Concerned Citizens Talk, May 7, 2002/Dr. J. Devine

1.                  I’ve brought my crystal ball…

2.                  Last year, the U.S. economy suffered from a short-lived recession, which only lasted for one quarter.

a.       I read the 2001 recession as happening mostly in manufacturing, sparked by problems in the high-tech and telecommunications sectors.

b.       the recovery was encouraged by two things:

                                            i.      the Federal Reserve’s eleven interest rate cuts during 2001.

                                          ii.      the Federal and State & Local governments worked to stimulate the economy by cutting taxes or raising outlays.

3.                  Nowadays, forecasters seem very optimistic, hoping that the economy is going to be growing well for the next year or so. However, there are two key concerns, one minor, one major.

a.       Minor: these forecasters have often been wrong. Almost all of them didn’t predict the 2001 recession. All they do is to extrapolate past trends & they tend to all predict exactly the same thing, since no-one wants to be “different.” This means that usually they can’t predict bad news such as recessions.

b.      Major:

                                            i.      a recession looks differently depending on who you are. If you’re on Wall Street, what’s important are financial markets and Gross Domestic Product. But if you’re a worker, what’s important is unemployment.

                                           ii.     GDP may be doing very good, but unemployment is likely to continue to rise for at least a year. Given the way that GDP has to increase at a fast rate (about 3 percent per year) simply to keep the unemployment rate from rising, at best we will see a “jobless recovery” of the sort that prevailed in the early 1990s.

4.                  Now that I’ve criticized the forecasters, I’m going to do some of my own. My view: the causes of the 2001 recession (“the three bears”) are still in place, while the countervailing forces seem unlikely to last. Thus, it’s likely that we’re going to have a “double dip” or “Dubya” recession.

a.       Baby Bear: excessive corporate debt: this is one thing that contributed to the 2001 recession, as debt rose and profitability fell. This is likely to cause businesses to continue to cut spending on new investment, encouraging further declines. Even if this pessimistic scenario doesn’t work out, such corporate debt discourages fast recovery. (The slowdown in corporate operations will eventually lead the debt/cash flow ratio to fall, as during previous recessions.)

b.      Mama Bear: excessive consumer debt. Consumer spending moderated 2001’s recession, but it kept the debt ratio rising.

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. The main prop for the U.S. economy in the 1990s and early 2000s is likely to go away.

The Federal Reserve’s rate cuts mostly worked by boosting the value of housing and the stock market: these added to consumer wealth and their spending. (If assets are rising in value, then it’s okay to get deeper in debt.) It’s hard to imagine that these will continue to rise in the future.


[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.]

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

This means that the U.S. has been enjoying a standard of living beyond what it produces, and so is increasingly in debt to the rest of the world. This means that an increasing amount of any domestic production must go to U.S. creditors in other countries. (It used to be that the U.S. earned income from the rest of the world. There’s been a role reversal here.)

This rising external debt 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, from’s data page,]

5.                  The role of government.

a.       The Fed is unlikely to cut interest rates any further, while there’s not much further to cut. It’s also hard to imagine that they could pump up the housing bubble or prop up the stock market more than they’ve already done. In fact, they seem to be leaning toward rate increases in a year or so.

b.      State & Local governments are unlikely to continue their stimulus, since most of them are strapped for cash these days. If anything, they will be contributing to the “second dip” of the “double dip” recession because they are cutting back.

c.       It’s possible that the Bush administration can get further 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 seems likely to 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