The Recession Prevention Handbook : Eleven Case Studies, 1948-2007 [1 ed.] 9781315699127, 9780765622839

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Recession Prevention Handbook

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Recession Prevention Handbook Eleven Case Studies, 1948-2007

Norman Frumkin

First published 2010 by M.E. Sharpe Published 2015 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN 711 Third Avenue, New York, NY 10017, USA Routledge is an imprint of the Taylor & Francis Group, an informa business

Copyright © 2010 Taylor & Francis. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Notices No responsibility is assumed by the publisher for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use of operation of any methods, products, instructions or ideas contained in the material herein. Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein. In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility. Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. Library of Congress Cataloging-in-Publication Data

Frumkin, Norman. Recession prevention handbook : eleven case studies, 1948–2007 / Norman Frumkin. p. cm. Includes bibliographical references and index. ISBN 978-0-7656-2283-9 (cloth: alk. paper)—ISBN 978-0-7656-2284-6 (pbk.: alk. paper) 1. Recessions—United States—Case studies. 2. Economic indicators—United States—Case studies. 3. United States—Economic conditions—20th century. 4. United States—Economic conditions—21st century. 5. United States—Economic policy—20th century. 6. United States—Economic policy—21st century. I. Title. HB3716.F78 2010 338.5’42—dc22

2009034474 ISBN 13: 9780765622846 (pbk) ISBN 13: 9780765622839 (hbk)

To Sarah, Jacob, Samuel, Susan, Isaac, Jonah

In memory of Anne Frances Feldman Frumkin and Joseph Harry Frumkin

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Contents

List of Figures List of Tables Preface

xi xix xxi

1. Characteristics of Recessions Business Cycles and Recessions A Proposed New Definition of Economic Downturns Frequency of Recessions Since the Early 1980s Severity of Recessions Jobless Recoveries from Recent Recessions Failure to Forecast Recessions and Its Policy Implications

3 3 10 10 13 35 41

2. The Recession of 1948–49 Backlog of Household Durable Goods, Housing, and Business Capital Needs at the End of 1947 Inflation at the End of 1947 Overview of the Economy During 1948 Economic Indicators in Real Time During 1948 Note on National Defense Assessment of Economic Policies Preceding the 1948–49 Recession Appendix 2.1. The Economy Before 1948

52

3. The Recession of 1953–54 Korean War and the Economy Federal Reserve Policy Change Economic Indicators in Real Time During 1952–53 Note on National Defense Federal Government Fiscal Position Assessment of Economic Policies Preceding the 1953–54 Recession

52 54 56 57 77 80 83 89 89 92 93 104 106 107 vii

viii

4. The Recession of 1957–58 Economic Indicators in Real Time During 1956–57 Assessment of Economic Policies Preceding the 1957–58 Recession 5. The Recession of 1960–61 Economic Indicators in Real Time During 1959–60 Assessment of Economic Policies Preceding the 1960–61 Recession 6. The Recession of 1969–70 Fiscal Policy and the Vietnam War Definition of Full Employment Economic Indicators in Real Time During 1968–69 Assessment of Economic Policies Preceding the 1969–70 Recession

111 112 127 129 130 145 146 147 148 149 167

7. The Recession of 1973–75 Economic Policy Changes of August 15, 1971 Economic Indicators in Real Time During 1972–73 Assessment of Economic Policies Preceding the 1973–75 Recession

193

8. The Recession of 1980 Productivity Slowdown Iranian Revolution Decline in the Foreign Exchange Value of the Dollar Economic Indicators in Real Time During 1978–79 Assessment of Economic Policies Preceding the 1980 Recession

196 196 197 198 200 217

9. The Recession of 1981–82 Effect of the 1980 Recession on Subsequent Inflation Economic Recovery Tax Act of 1981 and the 1981–82 Recession Economic Indicators in Real Time During 1980–81 Assessment of Economic Policies Preceding the 1981–82 Recession

222 222 223 224

10. The Recession of 1990–91 International Events Value of the Dollar Federal Government Regulations

170 170 175

239 243 243 244 244

ix

Natural Disasters Savings and Loan Associations Failures Stock Market Crash of 1987 Fiscal Policy Economic Indicators in Real Time During 1989–1990 Assessment of Economic Policies Preceding the 1990–91 Recession 11. The Recession of 2001 Economic Record Fiscal Policy Monetary Policy Stock Market and Telecommunications Company Bubbles Economic Indicators in Real Time During 1999–2000 Assessment of Economic Policies Preceding the 2001 Recession 12. The Recession of 2007–9 Economic Record Fiscal Policy and War Household Income, Spending, and Saving, Grouped by Household Income House Price Bubble Hurricane Katrina Economic Indicators in Real Time During 2006–7 Assessment of Economic Policies Preceding the 2007–9 Recession

246 247 247 249 252 268 272 272 275 279 280 282 298 303 303 305 310 314 316 317 332

13. Findings and Recommendations Precipitating Elements of Each Recession Themes and Agents of the Precipitating Elements Policy Recommendations for Avoiding or Ameliorating Future Recessions Conclusion

337 337 349 353 360

Bibliography Index About the Author

361 367 380

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List of Figures

1.1 Illustrative Phases of Business Cycles 1.2a Job Losses in General and Particular Recessions 1.2b Job Losses as a Percentage of Total Pre-Recession Jobs in General and Particular Recessions 1.2c Duration of Job Losses in General and Particular Recessions 1.3 Duration of Unemployment Rate Increases in General and Particular Recessions 1.4 Real Weekly Earnings in General and Particular Recessions 1.5a Real Gross Domestic Product in General and Particular Recessions 1.5b Duration of Declines in Real Gross Domestic Product in General and Particular Recessions 1.6a Corporate Profits in General and Particular Recessions 1.6b Duration of Declines in Corporate Profits in General and Particular Recessions 1.7a Proprietors’ Income in General and Particular Recessions 1.7b Duration of Declines in Proprietors’ Income in General and Particular Recessions 2.1 Jobs in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 2.2 Unemployment Rate in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 2.3a Consumer Prices in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 2.3b Wholesale Prices in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 2.4 Industrial Production in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 2.5 Housing Starts in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

7 16 17 18 23 26 31 32 33 34 36 37 60 62 65 67 68 70

xi

xii

2.6

LIST OF FIGURES

Job Earnings in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 71 2.7 Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time 72 2.8 Consumer Durable Goods Spending in Expansion Preceding the 1948–49 Recession, Plus One Recession Quarter, in Real Time 75 2.9 Gross National Product in Expansion Preceding the 1948–49 Recession, Plus One Recession Quarter, in Real Time 77 2.10 National Defense Expenditures as a Percentage of the Gross Domestic Product 79 3.1 Jobs in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 95 3.2 Unemployment Rate in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 97 3.3 Consumer Prices in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 98 3.4 Industrial Production in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 99 3.5 Housing Starts in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 101 3.6 Job Earnings in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 102 3.7 Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time 103 3.8 Gross National Product in Expansion Preceding the 1953–54 Recession, Plus Two Recession Quarters, in Real Time 105 4.1 Jobs in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 114 4.2 Unemployment Rate in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 115 4.3 Consumer Prices in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 117 4.4 Industrial Production in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 119 4.5 Housing Starts in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 120 4.6 Job Earnings in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 121

LIST OF FIGURES

xiii

4.7a Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 123 4.7b Federal Funds Interest Rate in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time 124 4.8 Consumer Durable Goods Spending in Expansion Preceding the 1957–58 Recession, Plus Two Recession Quarters, in Real Time 126 4.9 Gross National Product in Expansion Preceding the 1957–58 Recession, Plus Two Recession Quarters, in Real Time 127 5.1 Jobs in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 132 5.2 Unemployment Rate in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 133 5.3 Consumer Prices in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 135 5.4 Industrial Production in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 136 5.5 Housing Starts in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 137 5.6 Job Earnings in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 139 5.7a Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 140 5.7b Federal Funds Interest Rate in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time 141 5.8 Real Consumer Durable Goods Spending in Expansion Preceding the 1960–61 Recession, Plus Three Recession Quarters, in Real Time 143 5.9 Real Gross National Product in Expansion Preceding the 1960–61 Recession, Plus Three Recession Quarters, in Real Time 144 6.1 Jobs in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time 151 6.2 Unemployment Rate in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time 153 6.3 Consumer Prices in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time 154 6.4 Industrial Production in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time 157

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6.5 6.6 6.7a

6.7b

6.8

6.9

7.1 7.2 7.3 7.4 7.5 7.6 7.7a

7.7b

7.8

7.9

LIST OF FIGURES

Housing Starts in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time Job Earnings in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time Federal Funds Interest Rate in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time Real Consumer Durable Goods Spending in Expansion Preceding the 1969–70 Recession, Plus One Partial Recession Quarter, in Real Time Real Gross National Product in Expansion Preceding the 1969–70 Recession, Plus One Partial Recession Quarter, in Real Time Jobs in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Unemployment Rate in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Consumer Prices in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Industrial Production Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Housing Starts in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Job Earnings in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Federal Funds Interest Rate in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time Real Consumer Durable Goods Spending Preceding the 1973–75 Recession, Plus One Recession Quarter, in Real Time Real Gross National Product in Expansion Preceding the 1973–75 Recession, Plus One Recession Quarter, in Real Time

159 160

162

163

166

167 177 178 180 181 183 185

186

187

189

192

LIST OF FIGURES

8.1 8.2 8.3 8.4 8.5 8.6 8.7a

8.7b 8.8

8.9

9.1 9.2 9.3 9.4 9.5 9.6 9.7a

9.7b

Jobs in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Unemployment Rate in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Consumer Prices in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Industrial Production Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Housing Starts in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Job Earnings in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Federal Funds Interest Rate in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time Real Consumer Durable Goods Spending in Expansion Preceding the 1980 Recession, Plus Two Recession Quarters, in Real Time Real Gross National Product in Expansion Preceding the 1980 Recession, Plus Two Recession Quarters, in Real Time Jobs in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Unemployment Rate in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Consumer Prices in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Industrial Production Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Housing Starts in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Job Earnings in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time Federal Funds Interest Rate in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

xv

202 203 205 208 209 211

213 214

217

218 226 227 228 229 231 233

235

236

xvi

LIST OF FIGURES

9.8 Real Consumer Durable Goods Spending in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time 9.9 Real Gross National Product in Expansion Preceding the 1981–82 Recession, Plus One Recession Quarter, in Real Time 10.1 Jobs in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.2 Unemployment Rate in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.3 Consumer Prices in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.4 Industrial Production Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.5 Housing Starts in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.6 Job Earnings in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.7b Federal Funds Interest Rate in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.8 Real Consumer Durable Goods Spending in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time 10.9 Real Gross National Product in Expansion Preceding the 1990–91 Recession, Plus One Recession Quarter, in Real Time 11.1 Jobs in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.2 Unemployment Rate in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.3 Consumer Prices in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.4 Industrial Production Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.5 Housing Starts in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

238

240 255 256 258 260 262 263

265

266

267

268 284 286 287 289 291

LIST OF FIGURES

11.6 Job Earnings in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.7b Federal Funds Interest Rate in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time 11.8 Real Consumer Durable Goods Spending in Expansion Preceding the 2001 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time 11.9 Real Gross Domestic Product in Expansion Preceding the 2001 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time 12.1 Jobs in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.2 Unemployment Rate in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.3 Consumer Prices in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.4 Industrial Production Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.5 Housing Starts in the Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.6 Job Earnings in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.7b Federal Funds Interest Rate in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time 12.8 Real Consumer Durable Goods Spending in Expansion Preceding the 2007–9 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time 12.9 Real Gross Domestic Product in Expansion Preceding the 2007–9 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time

xvii

292

294 295

297

299 319 320 321 323 324 327

328 329

331

332

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List of Tables

1.1

Dating of Business Cycle Recessions and Expansions, 1945–2009 1.2 Unemployment Rates in General and Particular Recessions 1.3a U.S. National Average Weekly Unemployment Insurance Benefit Payments in Recession and Selected Recovery Years 1.3b Unemployment Insurance Average Weekly Benefit Payments, and Benefit Payments as a Percentage of Gross Weekly Earnings, for Selected States, 2008 1.4 Poverty Rate and People in Poverty 1.5 Displaced and Reemployed Full-Time Wage and Salary Workers, Short-Tenured and Long-Tenured Workers 1.6 Median Weekly Earnings of Long-Tenured and Short-Tenured Displaced Full-Time Wage and Salary Workers: Earnings of Workers on the New Job Relative to Earnings on the Lost Job 2.1 National Defense Expenditures and National Defense as a Share of Gross Domestic Product 3.1 National Defense Expenditures and National Defense as a Share of the Gross Domestic Product 3.2 Price and Wage Inflation 3.3 Defense Spending and the Gross Domestic Product 3.4 Federal Government Fiscal Position 4.1 Selected Economic Indicators 4.2 Consumer Price Index in Real Time 5.1 Duration of Expansions Preceding the Onset of Recessions 6.1 Consumer Price Index in Real Time 6.2 Job Earnings in Manufacturing in Real Time 7.1 Unemployment and Inflation Before or Coincident with the August 1971 Controls 8.1 Consumer Price Index in Real Time

