP estimate is preliminary and could be revised downward later.


Even if the economy is in recession, it’s important to keep in mind that from a historical perspective recessions are neither extraordinary nor even unusual events. And most recessions do not turn into economic meltdowns.


Business cycles—in which the economy grows, then runs out of steam and declines—seem to be a chronic feature of free-market economies and have been observed in the United States at least since 1854.


Since then, the economy has experienced 32 complete cycles, 10 since the end of World War II. Most recessions have been relatively mild, and most were self-correcting, as markets adjusted and excesses were wrung out of the system.


Some analysts warn that the current downturn could be the worst since the long, deep recessions of the 1970s. Some have even drawn comparisons to the Great Depression.


No one knows what the future holds, of course. But it’s important to note that none of the 10 recessions since the end of World War II were even remotely similar in magnitude or duration to the Great Depression. And there is no evidence today that the current slowdown will be an exception.


Consider a few salient facts:


—During the Depression, GDP plummeted by a third; during the postwar recessions it fell just 2 percent on average.


—During the Depression, one out of four workers was unemployed; in the 2001 recession, the unemployment rate peaked at 6.3 percent—and it now stands slightly above 5 percent.


—The Depression officially lasted nearly four years. But the average postwar recession lasted 10 months. The longest lasted 16 months, while others were as short as six months.


In the last 25 years there have been just two recessions, both relatively mild. The 2001 recession was the mildest of all, lasting eight months, with the GDP declining just 0.2 percent.


Recessions cannot be attributed solely to “bad policy” by the federal government or Federal Reserve. Similarly, government intervention is not necessarily the cure because it often postpones needed adjustments in the economy and can make matters worse. Indeed, efforts to avoid short-term pain have often had negative unintended consequences down the road.


Arguably, this is what happened in 2001. In an effort to counteract the triple whammy of the stock market’s dot-com bust, the terrorist attacks, and the recession, the Fed pushed interest rates to 40-year lows. It kept them too low for too long, setting the stage for the housing bubble.


The Fed’s latest efforts to deal with the subprime mortgage crisis and avoid another recession—by slashing interest rates, pouring liquidity into the financial system, arranging the rescue of the Bear Stearns investment bank, encouraging banks and other institutions to borrow freely from the Fed, and accepting mortgage-backed securities (instead of only Treasury securities) as collateral for such loans—clearly have the potential to create new problems.


The dollar has already fallen sharply, prices of gold and other commodities have soared, and consumer price inflation has accelerated.


No one knows how long these trends will continue. But at some point, the Fed could be forced to pull in the reins. And once again, the Fed’s efforts to save the day today will also set the stage for the next crisis.


Kerry Lynch is director of research at the American Institute for Economic Research. Readers may write to the author at 250 Division St., Great Barrington, Mass. 01230-1000; Web site: www.aier.org.

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