Recovery or a Second Dip?

[talk given to the Downey, CA, Rotarians on December 9, 2003]

1. Introduction

A. It’s always hard to predict the economic ups and downs of the economy, so we end up with the old Harry Truman economics joke: he was looking for a one-armed economist who wouldn’t say “on the one hand… on the other….” all the time.

B. But serious macroeconomic predictions tend to be like good news/bad news jokes.

C. this is because economics predicts as well (or poorly) as meteorology.

D. the short story.

1) there was an argument at the start of the current recession (in 2001) about whether the recession would be a “V” shaped recession (a fall followed by an immediate climb) or a “U” shaped recession (a fall followed by a year or two of slow growth and then recovery).

2) The “U” school seems to have won out. We’ve had a long period of slow growth followed by two years of slow growth. Generally, the growth of demand for business production has been so slow that the jobless rate has risen and then stayed high. That’s why economists talk about a “jobless recovery.”

3) But it’s possible that we’ll have a “W” pattern, as seems appropriate. The current recovery may be temporary, with a “Dubya” dip next year or during 2005.

2. The Good News: read the newspaper.

A. GDP growing fast, at an 8.2 percent annual rate during the third quarter

B. the falling international value of the dollar has helped manufacturing a bit.

C. corporate profits are rising (11.8% during the 3rd quarter).

D. business investment spending has picked up a bit (14.0% during the 3rd quarter, from a low base).

E. residential construction is growing (22.7% during the 3rd quarter).

F. the job situation has begun to be less miserable, with the unemployment rate edging downward to 6.9%

G. construction spending, the demand for durable goods, doing pretty well

H. Many economic prognosticators have suggested that the current boom will continue into 2004, though likely more moderate. This is based on simple extrapolation of current trends and an imitation of other predictions.

3. The Bad News. We’re not out of the woods yet.

A. we’ve seen one-quarter “boomlets” in the past, including one in the first quarter of 2002. Most economists don’t see a 8.2 percent real growth of GDP as sustainable, so that the economy is likely to slow.

B. Manufacturing is still in a bad situation at 75% of capacity, still cutting jobs.

C. the boomlet so far has been fueled by the same factor that prevented the 2001 recession from being even worse: personal consumption spending and borrowing.

1) consumer indebtedness is extreme.

Figure 1


Of course, big debts can be handled if assets are large enough, so we should look at net worth.

Figure 2


source of figures 1 and 2: Deficits, Debts and Growth: A Reprieve but not a Pardon  October 01, 2003 by: Anwar Shaikh, Dimitri B Papadimitriou, Claudio H Dos Santos, and Gennaro Zezza (


D. the job market situation is still bad: for example, long-term unemployment is up, not down.

1) People are losing jobs in the high-wage manufacturing sector and gaining them in the low-wage service sector (Walmart, etc.), so that in real terms, wages are falling.

2) This means that

(a) workers can’t afford to spend they way they’ve been spending based on current income and must borrow (or sell assets).

(b) those with limited assets are reaching the limits of borrowing, so that bankruptcy rates are up.

(c) so consumer spending (the engine that kept the 2001 recession moderate) is leveling off, and may fall.

(d) this also hurts new home purchases, which economists count as part of total investment.

3) Asset values are up, so that means that consumption by those who own stocks and/or houses can continue to spend. But it’s hard to imagine that this will continue.

(a) the price/earnings ratio for stocks is still high by historical standards, suggesting that the current stock market is being driven by optimism (which raises stock prices), not fundamentals (measured by earnings). The stock market is likely to fall in the next year or so, toward the trend line (the light black line), where the price/earnings ratio fits with historical experience. (Note that I assume an upward trend. This is optimistic.) Perhaps it will go below the trend line, since (in its normal wide fluctuations) it often over-shoots.

Figure 3: the price/earnings ratio for stocks

source: Robert Shiller (Yale University, data at:

(b) The housing boom has been an important reason why the recession of 2001 wasn’t as bad as it could be (especially given the stock market crash).

(i) But the “price/earnings ratio” on housing has been rising dramatically, suggesting that house ownership prices will fall soon, hurting consumer assets and discouraging spending.  The graph shows that the price of buying a house is rising much faster than the “earnings” from a house, i.e., the price of renting a house (which is actually falling). The purchase price is rarely out of line with the rental price in this way, so it’s likely to fall some time soon.

(ii) In fact, it looks as if the housing market is cooling, with mortgage borrowing slowing and mortgage companies laying off many workers.

Figure 4

source: Dean Baker & Simone Baribeau, “Homeownership in a Bubble: The Fast Path to Poverty?” (August 13, 2003)  


E. Traditionally, government policy could be used to fight the second dip. However,

1) Monetary policy (lowering interest rates) can’t go very far, since it’s gotten almost as low as it can go.

(a) The basic interest rate that the Fed uses for monetary policy (the Fed Funds rate) has hit 1%, which is pretty close to zero.

(b) it also hasn’t been very effective, either at preventing the 2001 recession (or even predicting it) or at encouraging recovery.

2) Fiscal policy (government deficits) works, but

(a) as practiced by the Bush administration, it’s very inefficient, giving money to the rich, who don’t change their spending plans much when their incomes change.

(b) the tax rebates helped in 2003, but those are temporary.

(c) the military spending upsurge helps the economy, but as a cost (bloody war).

(d) deficit spending is very limited politically, due to the growing fears of government debts.

(e) federal stimulus is counteracted by state & local cut-backs

F. The falling dollar has stimulated the economy, but also stimulates inflation, which would encourage higher interest rates. A steep fall in the dollar may be the “straw that breaks the camel’s back,” causing the second dip.

G. Of course, the path of the economy can’t be predicted. I’m hoping that my prediction doesn’t come true.


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