9 21 24

25 29 42

44 79 90 91 106 108 112 117 130 154 160 171 205

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LIST OF TABLES

9.1 Consumer Price Index, for All Items and for All Items Less Energy 9.2 Housing Starts 9.3 Worker Earnings 9.4 Business Loans at Commercial Banks 10.1 Real Gross Domestic Product and Labor Productivity 10.2 U.S. Government Revenue Effects of Selected Federal Tax Laws 10.3 Real Gross Domestic Product and Real Defense Spending 10.4 Federal Government Receipts Minus Expenditures 10.5 Consumer Price Index, with Food and Energy Components 10.6 Worker Earnings 11.1 Economic Trends, 1992–2000 11.2 Federal Government Receipts Minus Expenditures 11.3 Marginal Tax Rates on Married Individuals Filing Jointly, Before and After Omnibus Budget Reconciliation Act of 1993 11.4 Federal Government Expenditures 11.5 Stock Market Prices, Earnings-Price Ratios, and Dividend-Price Ratios 11.6 Consumer Price Index 11.7 Worker Earnings 12.1 Economic Trends, 2002–7 12.2 Federal Government Finances 12.3 Individual Income Tax Cuts of 2001 and 2003 Laws 12.4 National Defense Expenditures 12.5 Household Money Income, Percentage of Families That Saved, and Household Saving Rates, Grouped by Income, 2007 12.6 House Prices and Consumer Prices 12.7 Private Housing Starts 13.1 Relative Importance of Agents Precipitating the Eleven Recessions 13.2 Summary of Recommendations

223 232 234 237 246 251 252 253 259 264 273 277 277 278 282 288 292 304 307 308 309 312 315 325 350 354

Preface

Next to war and natural disasters, an economic recession and its more severe form-—economic depression-—wreaks the most widespread havoc on people, communities, and nations. It is in America’s interest to do much better in lessening the severity of recessions, and better yet, in avoiding them. I hope this book helps move toward these aims by focusing on what precipitated the eleven recessions since World War II ended in 1945, as opposed to how we got out of them. The recessions covered here that the American people have endured occurred in 1948–49, 1953–54, 1957–58, 1960–61, 1969–70, 1973–75, 1980, 1981–82, 1990–91, 2001, and 2007–9.1 This book highlights the performance of the economy and the actions taken by the economic policy makers—the Federal Reserve, the president, and Congress—during the expansion period before the onset of each recession. The book opens with a discussion of the overall characteristics of recessions in Chapter 1, which includes a snapshot of the declines in various economic indicators during each of the eleven recessions, before proceeding to individual case studies analyzing each recession. Each case study begins with the main economic events during the multiyear expansion period preceding the onset of the recession, and then focuses on the performance of the economy during the last twelve to twenty-four months of the expansion preceding the onset of the recession. I emphasize the nature of each expansion as it evolved, and then concentrate on those areas of the economy that were slowing down, or declining, in the last phase of the expansion. The book points to persistent failures over the last sixty-two years of the Federal Reserve and the president to forecast, or to acknowledge the possibility of a future recession; to deal appropriately with actual inflation or a perceived potential future inflation, and to Congress’s weak oversight of the Federal Reserve. Repeatedly, these three macroeconomic policymakers have failed to take timely, anticipatory or remedial economic actions. Accordingly, I recommend that the Federal Reserve and the president be far more willing to acknowledge publicly when economic indicators suggest the possibility of xxi

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PREFACE

a coming recession, and that Congress begin to exercise effective oversight of the Federal Reserve. The Federal Reserve and the central banks of other countries should hold down excessive inflation as a way to lessen future unemployment. Large and persistent price increases lead to undesirable speculative behavior by both businesses and households that distort investment, production, and spending decisions. These result in losses of real incomes and purchasing power, which are precursors to weaknesses in demand, and thus to subsequent recessions and rising unemployment. However, while there are periods when excessive demand leads to inflation, I believe that more often than not, the Federal Reserve has been mistaken in focusing on excessive demand as the major cause of actual and potential inflation. Instead, I believe that inflation is primarily caused by non-demand factors in particular parts of the economy. These include the psychology of inflationary expectations by businesses and workers, outsized speculation in the asset prices of stock equities and houses, and supply shocks causing temporary shortages of certain materials, such as price hikes in oil products. I include my ideas for coping with such sources of inflation. I also believe that the president’s Council of Economic Advisers should be more forthright in assessing the likelihood of a recession, and should explain its outlook in its accompanying report to the annual Economic Report of the President that is sent to Congress. And the president should be willing to publicly acknowledge the possibility of a recession, and act to prevent, or at least mitigate the effects of a recession, regardless of the possible negative effect on his or her approval rating. I believe that if adopted, these recommendations will achieve the following: s 3AVESIGNIlCANTNUMBERSOFWORKERSFROMLOSINGTHEIRJOBSANDTHEASSOCIated incomes, and obviate the dire psychological effects such losses could have on them and their families. This includes the fact that many who lose their jobs do not become re-employed, and many of those who do find new jobs work at much lower rates of pay than in their previous jobs (see Chapter 1 under Jobless Recoveries from Recent Recessions). s 3AVEHOMEOWNERSFROMLOSINGTHEIRHOMES BUSINESSOWNERSFROMLOSING their businesses, and investors from losing their savings and assets. s 0REVENTTHEOVERALLECONOMYFROMLOSINGBILLIONSOFDOLLARSINECONOMIC growth. In sum, the book challenges economic policy makers and the economics profession to look beyond the traditionally accepted tradeoff between inflation and unemployment. The challenge in most cases is to find ways to contain

PREFACE

xxiii

inflation directly at its source or sources. The blunt, inefficient, and unethical tool of increasing unemployment by restraining demand to combat inflation is antiquated and should be rejected. Each recession case study analyzes in real-time the economic data available to the economic policy makers and on which they made their decisions preceding each recession, that is, the “real-time” data. The valuable use of real-time data in hindsight, though, is a different matter from being faced with the conditions as they were occurring. But that is the nature of history, and from it we hope to learn to make things better in the future. Chapter 1 discusses several general characteristics of recessions that underlie the thrust of the book. The topics are: s "USINESSCYCLEEXPANSIONSANDRECESSIONS s ,ESSFREQUENTRECESSIONSSINCETHEEARLYS s 3EVERITYOFRECESSIONS s *OBLESSRECOVERIESFROMTHEnANDRECESSIONS s &AILURETOFORECASTRECESSIONSANDITSPOLICYIMPLICATIONS Chapters 2 to 12 analyze each recession separately. Each case study begins with the backdrop of main economic events during the multiyear expansion period preceding the onset of the recession. This is followed by an analysis of the monthly and quarterly movements of a number of economic indicators during the eighteen to twenty-four months that constituted the last phase of the expansion period. Each chapter includes the economic policy actions taken by the Federal Reserve, the president, and Congress at the time. Lastly, each chapter gives an overall assessment of the economic conditions and the economic policy actions preceding the onset of the recession. Chapter 13 highlights the overall findings of each recession, assesses general themes emerging from the findings, and gives economic policy recommendations for the Federal Reserve, the president, and Congress in acting to prevent or limit the impact of future recessions. Sources Used in the Analysis I have studied materials on the economy covering the multiyear expansions and the last eighteen to twenty-four months preceding the onset of the eleven recessions, as well as the initial months of each recession. They were published monthly in the Survey of Current Business, Federal Reserve Bulletin (monthly, until quarterly in the early 2000s), semiannually in the Budget and the Economic Outlook of the Congressional Budget Office, and biweekly (initially weekly) in Business Week.

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PREFACE

I have also reviewed the annual Economic Report of the President, including the accompanying “Annual Report of the Council of Economic Advisers,” and the semiannual “Monetary Policy Report to the Congress” by the Board of Governors of the Federal Reserve System. In addition, I have referred to nongovernmental journal articles and books. For other selected descriptive material, I used the text in my previous books, Tracking America’s Economy 4th edition, and Guide to Economic Indicators, 4th edition. Real-Time Data My main source of the real-time data on economic indicators that were available to analysts and policy makers in the months preceding the onset of the recessions was the large variety of contemporary statistical data of the economy published monthly in the Survey of Current Business (these data were discontinued in the period preceding the 2001 recession). I also used the on-line real-time data for selected economic indicators of the Federal Reserve Bank of Philadelphia and the Federal Reserve Bank of St. Louis. The two Banks developed the real-time data by collecting each revision of the data over the months and years after they were first published. Each successive data revision is classified in vintage sets when each vintage became available. Because the on-line, real-time data did not cover all economic indicators for all recessions, particularly for the earlier recessions, I began using the on-line data with the 1969–70 recession. There are two limitations in presenting real-time data in this book because of the continual revisions to the current data each month or quarter. One problem affects the data between adjacent months or quarters. For example, in calculating the monthly percentage change in employment from January to February, the January data differ from those previously used in calculating the percentage change from December to January, because the monthly employment data are continually revised for previous months. In this case, the data for January differ in the two calculations, and thus the monthly change estimates between December and January and January and February are based on inconsistent data. The other problem is more general. It results from continual revisions to the earlier data during the expansion period preceding the onset of each recession. For example, in monitoring housing start data during the eighteen months of an expansion period preceding the onset of a recession, economic policy makers see data each month that incorporate continual revisions to the entire monthly data series. To replicate this phenomenon in the book, it would have been necessary to provide a new chart each month to accommodate the

PREFACE

xxv

new revised data—say, a new monthly chart for each of the twelve months closest to the onset of a recession. Obviously, this would be unwieldy and difficult to absorb substantively. In practice, these problems in depicting the real-time data do not affect the monthly and quarterly patterns significantly. I mention them to make clear that the real-time data in the book are not precisely the same as those that policy makers had preceding each recession. Forecasts of the Overall Economy My conclusions regarding forecasts of the economy by the federal public sector are based on published materials of the Federal Reserve, the president and the president’s Council of Economic Advisers, and the Congressional Budget Office. Forecasts of the economy by economists in the private sector are based on three sources: s ,IVINGSTON3URVEYOFECONOMICFORECASTERSCOVERINGTO s *OINTPROJECTOFTHE!MERICAN3TATISTICAL!SSOCIATIONANDTHE.ATIONAL Bureau of Economic Research of economic forecasters covering 1968 to 1990. s 3URVEYOF0ROFESSIONAL&ORECASTERSCONDUCTEDBYTHE&EDERAL2ESERVE Bank of Philadelphia from 1990 to the present. Acknowledgments Lynn Taylor, economics editor of M.E. Sharpe, was instrumental in having the book published and seeing it through to completion. Mike Sharpe continued his support of my work in his publishing house. Two persons reviewed all initial drafts of the book. Edward Steinberg, on the economics faculty of New York University, brought his unique perception of the meaning and use of economic data in raising the level of the analytic and policy discussions. He also provided succinct, clarifying wording throughout the book. His perspicacious insights influenced the entire work. Sylvia Elan, who is my sister, added precision and concision to the book. Howard Rosen, of the Peterson Institute for International Economics, heightened the cogency and sharpened the issues in the book, and alerted me to studies relevant to it. Andrew Jakabovics, of the Center for American Progress, tightened the overall cohesion of the book. Jim Borbely, Jacob Frumkin, Samuel Frumkin, Sarah Frumkin, David Hirschberg, Thomas Jabine, Donald Mopsik, Ataman Ozyildirim, Harry

