Economics Society Talk, February 5, 2002/Dr. J. Devine


  1. Despite the title, this talk isn’t about the impact of 911 on the economy. The key fact about 911 is that it only gave extra impetus to events that were already happening, the recession of 2000.


  1. More important to me, what lies ahead? The big debate is whether the recession looks like a V or like a U.


    1. a V-shaped recession has a quick recovery, while


    1. a U-shaped recession lingers for a few years before recovery.


  1. the forecasters seem to be saying that there’s a mixture of the two.


    1. V-shaped:


                                                               i.      unemployment fell a little in January


                                                             ii.      real GDP grew a little in the last quarter of 2001.


                                                            iii.      some of the “consumer expectations” data is optimistic.


                                                           iv.      the Fed, which has more data than anyone, has stopped seeing any need to cut interest rates.


                                                             v.      it looks as if the rate cuts during 2001 have kept the stock market from falling any further and have boosted the value of housing, so that the “wealth effect” has kept the recession of 2001 from being deeper.


    1. U-shaped:


                                                               i.      most forecasters see the economy recovering so slowly that unemployment will continue to rise for a year or more, perhaps rising to 7 percent. Businesses are dealing with their profit problems by laying off a lot of people, cutting salaries & wages, etc. Whether it’s a V-shape or a U-shape depends on who you are.


                                                             ii.      businesses don’t seem ready to invest in new factories, etc. again yet.


                                                            iii.      the world economy – the source of demand for U.S. exports – isn’t prospering.


  1. My view is that it’s quite possible that if a recovery occurs in the near future, the economy is going to have a “W-shaped” pattern (as seems appropriate). I think that the current signs of recovery are likely to be reversed, as in 1981, a boom that occurred between the recessions of 1980 and 1982.


  1. why? for the same basic reasons that encouraged recession in the first place.
    1. excessive consumer debt


it’s quite likely that consumers will start cutting back on their accumulation of debt, especially given (1) rising unemployment and (2) rising bankruptcy rates. This means a cut-back in spending, pushing the U.S. economy toward further falls in GDP.


    1. excessive corporate debt


this is likely to cause businesses to continue to cut spending on new investment, encouraging further declines. There’s an excellent story on this in today’s L.A. Times (2/5/02, front page). The problem is that interest on this debt has to be paid to avoid bankruptcy. [the two charts above were produced by Wynne Godley and Alex Izurieta, “The Developing U.S. Recession and Guidelines for Policy” available at A lot of my analysis also follows their lead.]


    1. excessive U.S. external debt, seen to be growing by the following graph:


this means that the U.S. is increasingly in debt to the rest of the world, so that an increasing amount of any domestic production must go to U.S. creditors in other countries. This also encourages a steep fall in the value of the dollar in foreign exchange markets. That would encourage are re-appearance of inflation, likely resulting in Federal Reserve efforts to fight inflation via higher unemployment. [The chart was made using Federal Reserves Flow-of-Funds data and the National Income and Product Accounts, available from’s data page,]


  1. All of the above ignores things that haven’t happened yet. It’s possible that the Bush administration can get large increases in military spending and tax cuts through the Congress.  Though the tax cuts that have occurred and are projected are very inefficient at boosting aggregate demand (because they mostly go to the rich or reward corporations for past behavior rather than for new investment), an increase in the government deficit does stimulate the economy. That may speed up the process of recovery, though it will take a year or more to take hold.


James G. Devine

Professor of Economics

University Hall (Rm. 4227)

Loyola Marymount University

One LMU Drive, Suite 4200

Los Angeles, CA 90045-2659 USA

office phone: 310/338-2948; FAX: 310/338-1950