Commentary by John M. Berry
Dec. 19 (Bloomberg) -- A year ago, I didn’t expect the U.S. economy to fall into a recession in 2008 because I was confident consumers would continue to do what they do so well: spend money. I had plenty of company, and ultimately we were all wrong.
Now that the National Bureau of Economic Research has declared that a recession began in December 2007, it might seem we didn’t see the obvious. It’s more complicated than that, because this year has been like no other in modern economic times.
Federal Reserve officials and staff, the Congressional Budget Office, the influential forecasting firm Macroeconomic Advisers LLC and many private economists expected that the financial turmoil that began in the summer of 2007 -- and a continuing decline in housing construction and sales, which began in 2006 -- would take a toll on both household and business spending this year.
However, a weaker dollar was bringing down the U.S. trade deficit in real terms, offsetting part of the domestic weakness, and the drop in housing starts was slowing down. Furthermore, the Fed was cutting interest rates and taking other steps to improve financial market conditions.
“Although recent data suggest that a recession in 2008 has become more likely, CBO does not expect the slowdown in economic growth to be large enough to register as a recession,” the agency said in its January economic outlook.
At this time last year, many of us expected the economy to gather strength in the second half of this year.
Surprised by Crisis
With that in mind, I wrote there was no need for a major fiscal stimulus program, such as the one enacted in February. Again, I had company.
“With private spending weakening, not slumping, there is no case for a fiscal offset,” The Economist magazine wrote in its Jan. 3 issue.
Virtually no one, certainly not me, anticipated that the financial turmoil eventually would degenerate into a full-blown crisis involving the entire world.
The gross domestic product dipped at only a 0.2 percent annual rate in the fourth quarter of 2007, followed by gains of 0.9 percent in the first quarter of this year and 2.8 percent in the second, the latter boosted by the stimulus package’s personal tax rebates.
Even though payroll employment was falling slowly month by month in the first half of the year, the numbers hardly pointed to recession. The loss of jobs was due primarily to continued efforts by companies to increase productivity and reduce labor costs.
The Final Straw
In July, I asked economist Robert Hall of the Hoover Institute at Stanford University, chairman of the NBER Business Cycles Dating Committee, if the group would declare a recession without a decline in GDP. He responded, “Of course not.”
In the third quarter GDP fell again, at a 0.5 percent rate, and by the end of that three-month period it had become plain a recession, a very serious one, was at hand. The Sept. 15 filing for bankruptcy by Lehman Brothers Holdings Inc. was the straw that broke the camel’s back.
Many parts of world financial markets, including lending among banks, froze. Within a few days, stock prices plunged, with the Dow Industrials average tumbling from 11,388.44 on Sept. 19 to 8,451.19 on Oct. 10. The headlines and the actual loss of wealth shocked consumers, with the Conference Board’s confidence index falling from 61.40 in September to 38.80 in October.
Consumers Stop Spending
As a result, the economy’s mainstay, consumer spending -- which at the beginning of the year I had counted on to keep the economy out of recession -- led the way into it. Purchases of new cars and trucks, weak all year because of soaring fuel prices, dropped last month to the lowest level in 26 years.
Meanwhile, the squeeze on credit and the prospect of a contracting economy caused many companies to cut back on spending for new plants and equipment. And with sales falling, industrial production has been slashed to reduce inventories.
The drag from housing on growth did ease after the first quarter, and there were signs, as I wrote, that sales and construction appeared to be stabilizing. In fact, monthly sales of existing homes -- about 85 percent of all home sales -- have been hovering close to a 5-million-unit annual rate for a year.
However, tight credit and the worsening outlook caused additional declines in housing starts and new home sales this fall.
New Fed Strategy
With consumer price inflation running at more than 5 percent because of soaring oil and other commodity prices -- and with financial markets looking better -- Fed officials stopped cutting their target for the overnight lending rate after it reached 2 percent in April. As late as the end of June, they did not foresee a recession.
Now it’s a different story, of course. On Dec. 16, the Federal Open Market Committee lowered the lending rate target from 1 percent to a range of 0 to 0.25 percent. The FOMC also formalized its plan to continue buying assets to expand its balance sheet to add cash to the banking system and relieve specific problems in the credit markets.
The economy and Fed policy look vastly different than they did at the beginning of the year when I said no recession was likely.
(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net
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