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Rosenberg, and Victor Zarnowitz2 gave helpful comments on selected sections of the book. I had helpful discussions with Robert Arnold, Dean Baker, Martin Baily, Barry Bosworth, Albert Brodzinsky, Joel Darmstadter, Bruce Grimm, Henry Hertzfeld, Mun Ho, Francis Horvath, Randal Kinoshita, Leo Kramer, Laurence Meyer, Benjamin Mintz, Len Samowitz, Charles Schultze, James Stock, Catharine Tunis, and Mark Watson. Eric Horowitz organized the real-time database, including the monthly and quarterly percentage changes for the eleven recessions, both from the above on-line data and from the statistical data in the real-time monthly issues of the Survey of Current Business. These real-time data were the foundation for the statistical analyses in the book. Wayne Mason and his staff at the copy center of the American University library made it much easier to obtain considerable printed materials from journals and books. Thomas Clark of the Federal Reserve Bank of Philadelphia and George Essig of the Federal Reserve Bank of St. Louis walked me through the method of downloading the real-time, on-line data provided by the two Banks. Shelly Smith provided component data from the national economic accounts. Daniel Ginsburg helped with the history of the consumer price index data. Angie Clinton helped with the history of the establishment survey’s employment data. Steve Haugen and Steven Hipple helped with the characteristics of the labor force data. Steven Henderson helped with understanding the household saving rates that I derived from the consumer expenditure survey. Virginia Lewis helped with the history of interest rate data. Pamela Kelly helped with distinctions between different types of federal government fiscal data. Lorin Evans and Bruce Maliken gave important computer assistance. The editorial staff of M.E. Sharpe did a fine job in producing the book: Erin Coakely prepared the manuscript for publication; Angela Piliouras was the production editor; Susanna Sharpe was the copy editor; Nancy Connick was the typesetter; Barbara Long prepared the index. I thank all of the above for their help, which was essential. However, they may not agree with the general approach of the book, or with particular aspects of it. I alone am responsible for the interpretations and views expressed in the book. Notes 1. The recession from March 1945 to October 1945 began in the last phases of World War II. The war against Germany ended in May 1945 and the war against Japan ended in August 1945. The nation’s wartime production of goods and services for the armed forces and the civilian population was at its peak early in 1945. Germany’s defeat looked increasingly likely by late 1944 before it finally occurred in May 1945, so there had been some cutback in the massive wartime military

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spending early in 1945. Economists generally attribute the March 1945–October 1945 recession to that military cutback. The share that national defense took of all resources in the economy, as measured by the gross domestic product, declined from 43 percent in 1944 to 37 percent in 1945 (for perspective, the peak national defense share of the economy during the Iraq War was 5.1 percent in 2008). The 1945 recession is not included in this analysis because it was dominated by the beginning of the demobilization of the vast wartime economy. By contrast, the recessions in this book reflect the cyclical fluctuations of an economy that are overwhelmingly driven by civilian markets. The recession that began in December 2007 was in progress when the manuscript for the book was completed in June 2009. I cite no monthly ending date to the recession. But I believe it will be designated as ending sometime in 2009, and so I refer to it as the 2007–9 recession. 2. Victor Zarnowitz was the foremost student of business cycles. His book, Business Cycles: Theory, History, Indicators, and Forecasting, is a monument in the field. He was one of the seven members of the Business Cycle Dating Committee, convened by the National Bureau of Economic Research, which determines when a recession begins and when it ends. He worked up to the end of his life in 2009 at age eightynine: as a member of the Business Cycle Dating Committee; and as a Senior Fellow and Economic Counselor to the Conference Board on its leading indicator system for the United States, and for eight other countries and the Euro region. He was Professor Emeritus of Economics and Finance in the Graduate School of Business of the University of Chicago, and Research Associate of the National Bureau of Economic Research. He wrote an account of his incredible life, Fleeing the Nazis, Surviving the Gulag, and Arriving in the Free World: My Life and Times (Praeger, 2008). A highlight of my trips to New York was having lunch with Victor.

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Recession Prevention Handbook

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1 Characteristics of Recessions

This chapter discusses several general aspects of recessions in order to provide a broad underpinning for the essence of the book. The topics are: s "USINESSCYCLESANDRECESSIONS s &REQUENCYOFRECESSIONSSINCETHEEARLYS s 3EVERITYOFRECESSIONS s *OBLESSRECOVERIESFROMRECENTRECESSIONS s &AILURETOFORECASTRECESSIONSANDITSPOLICYIMPLICATIONS Business Cycles and Recessions Business cycles are the recurring expansion and contraction of overall economic activity associated with changes in employment, income, prices, sales and profits. These cycles do not necessarily follow a standard pattern and they do not occur on a regular basis. In the United States, the time between recessions has typically varied from a few years (though in one case back-to-back recessions occurred only one year apart) to as much as a decade. Each cycle has its unique characteristics that reflect the underlying structure of an economy, including the composition of industries and employment, inflationary pressures, private and public finance and the economy’s openness to domestic and international competition. Business cycles occur predominantly in market economies, and they are especially prevalent in industrialized countries with highly developed business and financial infrastructures. The nature of the business cycle can be affected by the appearance of new and substitute products, the introduction of new technologies, uncertainty and risk associated with business investment, stock market and real estate speculation, intensification of domestic and international competition, supply and price shocks due to cartels, disruptions in output and sharp increases in demand for products as a result of wars and other threats to national security. Businesses also face the ongoing challenge of accurately gauging the demand 3

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for their products in order to avoid shortages or inventory build-ups. Overshooting in either direction can contribute to business cycle swings. Animal Spirits and Irrational Behavior Also, it is important to keep in mind that households and businesses do not always act rationally. George Akerlof and Robert Shiller cite such lack of rationality as a major source of business recessions and depressions. “To understand how economies work and how we can manage them, we must pay attention to the thought patterns that animate people’s ideas and feelings, their animal spirits.”1 The idea of animal spirits in driving the macroeconomy originated with John Maynard Keynes in his 1936 book, The General Theory of Employment, Interest, and Money. Keynes defined animal spirits as a motivating force in initiating investments in which the potential returns are too problematic to be calculated realistically by an assessment of prospective costs and benefits. “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be undertaken as a result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come.”2 Akerlof and Shiller note that irrational economic and noneconomic behavior is part of animal spirits that affect the overall economy. The intertwining of economic and noneconomic behavior consists of the degree of confidence that people have in the future, the aspect of fairness in setting prices and wages, corruption and bad faith present in economic enterprises, money illusion in focusing on the dollar value of income and assets while neglecting the effects of inflation on the purchasing power of income and assets, and stories that affect public perceptions received from the media, discussions with friends and fellow workers, and memories of past events, accurate and inaccurate. Moreover, Akerlof and Shilling consider that irrational behavior especially during prosperous times increases the risk of subsequent business recessions and depressions. I have put forward the following examples of such irrational behavior in this book, I conclude that these behaviors were important factors leading to several recessions: s Recessions of 1973–75, 1980, and 1981–82: The expectation of businesses and workers during the 1970s that high rates of inflation would continue indefinitely. This led them to engage in an upward spiral of

CHARACTERISTICS OF RECESSIONS

5

prices and wages, with higher prices followed by demands for higher wages, higher wages followed by higher prices, and so on. Both sets of actions were undertaken to maintain business profit margins and the purchasing power of wages. s Recession of 2001: The dot-com and stock market speculation in the last part of the 1990s in which the creation of telecommunications companies that often were not economically viable, or that existed on paper only. Much of the financing of the dot-com companies was fueled by a speculative rise in stock market prices. The general rise in stock market prices in turn hinged on expected growth of company profits and dividends so far into the future that it gave an overly optimistic view of company prospects. s Recession of 2007–9: The perception by households, businesses, banks, and other lenders in the early 2000s that house prices would rise indefinitely. This mindset led households to buy houses priced much above what they could afford, and banks and other lenders to lower their lending standards much below prudent financial practice. This concept of irrational behavior breaks with the classical economic theory of the “invisible hand” derived from Adam Smith, which assumes that the market is inherently efficient, and so results in only minimal shortterm deviations from long-term economic growth. In this view, the market contains a built-in self-correcting mechanism that smooths the short-term deviations from long-term growth into a residual of only minor recessions of short duration. An earlier break with the premise of the invisible hand was of course John Maynard Keynes’ book noted above. The break was one of the components underlying Keynesian economics of using fiscal policy to stimulate economic growth when the economy is operating below its potential, and similarly, using fiscal policy to restrain economic activity when the economy is operating above its potential. The irrational behavior associated with bringing on the several recessions cited above is driven by two general factors. One is the quality of the information that individuals and businesses possess, which ranges from accurate to inaccurate and complete to incomplete. This imperfect information diverges from the premise of efficient markets underlying the idea of the invisible hand, which assumes that all buyers and sellers have accurate and complete information. The other is that individuals and businesses have varying psychological predilections for risk-taking, ranging from cautious to gambling. These innate predilections are also likely affected during particular periods by a herd mentality in which the thought is that, say, because prices of houses or stocks

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appear to be rising indefinitely into the future, houses and stocks will only become more expensive if not purchased at the present time. Other examples of differing predilections for risk-taking are the ranges of willingness to invest in new ventures, housing, and financial assets; to borrow funds for purchasing household goods, health, education travel services, etc.; to enlarge business operations, and for lenders to extend credit. The varying quality of information that individuals and businesses possess on the one hand, and their varying psychological predilections for risk-taking on the other, may contribute to some irrational economic behavior on their part. Business Cycle Phases In most cases, a business cycle is composed of three stages: expansion, recession, and recovery; in rare cases, a fourth stage occurs, which I refer to as contraction.3 The four stages are defined as follows: Expansion and recovery refer to rising phases of a business cycle. A recovery has begun when the economy stops declining and turns upward. An expansion occurs when the upward recovery exceeds the level of the previous expansion. Recession and contraction refer to falling phases of a business cycle. If, from the high point of an expansion, the economy turns downward with persistent declines in production and employment and increases in unemployment, then a recession has set in. In rare cases, when the decline in production and employment falls below the low point of the previous recession, a contraction has set in. The last contraction extended the 1981–82 recession. The high point of an expansion is referred to as the “peak,” and the low point of a recession/contraction is referred to as the “trough.” Figure 1.1 depicts these generic phases of the business cycle. It is important to note that a recession signifies an actual decline in production and employment. By contrast, a recession is not present when there is a decline solely in the rate of growth of production during an expansion (what mathematicians call a “second derivative”). This is referred to as a growth recession. A last term that fortunately has not arisen since the 1930s is “depression.” A depression is a collapse of the economy affecting people in all social and economic strata, with mass unemployment, the widespread loss of assets such as homes and life savings, the disappearance of businesses through bankruptcy, and the undermining of the financial system through failures of the banking, securities, and insurance industries. A depression is far more devastating than a recession.4 For example, unemployment rose to about 25 percent in the Depression of the 1930s, compared with unemployment highs of 9 percent to 11 percent in the severe recessions of 1973–75, 1981–82, and 2007–9 and their subsequent recoveries. There is no systematic formula or model that determines the onset or the end

CHARACTERISTICS OF RECESSIONS

Figure 1.1

7

Illustrative Phases of Business Cycles

of a recession/contraction. The Business Cycle Dating Committee, convened by the National Bureau of Economic Research, Inc. (NBER), a private nonprofit organization in Cambridge, Massachusetts, determines the designation of such cyclical turning points by its judgmental assessment of the movements of statistical measures of the economy, referred to as economic indicators. Examples of the economic indicators included in the cyclical assessment are business sales, bank debits outside New York City, industrial production, unemployment rate, nonfarm employment and hours worked, personal income, and the less cyclically sensitive gross domestic product (GDP) in nominal dollars and in inflationadjusted dollars (real GDP). Though statistical tests are applied to these and other economic indicators to assess their direction, ultimately the designation of the beginning and end of a recession/contraction is based on professional judgment. While the cyclical turning points are linked to a particular month, rather than to a quarter of the year, reference to the quarterly GDP data adds confidence in assessing the approximate time of the directional change. However, the common implication by reporters, journalists, and politicians that a recession is determined when the real GDP declines for two consecutive quarters, is wrong. The behavior of the above-noted array of monthly indicators used by the Dating Committee determines, in the judgment of the committee, the particular month in which a recession begins and ends. The monthly indicators are used in the statistical preparation of the quarterly GDP, and the GDP measure of the overall economy is built up from the database of the monthly indicators as well as from a host of other statistical data. Therefore, the quarterly GDP is not nearly as sensitive or as timed to the cyclical movements of the economy as are the separate monthly indicators. While the Dating Committee includes the GDP in its deliberations, it does

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not specify that a period of economic downturn must include a decline in the real GDP for two consecutive quarters in order for it to be classified as a recession. In fact, the 1980 and the 2001 recessions did not include declines in the real GDP for two consecutive quarters. Of course, the longer a recession lasts, the greater the chances are that the period will contain two consecutive quarterly declines in the real GDP. But that is only a passive result of time. It is not an active determinant of the onset or of the end of a recession. Therefore, the popularized statement that a recession period is determined when the real GDP declines for two consecutive quarters is not true, no matter how many times or how often reporters, journalists, and politicians say it is. Moreover, the NBER committee’s identification of the beginning of a recession comes close to a year after the actual onset of a recession, well after GDP data are available. Nevertheless, statistical markers of the economy are essential for economic analysis and future policy making. As an example of the lag in determining the cyclical turning points of recessions and recoveries, the recession that ultimately was determined to have started in July 1990 was first announced by the committee nine months later, in April 1991, and the subsequent recovery that began in April 1991 was first announced by the committee twenty-one months later, in December 1992.5 The NBER Business Cycle Dating Committee is composed of seven economists, and is convened specifically to determine the beginning and ending points of expansions and recessions by assessing the preponderant direction of a wide variety of economic indicators. The committee has established a reputation for objectivity, and liberal and conservative economists and politicians alike accept its designations. There is a clear advantage in having a nongovernmental body such as the NBER Business Cycle Dating Committee designate cyclical turning points. Because the executive branch of the federal government runs the federal government’s statistical programs, upon which most of the economic indicators are based, there is always the possibility that an administration will politicize the designation of a cyclical turning point to put its own economic policies in the most favorable light, or even revise designations for previous cycles to make the opposition party look worse. The presence and acceptance of the NBER Business Cycle Dating Committee has helped to obviate those possible outcomes. Even so, because of the importance of the designation of recessions, I believe there should be more transparency in the deliberations of the NBER Business Cycle Dating Committee. I include a recommendation for such transparency in Chapter 13. Table 1.1 shows the monthly dating points of the beginning and end of the eleven recessions that are designated by the NBER Business Cycle Dating Committee.

CHARACTERISTICS OF RECESSIONS

9

Table 1.1 Dating of Business Cycle Recessions and Expansions, 1945–2009 Recessions Peak

Trough

Feb 1945a Nov 1948 Jul 1953 Aug 1957 Apr 1960 Dec 1969 Nov 1973 Jan 1980 Jul 1981 Jul 1990 Mar 2001 Dec 2007

Oct 1945a Oct 1949 May 1954 Apr 1958 Feb 1961 Nov 1970 Mar 1975 Jul 1980 Nov 1982 Mar 1991 Nov 2001

Expansions Duration (months) 8 11 10 8 10 11 16 6 16 8 8

Trough

Peak

Oct 1945 Oct 1949 May 1954 Apr 1958 Feb 1961 Nov 1970 Mar 1975 Jul 1980 Nov 1982 Mar 1991 Nov 2001

Nov 1948 Jul 1953 Aug 1957 Apr 1960 Dec 1969 Nov 1973 Jan 1980 Jul 1981 Jul 1990 Mar 2001 Dec 2007

Duration (months) 37 45 39 24 106 36 58 12 92 120 73

b

Source: National Bureau of Economic Research, Business Cycle Dating Committee. Notes: The NBER Business Cycle Dating Committee includes the monthly cyclical turning points as occurring in the same month for both the end of the expansion and the beginning of the recession in the peak month, and the end of the recession and the beginning of the recovery in the trough month. Because the most frequent data available for assessing the cyclical turning points are monthly, in practice the determination of a cyclical turning point occurs some time within a month rather than on the first day or the last day of a month. This results in overlapping months in determining the beginning and end of expansions and recessions. Therefore, the duration of expansions and recessions both include the same month. The issue occurs because the determination of the turning points is based on data gathered that represents one calendar month. Thus, there will always be a confluence of the peak and trough in the same month unless sufficient daily or weekly data were available to specify the day or week of the cyclical turning point. Given the additional reporting burden on survey respondents for obtaining such data, the additional dollar costs, and the dubious benefits from such a refinement, it is unlikely such data will become available in the foreseeable future. Peak. High point of expansion before economy turns down into recession. Trough. Low point of recession before economy turns up into recovery. a As noted in the Preface (note 1), I do not include the 1945 recession in the analysis because it was dominated by the transition from a military to a civilian economy that was associated with the end of World War II in August 1945. Thus, the underlying cause was external, not endogenous to the business cycle. It is shown in the table for completeness. b The recession that began in December 2007 was still in progress when the manuscript was completed in June 2009.

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A Proposed New Definition of Economic Downturns The above discussion provides three categories of economic downturns: recession, contraction, and depression. William Nordhaus suggests that because downturns vary considerably in intensity, it would be beneficial to define them analogously to the varying intensities of hurricanes.6 This presumably would replace the existing method of classifying economic downturns that focuses on the sequential stages of a particular downturn, which by its terminology is neutral on the impact on people and businesses, with the exception that the image of a depression conjures a widespread collapse of the economy, which wreaks havoc across all social and economic groups of the population. In a tentative classification system, Nordhaus offers the following: s #ATEGORY)PAUSEINECONOMICACTIVITY   ;= s #ATEGORY))MILDDOWNTURN   s #ATEGORY)))TYPICALRECESSION      s #ATEGORY)6DEEPANDPROLONGEDRECESSION n s #ATEGORY6DEPRESSION S The listing addresses the intensity with such words as mild, typical, and deep and prolonged. With one exception, it shows downturns occurring within one year only, though they actually occurred during part of one year and part of the subsequent year. Category I, characterized as a pause in economic activity, diverges most from the traditional definitions of an economic downturn, which signifies an absolute decline in production and employment. Moreover, it includes the 2001 recession, albeit with a question mark, along with 1963 and 1967, which were not recession years.7 Category IV, characterized as a deep and prolonged recession, combines two back-to-back recessions as one, even though the 1980 recession was followed by a short-lived expansion during parts of 1981–82, the 1981–82 recession fast on its heels. The acceptance of such designations, considered when recessions seem likely to begin in light of a weakening economy, or have just begun, could promote counteracting economic policies. However, I believe that even without such formal designations, economic policy makers intrinsically have in mind the nature of a particular downturn when pursuing a course of action. This does not preclude using such designations in retrospective analyses of recessions. Frequency of Recessions Since the Early 1980s Since the early 1980s, the U.S. economy has become less cyclical, with fewer recessions. The length of the expansions between recessions determines the

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11

frequency of recessions. The longer the expansions between recessions, the less frequent the recessions. Table 1.1 above under Business Cycles and Recessions showed the beginning and ending dates of all the recessions and expansions from 1945 to 2009. As noted in the Preface, I do not include the 1945 recession in the analysis because it was dominated by the transition from a military to a civilian economy. It is included in the table for completeness. From 1948 to 1981 (thirty-three years), there were eight recessions, occurring on average every four years. The duration of expansions ranged from one year between the 1980 and the 1981–82 recessions to almost six years between the 1973–75 and the 1980 recessions. The exception to this was one long period of close to nine years between the recession of 1960–61 and that of 1969–70. By contrast, from 1982 to 2007 (twenty-five years), the U.S. economy was less cyclical, sustaining four recessions, which occurred on average every 6.5 years. The duration of the expansions was close to 8 years between the 1981–82 and the 1990–91 recessions, 10 years between the 1990–91 and the 2001 recessions, and 6 years between the 2001 and the 2007–9 recessions. 7HATACCOUNTSFORTHELESSFREQUENTRECESSIONSSINCETHEEARLYS3EVeral studies have commented on the decline in the volatility of the economy. But the studies do not directly address the decline in the frequency of recessions. I comment on this at the end of this section. For example, in one study, James Stock and Mark Watson provide comprehensive quantitative estimates of the declining volatility, developing some estimates themselves as well as drawing on estimates by others.8 They understand the declining volatility of the economy since the early 1980s as the greater stability in the four-quarter growth rate of the real gross domestic product (GDP adjusted for inflation) and its components, together with the growth rates of employment, prices, and interest rates. Stock and Watson feel they had limited results in accounting for the greater stability of the economy, with the identified factors explaining only about half of the decreased volatility. They attribute 10 to 25 percent of greater economic stability to the more aggressive stance on inflation by the Federal Reserve since the mid-1980s. Other contributors to the improvement in economic stability they cite are the decline in certain sudden shocks to the economy: less-volatile productivity shocks, less-volatile commodity price shocks for food, industrial materials, and sensitive materials (raw materials requiring further processing), and to a lesser extent less volatile federal fiscal policy shocks for taxes and government spending. However, the authors do not find that the long-term shift from manufacturing to the less cyclical service industries and the improved inven-

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tory management associated with the use of computers to have contributed to greater economic stability. In another study, Kevin Stiroh characterizes the decline in the volatility of the economy in a rolling twenty-quarter growth rate of the real GDP since 1984.9 Stiroh attributes this decline to the less volatile labor input of hours worked (the combination of employment and average weekly hours per employee) together with the less volatile movements of the residual component of total factor productivity. This residual component of total productivity excludes inputs of employment and average weekly hours worked and of capital services inputs of equipment, structures, land, and inventories. Thus, the productivity residual (also referred to as multifactor productivity) comprises the aggregate effect on productivity of worker skills and effort, executive direction and management skills, technology, level of output, capacity utilization, energy consumption, materials quality, public sector infrastructure, all other factors, and the interactions among them. Other factors of differing relative importance may have contributed to the less volatile economic growth over the last few years. For example, globalization and the intensification of domestic and international competition that became a noticeably growing factor in the 1990s may have reduced volatility in the U.S. economy by shifting the production of cyclical products from the United States to abroad. Also, other analysts may give less importance to shocks and more importance to the gradual long-term shift from the more cyclical manufacturing industries to the more cyclically stable services industries. In sum, the declining volatility of the economy may be associated with less frequent recessions, though no direct relationship between the two phenomena has been quantified. This sense of the relationship is solely statistical in nature, not explanatory of the interaction of substantive elements of the economy. In this view, because recessions are themselves a volatile interruption of a growing economy, it is possible that as the economy in general has become less volatile, the diminished volatility also is reflected in fewer recessions. This puts the declining volatility of the economy as the initiating force leading to fewer recessions. Yet it may be that the reverse is true, with fewer recessions being the initiating force leading to the declining volatility of the economy.10 Or, given the complexity of the economy, the two may interact simultaneously, with no discernible initiating force. An interesting area for research is to determine the nature of the relationship between the declining volatility of the economy and the less frequent recessions, if indeed there is a relationship.

CHARACTERISTICS OF RECESSIONS

13

Severity of Recessions The evidence cited above of fewer recessions since the early 1980s is good news. Ideally, there would be no recessions. However, given the complex interactions among buyers, sellers, workers, investors, borrowers, and lenders, it is utopian to expect that the economy will not, from time to time, get off kilter and deteriorate into recession.11 When a recession occurs, it is hoped that it will be short-lived and that the recovery will be robust. Table 1.1 under the above section on business cycles and recessions shows the duration of recessions since the end of World War II. Eight of the eleven recessions lasted less than one year, ranging from six to eleven months. Two recessions, 1973–75 and 1981–82, lasted sixteen months each. The recession of 2007–9 was in progress for seventeen months when this manuscript was completed in June 2009. The duration of a recession does not fully reflect the length of time it takes workers to find new jobs or the long-term earnings losses they experience due to job losses (see the section below entitled Jobless Recoveries from Recent Recessions). Recessions from the Late 1940s to the 2000s This section summarizes the economic impacts of the eleven recessions since the end of World War II, as measured by the following economic indicators: s %MPLOYMENT s 5NEMPLOYMENT s 2EALWEEKLYEARNINGS s 0OVERTY s 2EAL'$0GROSSDOMESTICPRODUCT s #ORPORATEPROlTS s 0ROPRIETORSINCOME This review provides statistical evidence of how the recessions affected the overall economy, the lives of the American people and their families, and American businesses. Each discussion begins with a description of the content of the indicator, which is followed by an analysis of the cyclical movements of the indicator in the eleven recessions. The data used here are the most recently revised statistics depicting these events. They are keyed to the monthly cyclical turning points of the general economy, as determined by the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) and as shown previously in

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Table 1.1. The timing of changes in the monthly data on employment, unemployment, and real weekly earnings are easily compared with the monthly cyclical turning points of the overall economy. Because real GDP, corporate profits, and proprietors’ income are only available on a quarterly basis, I have used the timing of those quarterly data that most closely corresponds to the monthly turning points of the general economy in this assessment. Data measuring poverty are only available on an annual basis and therefore are less synchronized with the general cyclical turning points than the other economic indicators. The cyclical turning points in monthly and quarterly economic indicators do not always coincide with turning points in the general economy that reflect the overall economy. An indicator may have begun declining during the expansion before, or after, a general recession began. Alternatively, an indicator may have begun rising before the recession, or after a recession officially ended. Thus, solely confining the movements of the data to the general cyclical turning points does not give a complete picture of the impact of the recession attributable to individual indicators when they diverge from the monthly dating of the general recession. Therefore, the data for each monthly and quarterly indicator are shown both for their timing correspondence to the general recession and to their own particular cyclical turning points, as described below. To account for the divergence of some indicators in their movements from the timing of the general cyclical tuning points over the eleven recessions, the figures include two sets of data for each indicator (except for the annual poverty data). One set, the first bar, represents the data for each indicator as they appeared in the month (or quarter) that coincides with peaks and troughs of the month represented by the general recession in the overall economy. The other set, the second bar, represents the cyclical turning points of each individual indicator, referred to as the particular recession, which contrasts when the indicator’s own turning points diverged from the general cyclical turning points. As noted earlier in the Business Cycles and Recessions section, the high point of an expansion is referred to as the “peak,” and the low point of a recession/contraction is referred to as the “trough.” Both sets of data in the figures reflect the monthly (quarterly) peaks and troughs for each indicator. Rising employment, real weekly earnings, real GDP, corporate profits, and proprietors’ income are “good,” while rising unemployment is “bad.” This difference is reflected in the headings of the two columns of the table. Employment, real weekly earnings, real GDP, corporate profits, and proprietors’ income are shown as highest peak and lowest trough, while unemployment is shown as lowest peak and highest trough. In both cases, the peak is the point of departure for assessing the impact of the recession,

CHARACTERISTICS OF RECESSIONS

15

but the peak for unemployment logically differs from the peak for the other indicators because of the nature of the “good” and “bad” noted above. Poverty, like unemployment, is also “bad” when it rises, but because the poverty indicator is limited to annual data, it is not referenced in cyclical monthly low points and high points. Employment Indicator Content Employment represents the number of nonfarm civilian jobs every month based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. The employer organizations, referred to as establishments, are both U.S.-owned and foreignowned, and include workers of all ages. All jobs are counted equally, from the lowest pay scales to company executives and officers, as are full-time and part-time jobs. The Bureau of Labor Statistics in the U.S. Department of Labor prepares the employment data. This measure of employment excludes farm workers, people who are self-employed, employed by private households, or employed by religious organizations, and military personnel on active duty in the armed forces (although uniformed military personnel who hold civilian jobs are included in the job count), workers in the intelligence and national security government agencies, workers in foreign embassies, and workers in international organizations such as the International Monetary Fund and the World Bank. The number of jobs exceeds the number of workers since some workers have more than one job. Cyclical Movements Figure 1.2a shows the cyclical patterns of employment around recession periods. Employment declined in all eleven recessions. The recession-to-recession movement of decreases in both dating measures fluctuated similarly over the eleven recessions. The job losses were larger in the particular recession measure in seven of the eleven recessions. The largest job losses were 5.9 million jobs in the 2007–9 recession (in progress in April 2009), 2.7 and 2.8 million jobs in the 1981–82 and 2001 recessions, and 2.2 to 2.3 million jobs in the 1948–49, 1957–58, 1960–61, and 1973–75 recessions. The smallest losses were 0.8 million jobs in the 1969–70 recession, and 1.2, 1.6, and 1.7 million jobs respectively in the 1953–54, 1980, and 1990–91 recessions.

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Figure 1.2a Job Losses in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on the U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government employer payrolls from the establishment survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, jobs.

Figure 1.2b shows job losses as a percentage of the total pre-recession jobs. The greatest relative job losses of 4 to 5 percent occurred in the 1948–49, 1957–58, 1960–61, and 2007–9. Smaller relative job losses of 3 percent occurred in 1953–54 and 1981–82, and of 1 to 2 percent in 1969–70, 1980, 1990–91, and 2001. Figure 1.2c (page 18) shows the duration in months of the job losses. The duration during which employment declined in the particular recession measure typically ranged from 10 to 15 months. The longest periods were 17 months (1981–82 recession) and the 2007–9 recession (in progress in June 2009), 24 months (1973–75 recession), and 25 months (2001 recession). The shortest period of job losses was four months (1980 recession). Job losses affect the workers, their families, and their communities. As a broad approximation of the spread of job losses to people beyond the individual worker, one may assume that on average, between two and three other people are dependent on each worker’s income. On this basis, 6 to 8 million people can be affected from a 2 million decline in jobs, and 9 to 12 million people can be affected from a 3 million decline in jobs.12

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17

Figure 1.2b Job Losses as a Percentage of Total Pre-Recession Jobs in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government employer payrolls from the establishment survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, jobs.

Unemployment Indicator Content Unemployment represents the number of persons without jobs who are actively seeking work every month. The data are based on surveys of households. The Bureau of Labor Statistics in the U.S. Department of Labor prepares the unemployment data. For the real-time data used in this book, the age of persons included in the unemployment count changed from fourteen years and older in the first four recessions (1948–49, 1953–54, 1957–58, 1960–61), to sixteen years and older in the last seven recessions (1969–70, 1973–75, 1980, 1981–82, 1990–91, 2001, 2007–9). Also, the real-time unemployment data were first seasonally adjusted in the 1960–61 recession. The unemployment rate is the number of unemployed persons as a percentage of the labor force (the labor force is the sum of employment and unemployment). Mathematically, the unemployment rate is:

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Figure 1.2c Duration of Job Losses in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government employer payrolls from the establishment survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, jobs.

(Unemployed persons) ___________________________________________ × 100 Employed persons + unemployed persons (labor force) Employed persons cover nonfarm and farm workers aged sixteen years and older who work at least one hour a week at paid jobs, self-employed persons working in their own businesses, and unpaid workers in family businesses who work at least fifteen hours a week (family workers are assumed to share in the profits of the business). Persons temporarily absent from their jobs because of illness, vacation, strike, or lockout are included as employed whether or not they are paid while they are absent from work. This measure of employment is the alternative count of employment cited in the above section on employment. Unemployed persons cover individuals who have been employed before, as well as those who have never been employed. Unemployed persons include those who collect unemployment insurance as well as those who are not eligible for unemployment insurance. Persons who are not working and are not actively seeking work are defined as “not in the labor force” and therefore are not counted as unemployed.

CHARACTERISTICS OF RECESSIONS

19

To be considered as unemployed, a job seeker must have actively sought a job at least once in the previous four weeks of the surveyed month. Such pursuit of a job requires taking at least one of the actions listed below. The exception to this is that persons who have been laid off, but expect to be recalled to that job, do not need to actively look for a job to be classified as unemployed. s (AVINGAJOBINTERVIEW s #ONTACTINGANEMPLOYERFORAJOBINTERVIEW s !NSWERINGAJOBADVERTISEMENT s 3ENDINGOUTRESUMES s #ONTACTINGANEMPLOYMENTAGENCY AFRIEND ORARELATIVE s 0LACINGANADVERTISEMENTINANEWSPAPER s #HECKINGWITHAUNIONORAPROFESSIONALREGISTER s /BTAININGASSISTANCEFROMACOMMUNITYORGANIZATION s 7AITINGATADESIGNATEDLABORPICKUPPOINT In addition to the official measure of unemployment that totaled 8.9 million workers in 2008, taken from the household survey that covers all people in the labor force sixteen years and older, there are five alternative measures that provide a range of unemployment that vary from the official rate. These are referred to as alternative measures of labor underutilization. They vary from the official measure based on different categories of workers who are defined as unemployed: 1. Workers unemployed fifteen weeks or longer 2. Workers who have lost a job or completed a temporary job 3. Official unemployment rate, plus “discouraged” workers who no longer look for a job because they think no jobs are available in the local labor market or that they are not qualified for existing job vacancies 4. Number 3, plus “marginally attached” workers who do not look for a job because of noneconomic reasons such as illness or medical limitations, child care problems or other family or personal obligations, school, or training 5. Number 4, plus workers employed part-time because full-time jobs are not available. Unemployment defined in the first two categories is less than the official rate, and unemployment defined in the last three categories is greater than the official rate. The measure of unemployment that is limited to persons who collect

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unemployment insurance benefits is consequently much smaller than the household measure. It is based on records of state agencies that administer the unemployment insurance program. In 2007, unemployment based on the collection of unemployment insurance benefits averaged 2.5 million workers, compared with unemployment based on the household survey of 7 million workers. Cyclical Movements Table 1.2 shows the cyclical patterns of the unemployment rate around recession periods. Unemployment increased in all eleven recessions in both the general recession measure and the particular recession measure. The increases in the particular recession measure were larger than those in the general recession measure in ten of the eleven recessions. The exception was the 1981–82 recession, which showed the same increase in both measures. The unemployment rate ranged from 6.1 percent to 10.8 percent at the troughs of the eleven recessions. Three recessions ranged from 6.1 to 6.3 percent, five recessions ranged from 7.1 to 7.9 percent, and two recessions were 9 and 10.8 percent. The highest unemployment during recessions was 10.8 percent in the 1981–82 recession. The rate declined to 7.8 percent in the 1990–91 recession and 6.3 percent in the 2001 recession. Unemployment during the ongoing 2007–9 recession, when this manuscript was completed in June 2009, rose to 9.4 percent in May 2009. The sharpness of the increase in unemployment is seen in the change in the unemployment rate from its low point to the high point. The largest increases in percentage points in the unemployment rate in the recession measures were: the 1948–49 recession (4.5 percentage points), the 1973–75 recession (4.4 percentage points), the 2007–9 recession (4.7 percentage points) in progress in June 2009, and the 1953–54, 1957–58, and 1981–82 recessions (3.6 percentage points). The smallest increases in percentage points in the unemployment rate in the recession measures were: the 1969–70 recession (2.7 percentage points), the 1990–91 recession (2.6 percentage points), the 2001 recession (2.4 percentage points), the 1960–61 recession (2.2 percentage points), and the 1980 recession (2.1 percentage points). While the unemployment rate is a critical economic indicator, it is important to see its effect on the everyday lives of people. During the 2007–9 recession, in the general recession the unemployment rate rose from 5.0 percent in December 2007 to 9.4 percent in May 2009, for an increase of 4.4 percentage points. In the particular recession, the unemployment rate rose from 4.7 percent in November 2007 to 9.4 percent in May 2009, for an increase of 4.7 percentage points.

CHARACTERISTICS OF RECESSIONS

21

Table 1.2 Unemployment Rates in General and Particular Recessions (percentage) Year (Increase) 1948 1949 Increase (% points) 1953 1954 Increase (% points) 1957 1958 Increase (% points) 1960 1961 Increase (% points) 1969 1970 Increase (% points) 1973 1975 Increase (% points) 1980 1980 Increase (% points) 1981 1982 Increase (% points) 1990 1991 Increase (% points) 2001 2001 2003 Increase (% points) 2007 2009* Increase (% points)

General

Particular

3.8 7.9 4.1 2.6 5.9 3.3 4.1 7.4 3.3 5.2 6.9 1.7 3.5 5.9 2.4 4.8 8.6 3.8 6.3 7.8 1.5 7.2 10.8 3.6 5.5 6.8 1.3 4.3 5.5 — 1.2 5.0 9.4 4.4

3.4 7.9 4.5 2.5 6.1 3.6 3.9 7.5 3.6 4.8 7.0 2.2 3.4 6.1 2.7 4.6 9.0 4.4 5.7 7.8 2.1 7.2 10.8 3.6 5.2 7.8 2.6 3.9 — 6.3 2.4 4.7 9.4 4.7

Source: Bureau of Labor Statistics, U.S. Department of Labor, from the household survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, unemployment. *The 2007–9 recession was in progress when the manuscript was completed in June 2009. See beginning of Chapter 12.

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The increases in the unemployment rate in the general and particular recessions reflected net increases of 5.5 million workers in the general recession (15 months) and 6.0 million workers in the particular recession (16 months). The net increase represents jobs lost minus jobs gained. Figure 1.3 shows the duration of the increases in the unemployment rate. The unemployed rate continued to rise for 15 or more months in nine of the eleven recessions in the particular recession measure. The longest periods were 21 months in the 1948–49 recession, 24 months in the 1990–91 recession, and 30 months in the 2001 recession. The shortest period was 12 months in the 1980–80 recession. Income from Unemployment Insurance Benefit Payments Unemployment insurance (UI) benefit payments provide some income subsistence to unemployed workers through the federal-state unemployment insurance system. The federal-state system allows states to pay benefits up to a maximum of twenty-six weeks of unemployment, though eligibility criteria, duration of assistance, and amount of benefit payment vary considerably by state. The unemployment insurance system also triggers additional benefit payment during prolonged periods of high employment in particular states. These extended benefit payments go beyond the first 26 months to an additional 13 to 20 weeks among individual states. Congress can also act to extend UI benefit payments. The Employment & Training Administration in the U.S. Department of Labor prepares the unemployment insurance data. In order to qualify for UI benefits, the person must have worked a specified period of time for a private employer (in a place of business or as a household worker) or for a state or local government. There is no federal-state UI coverage for employees of religious organizations or for self-employed workers. The federal-state system excludes other UI systems that cover federal or railroad workers. Table 1.3a shows the national average weekly UI benefit payments in dollars, and those payments as a percentage of nonfarm average gross weekly wages and salaries of workers in the highest unemployment years of the eleven recessions: 1949, 1954, 1958, 1961, 1975, 1981, 1982, 1991, 2001, and 2008 (the still higher unemployment for 2009 was in progress when the manuscript was completed in June 2009). The table also includes the UI benefit payments during the high unemployment of the jobless recovery years of 2002 and 2003. Gross weekly wages and salaries cover money wages and salaries before the payment of income and Social Security taxes of workers in all income levels; these data exclude employer-paid fringe benefits for health insurance and retirement.

CHARACTERISTICS OF RECESSIONS

Figure 1.3

23

Duration of Unemployment Rate Increases in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on the U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, unemployment.

Average unemployment insurance benefits for the United States ranged from 33.5 percent to 37.7 percent during the eleven recessions and for the 2002 and 2003 recovery years. Table 1.3b shows the ten states with the highest and the lowest average weekly benefit payments in dollars, and those payments as a percentage of average gross weekly wages and salaries, in 2008. The ten states with the highest weekly benefit payments in 2008 ranged from Hawaii ($413) to Kansas ($316). The weekly benefit payments as a percentage of each state’s gross weekly earnings ranged from Hawaii (55 percent) to Connecticut (29 percent). The ten states with the lowest weekly benefit payments in 2008 ranged from West Virginia ($241) to Mississippi ($223). The weekly benefit payments as a percentage of each state’s gross weekly earnings ranged from South Dakota (39 percent) to Alaska (24 percent).

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Table 1.3a U.S. National Average Weekly Unemployment Insurance Benefit Payments in Recession and Selected Recovery Years

1949 1954 1958 1961 1970 1980 1982 1991 2001 2002 2003 2008

Payments (dollars)

Payments as a Percentage of Gross Weekly Earnings

20.48 24.93 30.54 33.80 50.31 99.66 119.34 169.88 238.07 256.79 261.67 297.09

36.0 33.5 35.3 35.4 35.7 36.6 37.7 36.4 34.6 36.8 36.5 34.8

Source: Employment & Training Administration, U.S. Department of Labor.

Real Weekly Job Earnings Indicator Content Real weekly job earnings represent the money wages and salaries of workers in private nonagricultural industries, adjusted for the monthly movements of inflation or deflation. The data are based on payroll records of employers. They cover earnings of production workers in manufacturing industries and nonsupervisory workers in other private nonagricultural industries before the payment of income and Social Security taxes. The data exclude earnings for office and sales workers in manufacturing, for supervisors and executives in all industries, and for government workers. The Bureau of Labor Statistics in the U.S. Department of Labor prepares the earnings data. Earnings include paid vacations, sick leave, holidays, and overtime, but exclude health, retirement, and other noncash fringe benefits. The earnings are influenced by changes in the composition of high-paying and low-paying industries and occupations. Cyclical Movements Figure 1.4 (page 26) shows the cyclical patterns of real weekly job earnings during the 1969–70, 1973–75, 1980, 1981–82, 1990–91, 2001, and 2007–9

CHARACTERISTICS OF RECESSIONS

25

Table 1.3b Unemployment Insurance Average Weekly Benefit Payments, and Benefit Payments as a Percentage of Gross Weekly Earnings, for Selected States, 2008 Ten States with the Highest Unemployment Benefit Payments:

Hawaii Massachusetts New Jersey Rhode Island Washington Minnesota Colorado Pennsylvania Connecticut Kansas

Average Weekly Benefit Payment (dollars)

Percentage of Gross Weekly Earnings

413 391 377 370 355 347 341 335 322 316

55.1 36.3 36.1 46.4 40.7 40.3 38.8 40.1 28.9 44.3

Ten States with the Lowest Unemployment Benefit Payments:

West Virginia South Carolina South Dakota Florida Tennessee Arizona Louisiana Alaska Alabama Mississippi

Average Weekly Benefit Payment (dollars)

Percentage of Gross Weekly Earnings

241 240 239 238 221 218 209 202 196 183

37.0 35.2 39.2 31.1 29.4 27.2 28.0 24.1 27.4 29.4

Source: Employment and Training Administration, U.S. Department of Labor.

recessions. Real weekly earnings data were not available before the 1969–70 recession because the survey data were not collected for some service industries before then. Earnings declined in five of the seven recessions in the measure coinciding with the general recession measure, and increased in the general recession measure in the 2001 and 2007–9 recessions. Earnings declined in six recessions in the particular recession measure, and increased in the 2007–9 particular recession measure. Decreases in the particular recession measure were larger than those in the general recession measure in the six recessions.

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Figure 1.4

Real Weekly Earnings in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on the U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government employer payrolls from the establishment survey. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, real weekly earnings.

The largest decreases in worker earnings were 9.3 and 9.5 percent in the 1973–75 and 1980 recessions, followed by 3.7 and 4.0 percent in the 1981–82 and 1990–91 recessions. The smallest decreases were 0.8 percent in the particular recession measure of the 2001 recession, 1.7 percent in the general recession measure in the 1981–82 recession, and 2.1 and 2.5 percent in the two measures of the 1969–70 recession. The duration of the decline in real weekly earnings in the particular recession measure ranged from 17 to 22 months in five recessions and was 29 months in one recession. Poverty Indicator Content Poverty represents the number of persons and families living below a minimum income that is considered adequate. The data are prepared annually, and so

CHARACTERISTICS OF RECESSIONS

27

do not correspond to the peaks and troughs of the monthly cyclical data. The measure of poverty is based on an income standard that was adopted in 1964. The income standard is updated only for increases in inflation as determined by yearly movements in the consumer price index. The Bureau of the Census in the U.S. Department of Commerce prepares the poverty data. Poverty is defined as a threshold income that is below the standard of living recognized by society as necessary for meeting minimum economic living needs at a particular point in time. Thus, poverty is an evolving, normative concept of economic deprivation that changes over time. Perceptions rise of “how much income is too little” as income gains over time in the general population raise the living conditions and aspirations of society. For example, when President Franklin Roosevelt in 1937 said “I see one third of a nation ill-housed, ill-clad, and ill-nourished,” it was based on a poverty standard developed in the 1930s. Three decades later, the poverty standard adopted by President Lyndon Johnson in 1964 was 75 percent higher in real terms than the 1937 standard. One economist estimated that if the Johnson standard of the 1960s had been used in the 1930s, Roosevelt’s one-third of a nation would have been close to two-thirds.13 Analogously, the poverty standard of the 1930s was considerably above an unofficial one of the early 1900s.14 The poverty standard in 2008 is the same as the 1960s standard. That standard is based on estimates by the U.S. Department of Agriculture in 1961 of the least expensive of four food plans to meet nutritional adequacy standards. In order to cover all living expenses, including housing, health, transportation, and other nonfood items, the food costs were multiplied by a factor of three, based on a 1955 study indicating that food accounts for one-third of the average household budget for families of three or more persons at all income levels, not just low-income families. Food accounted for slightly under 14 percent of all expenditures by urban households in 2008, and if the poverty standard were updated based on its original methodology, the approximate nonfood “multiplier” in 2008 would be a 7, resulting in a much higher poverty income threshold and a larger estimate of the number of people living in poverty. Because the threshold income of the 1960s standard was confined to money income only, it did not include the subsequent nonmoney income supplements such as food stamps, housing subsidies, medical care assistance, and energy assistance, as well as accounting for the earned income tax supplement. A 1995 study by the National Research Council (the NRC is associated with the National Academy of Sciences) recommended a new methodology for establishing a poverty standard that would accommodate both the rising incomes and aspirations of the general population and the nonmoney income supplements, and so provide a basis for updating the standard in the future.15 The new methodology has several variants that include different component

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living needs as well as geographic adjustments for different prices of goods and services in regions around the country. Based on these variants, the new methodology would raise the percentage of the population that is in poverty in 2007 from the official rate of 12.5 percent to a range of 12.6 to 16.0 percent. The U.S. Census Bureau updates the NRC calculation every year. Raising the poverty standard raises the number of people living in poverty, which in turn would increase federal spending on social entitlement programs. This would increase the federal budget deficit unless taxes are increased or other federal spending is decreased. As a political issue, it would have to be resolved by Congress and the president.16 All economic indicators have an aspect of subjectivity in their definitions. However, as evident from this discussion, the measure of poverty is far more subjective than the other economic indicators covered in the book. The establishment of a poverty line does not mean that people with incomes slightly above the line have an easy time, though it may disqualify them for some income support programs.17 Cyclical Movements Table 1.4 shows the shows the number of people living in poverty and the poverty rate. The poverty rate is the percentage of the civilian noninstitutional population living below the poverty standard. The poverty rate in the years immediately preceding and following the general recession years generally conformed to the corresponding monthly cyclical turning points of the recessions, though with some exceptions. The exceptions are the pattern of the poverty rate rising during the recession and in the first recovery year. Poverty data first became available in 1959, immediately preceding the 1960–61 recession. The poverty rate declined both during the recession and the first recovery year of that recession, which was an exception from the above-noted general pattern. There also was a one-time sharp drop in the poverty rate of over 20 percent around the 1960–61 recession to over 12 percent around the 1969–70 recession. This significant lessening of poverty during the 1960s resulted from the substantial increase in the Great Society income support programs initiated by President Lyndon Johnson, together with high economic growth during the decade. Over the subsequent five recessions, the poverty rate fluctuated around 11 to 15 percent. Thus, from a longer perspective of the 1970s to the 2000s, there was no decline in the poverty rate following the striking drop during the 1960s. The poverty rate and the absolute number of people in poverty declined in the first recovery year in the 1960–61, 1969–70, and the 1973–75 recessions, except for the number of people in poverty in the 1969–70 recession.

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29

Table 1.4 Poverty Rate and People in Poverty Poverty Ratea (%)

People in Poverty

1959 1960 1961 1962

22.4 22.2 21.9 21.0

39,490 39,581 39,628 38,625

1968 1969 1970 1971

12.8 12.1 12.6 12.5

25,389 24,147 25,420 25,559

1972 1973 1974 1975 1976

11.9 11.1 11.2 12.3 11.8

24,460 22,973 23,370 25,877 24,975

1979 1980

11.7 13.0

26,072 29,272

1981 1982 1983

14.0 15.0 15.2

31,882 34,398 35,303

1989 1990 1991 1992

12.8 13.5 14.2 14.8

31,528 33,585 35,708 38,014

2000 2001 2002 2003 2004

11.3 11.7 12.1 12.5 12.7

31,581 32,907 34,570 35,861 37,040

2006 2007

12.3 12.5

36,460 37,276

Recession Years 1960–61

1969–70

1973–75

1980 1981–82

1990–91

2001

2007–9*

Source: “Income, Poverty, and Health Insurance Coverage in the United States: 2007,” Current Population Reports, Bureau of the Census, U.S. Department of Commerce, August 2008. Note: Because the poverty data are available only annually, it is not feasible to synchronize them with the monthly cyclical peaks and troughs of recessions. Data for poverty first became available in 1959. a Poverty rate is people in poverty as a percentage of the civilian noninstitutional population. *The 2007–9 recession was in progress when the manuscript was completed in June 2009.

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By contrast, the poverty rate and the number of people in poverty rose in the first recovery year following the 1980, the 1981–82, and 1990–91 recessions, and into the first two recovery years after the 2001 recession. The poverty rate in 2007 was 12.5 percent, the latest year that the poverty data were available when the manuscript was completed in June 2009. This was up slightly from 12.3 percent in 2006. Because the recession of 2007–9 began in December 2007, the poverty data for 2008 will be the first measure of poverty for a full recession year. Real GDP Indicator Content The gross domestic product is the most comprehensive measure of the health of the overall economy. The nominal GDP is estimated in dollars in the market prices of each quarter. The real GDP is the nominal GDP adjusted for inflation or deflation from quarter to quarter and year to year. Movements in the real GDP from quarter to quarter and year to year are the major indicator of economic growth. They are presented as quarterly percentage changes at seasonally adjusted annual rates. The Bureau of Economic Analysis in the U.S. Department of Commerce prepares the GDP data as part of the national income and product accounts. The GDP covers the goods and services produced in the private, government, domestic, and foreign sectors of the economy. Two measures of the GDP are prepared. One is from the viewpoint of demand, which shows the goods and services purchased by households, business, governments, and foreign exports and imports. The other is from the viewpoint of supply, showing the resource costs in producing the goods and services, for labor, use of equipment and structures, business profits, interest, sales and property taxes, customs duties, and miscellaneous payments to governments. The GDP represents a “value-added” concept, in which only the value that is produced in each stage of production is counted. Thus, the raw materials, semi-finished goods, and final products that are purchased from suppliers earlier in the production chain are only counted once when they were originally produced, because to count them in successive stages of production would double count them. Cyclical Movements Figure 1.5a shows the movements of real GDP in all recessions. Real GDP declined in all recessions, except 2001, in the general recession measure. Real GDP declined in all recessions in the particular recession dating measure. The recession-to-recession movement of decreases in both dating measures

CHARACTERISTICS OF RECESSIONS

31

Figure 1.5a Real Gross Domestic Product in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data on the gross domestic product. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, real GDP.

fluctuated similarly over the eleven recessions: the rate of decrease rose from 1948–49 to 1957–58, declined in 1960–1 and 1969–70, rose in 1973–75, and declined subsequently to 2007–9, except for the rise in 1981–82. The rate of decrease in real GDP was larger in the particular recession measure in seven of the eleven recessions. The largest decreases in real GDP were in the 1957–58, 1973–75, and 1981–82 recessions, which ranged from 2.9 to 3.7 percent. The smallest decreases were in the 1960–61, 1969–70, 1990–91, and 2001 recessions, which ranged from 0.2 percent in 2001 to 1.6 percent in 1960–61. The 2001 recession showed an increase of 0.3 percent in the general recession measure, and the smallest decrease (0.2 percent) in the particular recession measure. Figure 1.5b shows the duration in quarters of the decreases in real GDP during recessions. The duration of the two dating measures of real GDP were identical in the 1948–49, 1953–54, 1960–61, 1973–75, 1980, and 1990–91 recessions. The general recession measure was longer in the 1957–58 and 1981–82 recessions, and the particular recession measure was longer in the 1969–70, 2001, and 2007–9 recessions.

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Figure 1.5b Duration of Declines in Real Gross Domestic Product in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data on the gross domestic product adjusted for price change. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peak and troughs of cyclical turning points of the individual indicator, in this case, real GDP.

Corporate Profits Indicator Content Corporate profits are the returns to corporate business enterprises from their current operations. Movements in corporate profits from quarter to quarter and year to year are presented as quarterly percentage changes at seasonally adjusted annual rates. Corporate profits represent business income before the payment of federal, state, and local income taxes. The Bureau of Economic Analysis in the U.S. Department of Commerce prepares the corporate profits data as part of the national income and product accounts. Profits occur when operating income (receipts) exceed operating expenses (costs). Losses (negative profits) occur when expenses exceed income. Because profits are the difference between income and expenses, both elements affect profits. From one year to the next, for example, profits decline when income increases less than expenses increase, or when income decreases more than expenses decrease; while profits rise when income increases more than expenses increase, or when income decreases less than expenses decrease.

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Figure 1.6a Corporate Profits in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data from the national economic accounts. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, corporate profits.

The corporate profits measure adjusts for changes over time in the valuation of the inventories held by the business and for the business’s capital equipment and structures used in production. The inventory valuation adjustment excludes the profit or loss due to cost changes between the time of purchase and sale of inventoried goods. The capital consumption adjustment excludes the profit or loss due to price changes in replacing existing capital facilities since their acquisition. Cyclical Movements Figure 1.6a shows the movements of corporate profits in all recessions. Corporate profits declined in nine of the eleven recessions in the measure coinciding with the general recession. The exceptions were the 1990–91 and the 2001 recessions, when profits rose. However, profits declined in all eleven recessions in the measure of particular recessions. Figure 1.6b shows the duration of corporate profits declines during recessions. The longest durations were in the 1969–70, 1973–75, and 2007–9

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Figure 1.6b Duration of Declines in Corporate Profits in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data from the national economic accounts. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, corporate profits. Because corporate profits increased in the general recessions of 1990–91 and 2001–1, there are of course no durations of decline for those periods.

recessions. Because corporate profits increased in the 1990–91 and 2001–1 general recession measures, there are of course no durations of decline for those periods. Proprietors’ Income Indicator Content Proprietors’ income refers to the profits of unincorporated business enterprises. It differs from corporate profits discussed above only in that the companies it covers are unincorporated in their legal organization. Movements in proprietors’ income from quarter to quarter and year to year are presented as quarterly percentage changes at seasonally adjusted annual rates. The Bureau of Economic Analysis in the U.S. Department of Commerce prepares the proprietors’ income data as part of the national income and product accounts. Proprietors’ income is based on the same concepts and the same definitions

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35

as corporate profits. Proprietors’ income is the difference between business operating receipts and expenses. It represents profits before the payment of income taxes, and it includes the same valuation adjustments for inventories and for capital equipment and structures used in production as corporate profits. Cyclical Movements Figure 1.7a shows the movements of proprietors’ income in all recessions. Proprietors’ income declined in six of the eleven recessions in the general recession measure. In contrast, proprietors’ income declined in nine of the eleven recessions in the particular recession measure, with an increase in the 1957–58 recession and no change in the 1960–61 recession. The decreases were larger in the particular recession measure in all recessions, except for the 1990–91 recession, in which both dating measures had the same decrease. Figure 1.7b shows the duration of proprietors’ income declines during recessions. The duration of the decline in proprietors’ income ranged from two to five quarters in the general recession and the particular recession measures. Exceptions occurred in the 2001 particular recession measure, in which the decline was one month, and in the 2007–9 particular recession measure, in which the decline was six quarters (while the recession was still in progress in June 2009). The longest durations of decline were in the 1948–49, 1973–75, 1981–82, 2007–9 recessions. Because proprietors’ income increased in the general recession measure in the 1953–54, 1957–58, 1960–61, 1969–70, and 2001 recessions, there are of course no durations of decline for those periods. Similarly, because proprietors’ income in the particular recession measure increased in the 1957–58 recession and remained constant in the 1960–61 recession, there are no durations of decline for those periods. Jobless Recoveries from Recent Recessions 7HATHAPPENSWHENTHERECESSIONENDS)TISONETHINGFORPRODUCTIONAND employment to stop their absolute declines (a recession is defined by such declines). It is another thing to assess the increase in both production and employment during recovery. As noted in the beginning of this chapter under Business Cycles and Recessions, designation of the beginning and end of recessions by the Business Cycle Dating Committee of the National Bureau of Research is based on a judgmental assessment of the direction of a wide range of economic indicators. In fact, there was a shift in the strength of the recoveries following the 1990–91 and 2001 recessions compared with the recoveries from previous recessions. Specifically, employment growth was far weaker in these more recent

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Figure 1.7a Proprietors’ Income in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data from the national economic accounts. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, proprietors’ income.

recoveries than in the previous recoveries. The recoveries that began during 1991 and 2001 have been referred to as “jobless recoveries.” A jobless recovery is defined as an absence of employment growth when economic growth (the real GDP) resumes expanding from its decline during the recession. Two studies quantified reemployment in these jobless recoveries. A third study assessed reemployment in all periods, not just in recoveries from recessions. In one study, Stacey Schreft and Aarti Singh concluded that:18 s %CONOMIC GROWTH RATES DURING THE n AND THE  RECOVERIES were substantially below the average growth rate of the previous five recessions. s %MPLOYERSDURINGTHEnANDTHERECOVERIESMADEGREATERUSE of overtime work for existing workers rather than hiring new workers. s %MPLOYERSDURINGTHEnANDRECOVERIESMADEGREATERUSEOF temporary and part-time workers. These workers have less job stability and work for lower pay and fewer benefits than permanent, full-time workers.

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37

Figure 1.7b Duration of Declines in Proprietors’ Income in General and Particular Recessions

s4HEnRECESSIONWASINPROGRESSWHENTHEMANUSCRIPTWASCOMPLETEDIN*UNE 2009. See beginning of Chapter 12. Source: Based on Bureau of Economic Analysis, U.S. Department of Commerce, data from the national economics accounts. Note: General recession represents peaks and troughs of cyclical turning points in the overall economy. Particular recession represents peaks and troughs of cyclical turning points of the individual indicator, in this case, proprietors’ income. Because proprietors’ income increased or did not change in selected recession periods, there are of course no durations of decline for those periods.

Schreft and Singh excluded the 1949–50, 1954–55, and 1958–59 recoveries from their analysis because comparable labor market data to those used in the subsequent recoveries were not available for the earlier recoveries. But the authors noted that with acknowledgment of the strong employment growth in those previous recoveries, the 1991–92 and the 2002 recoveries would have been portrayed as even more jobless. In another assessment of the jobless recoveries in 1991–92 and 2002, Erica Groshen and Simon Potter highlighted the difference between temporary and permanent job losses.19 Temporary job losses are cyclical in nature: they are associated with short-term weak demand, and both employers and workers expect that the workers will be rehired when business picks up. By contrast, permanent job losses, in which workers must find jobs with other firms and often other industries, are structural in nature. Of course, the process of matching workers who have permanently lost their jobs with newly created jobs takes longer than simply rehiring workers

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at their previous jobs. Further, in the uncertain economic environment of 2002–3, only a relatively small number of jobs were created. A longer-term study by Henry Farber assessed reemployment following job losses in all periods from 1981 to 2001, not just in recoveries following recessions.20 He found that job losses of more-educated workers, as well as of less-educated workers, increased over time, with overall job losses for less-educated workers being greater. He also noted that though more-educated workers are more likely to become reemployed, and at full-time rather than part-time jobs, on average all workers who lose jobs, regardless of education, have experienced substantial earnings losses. Reemployment of Displaced Workers This section concentrates on what happens to workers twenty years and older who lost their jobs during a recession. It covers (a) the number of workers who lost their jobs and subsequently found new jobs, and (b) compares the earnings between their lost jobs and their new jobs. Displaced workers are those who have permanently lost their jobs, because (a) their plants or companies closed or moved; (b) there was insufficient work for them; or (c) their positions or shifts were abolished. Reemployed workers are identified separately, and within each category, long-tenured workers are those who had three or more years of tenure on lost jobs, and short-tenured workers are those with less than three years of tenure on lost jobs. Data for long-tenured workers are available from the early 1980s, while data for short-tenured workers are first available from the early 1990s. Workers who have temporarily lost their jobs and expect to be called back by their employers when business picks up are not included in the following job displacement data. The displaced worker data are based on information obtained from household surveys conducted by the U.S. Bureau of Labor Statistics (BLS) every other year for the previous three years. The displaced worker survey is a supplement to the BLS current population survey that is conducted monthly and annually. The data represent the combined annual totals of two adjacent calendar years (January to December) that are connected within each of the three most recent recessions and recoveries in the book: 1981–82, 1983–84; 1989–90, 1991–92; 2001–2, 2003–4. The data were first collected for the early 1980s, so similar data for previous recessions are not available. Because of the combined two-year totals, there is an overlap of a recession and a recovery occurring in some two-year periods, while some two-year periods occur solely during recoveries. There is one overlap of an expansion and a recession during the

CHARACTERISTICS OF RECESSIONS

39

1981–82 period, in which the short-lived expansion ended in mid-1981 and was followed by the recession of July 1981 to November 1982. There is an additional complication to the data shown for each two-year period. While the survey collects information on the previous three years, the data on displacement are shown only for the first two years of the survey period, but the data on reemployment are shown for all three years of the survey period. For example, in the survey conducted in January 2006, the job displacement data were confined to 2003 and 2004, while the job reemployment data were recorded for 2003, 2004, and 2005 at the time of the survey in 2006. Job displacement data are not provided for the third year of the survey period because the job loss was relatively recent, and since in some cases it could turn out to be temporary, it would not be a permanent job loss defined as job displacement. It should be noted that the job loss and reemployment data refer solely to the periods of the survey, and do not include carryovers from previous periods. There have been several methodological changes in conducting the survey over the years, so the data for 1991–92 and 1993–94 are not directly comparable with those for 1981–82 and 1983–84.21 Also, beginning with the 2001–2 period, the data include the introduction of population controls from the 2000 census of population used in selecting samples of households to be surveyed, and these data cause further noncomparability in the longterm data series. Such developments in preparing statistical data are necessary to continually improve the quality of the new data over time, but because they introduce problems of comparability, relatively small changes over time may reflect statistical problems with the data rather than real changes. Number of Workers Table 1.5 (pages 42–43) shows the extent to which workers who have lost their jobs (displaced workers) found new jobs (reemployed workers). Bearing in mind the data complications and problems arising from the noncomparability of the surveys over time, the following overall patterns emerge: s ,ONG TENURED DISPLACED WORKERS RANGED FROM  TO  MILLION AND short-tenured displaced workers ranged from 2.1 to 3.1 million in each two-year period. The exceptions were the job losses of 1.8 million for long-tenured workers during the 1983–84 recovery and 1.9 million for short-tenured workers in the 2003–4 recovery. The total number of displaced workers in each two-year period in the recession/recovery period, together with those only in the recovery period, was over 4 million.

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s ,ONG TENUREDDISPLACEDWORKERSINCREASEDFROMTHEEARLYSTOTHE early 2000s. For example, long-tenured displaced workers rose from 2.2 million in the 1981–82 expansion/recession, to 2.6 million in the 1991–92 recession/recovery, to 2.8 million in the 2001–2 recession/ recovery. In the recovery periods only, long-tenured displaced workers rose from 1.8 million in the 1983–84 recovery to 2.2 (2.17) million in the 1993–94 recovery and 2.2 (2.21) million in the 2003–4 recovery. s 3HORT TENUREDDISPLACEDWORKERSROSEFROMMILLIONINTHEn recession/recovery to 3.1 million in the 2001–2 recession/recovery. Shorttenured displaced workers declined from 2.2 million in the 1993–94 recovery to 1.9 million in the 2003–4 recovery. s The percentage of displaced workers who were reemployed over each three-year period, generally rose from 60 to 64 percent over time (the exception was the reemployment rate of 52.6 percent for long-tenured workers in 1981–82). The remaining 36 to 40 percent of the displaced workers did not find work within each three-year period. They either were counted as unemployed, or if they stopped looking for work, were defined as not in the labor force and consequently not counted as unemployed. The overall picture of the job losses and reemployment of displaced workers during each of the recessions and recoveries during the early 1980s and the early 1990s is that over 4 million workers lost their jobs, which rose to 6 million workers in the early 2000s. And 34 to 40 percent of the job losers did not find jobs in each three-year period. Relative Earnings of Reemployed Workers Table 1.6 (pages 44–45) shows the earnings of displaced workers in their new jobs relative to those in their previous jobs. The earnings data cover money wages and salaries before the payment of income and Social Security taxes, and exclude employer-paid fringe benefits for health insurance and retirement. For long-tenured workers, approximately 33 percent earned at least 20 percent less in new than in the lost jobs. The largest differences from the 33 percent level were 26.5 percent in the 1983–84 recovery, 37.8 percent in the 2001–2 recession/recovery, and 28.2 percent in the 2003–4 recovery. A further 20 percent of long-tenured workers earned below, but within 20 percent, of their former earnings. During the early 1980s and 1990s, the percentages were slightly less than 20 percent, and during the early 2000s, the percentages were slightly more that 20 percent. The largest difference was 13.9 percent during the 1983–84 recovery. For the combined total of the relative earnings regardless of the amounts

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of the difference between their old and new jobs, over 50 percent of the reemployed workers earned less on their new job than on their previous job. The one exception was the 1983–84 recovery, during which 40.4 percent of the reemployed workers earned less on their new job than on their old job. During the early 1990s, a little less than 55 percent of the workers experienced earnings loss. During the early 2000s, the percentages of lower earners at the new job fluctuated from 59.8 percent during the recession/recovery to 50.1 percent during the recovery. For short-tenured workers, 18.7 to 26.4 percent of the workers experienced at least a 20 percent loss in earnings. A further 13 to 19.5 percent of short-tenured workers earned below, but within 20 percent, of their former earnings. The overall picture of the reemployment earnings is that 43 to 53 percent of all workers, long-tenured and short-tenured, experienced earnings losses on their new jobs in each three-year period. Failure to Forecast Recessions and Its Policy Implications Macroeconomic forecasting is difficult, and forecasting cyclical turning points even more so. But forecasting is intrinsic to economic policymaking, whether it is explicit or implicit. It is axiomatic that economic policy decisions to stimulate or restrain the economy are made with a basic outlook of the future in mind. In reviewing published materials preceding the eleven recessions since the end of World War II, I found no forecasts of the recessions by the Federal Reserve and the Congressional Budget Office, and only one for the President’s Council of Economic Advisers.22 Some private forecasters predicted recessions. Lakshman Achuthan and Anirvan Banerji of the Economic Cycle Research Institute report that they gave forecasts of the 1990–91 and 2001 recessions to their clients.23 Forecasts of the overall economy have been available to the public in the Livingston Survey from 1960 to 2003, the American Statistical Association/National Bureau of Economic Research joint forecasting project from 1968 to 1990, and the Survey of Professional Forecasters by the Federal Reserve Bank of Philadelphia from 1990 to the present. Each provides median forecasts of the panels of forecasters of the real gross domestic product. When they showed negative forecasts growth rates in the real GDP, the declines in the real GDP were close to the quarter beginning a recession or for the quarters already in a recession. This was very short notice of a pending recession. Also, a decline in the real GDP for two consecutive quarters is often cited in the press as a recession period, though this is not always the case, as noted in the earlier section on Business Cycles and Recessions. I did not come across any cited forecasts of recessions

2,157 1,798 2,563 2,167 2,790 2,211 NA NA 2,081 2,156 3,126 1,926

Long-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

Short-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

Displaced Workers

NA NA 1,242 1,347 2,037 1,231

1,135 1,087 1,536 1,396 1,791 1,404

Reemployed Workers

NA NA 59.7 62.5 65.2 63.9

52.6 60.5 59.9 64.4 60.3 63.5

Reemployed Workers as a Percentage of Displaced Workers (2/1 × 100)

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Recession/Recovery/ Expansion Status

Displaced and Reemployed Full-Time Wage and Salary Workers, Short-Tenured and Long-Tenured Workers (thousands of workers)

Table 1.5

42

NA NA 4,644 4,323 6,096 4,136

NA NA 2,778 2,743 3,828 2,634

NA NA 59.8 63.5 62.8 63.7

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Source: Displaced worker supplement, Current Population Survey, Bureau of Labor Statistics, U.S. Department of Labor. Notes: NA—Not available. The author calculated the percentages of reemployed workers in column 3 from the actual data in columns 1 and 2. Data cover workers twenty years and older. Displaced workers are defined as having lost their jobs permanently because they were laid off or left because their plants or companies closed or moved, there was insufficient work for them to do, or their positions or shifts were abolished. Long-tenured workers represent wage and salary workers who had three or more years of tenure on jobs they lost or left. Short-tenured workers represent wage and salary workers who had less than three years of tenure on jobs they lost or left. Workers who lost their jobs temporarily and expected to be called back by employers when business picked up are not included in the data. The survey data are obtained every other year for the preceding three years. The displaced-worker data represent the first two years and the reemployment data represent all three years of the survey period. For example, the data for 2003–4 were recorded at the time of the survey in January 2006. The displaced worker data cover 2003–4, while the reemployment data cover 2003, 2004, and 2005. Each two years of the survey sometimes represent part recession and part recovery years and sometimes solely recovery years. The exception is 1981–82, which represents part expansion and part recession years.

Long-Tenured and Short-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

43

33.7 26.5 34.4 33.7 37.8 28.2 NA NA 22.4 18.7 26.4 20.8

Long-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

Short-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

At Least 20 Percent Below Previous Job

NA NA 16.9 15.9 19.5 13.0

17.5 13.9 17.8 19.8 22.1 21.9

Below, but Within 20 Percent of, Previous Job

NA NA 39.3 34.6 45.9 33.8

51.2 40.4 54.2 53.5 59.8 50.1

Total Below Previous Job

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Recession/Recovery/ Expansion Status

Median Weekly Earnings of Long-Tenured and Short-Tenured Displaced Full-Time Wage and Salary Workers: Earnings of Workers on the New Job Relative to Earnings on the Lost Job (percentage of workers)

Table 1.6

44

NA NA 29.1 26.5 31.9 24.8

NA NA 17.4 17.9 20.7 17.9

NA NA 46.5 44.4 52.6 42.7

Expansion & recession Recovery Recession & recovery Recovery Recession & recovery Recovery

Source: Displaced worker supplement, Current Population Survey, Bureau of Labor Statistics, U.S. Department of Labor. Notes: NA—Not available. Wage and salary earnings cover money wages and salaries before the payment of income and Social Security taxes, and exclude employerpaid fringe benefits for health insurance and retirement. Displaced workers twenty and older have lost their jobs permanently. Long-tenured workers represent wage and salary workers who had three or more years of tenure on a job they had lost or left because their plant or company closed or moved, there was insufficient work for them to do, or their position or shift was abolished. Short-tenured workers represent wage and salary workers who had less than three years of tenure on a job they had lost or left because their plant or company closed or moved, there was insufficient work for them to do, or their position or shift was abolished. The survey data are obtained every other year for the preceding three years. For example, the data for 2003–4 were collected in January 2006. The displaced worker data cover 2003–4, while the reemployment data cover 2003, 2004, and 2005 at the time of the survey in January 2006. Each two years of the survey sometimes represent part recession and part recovery years and sometimes solely recovery years.

Long-Tenured and Short-Tenured Workers 1981–82 1983–84 1991–92 1993–94 2001–2 2003–4

45

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by economic consulting firms preceding the onsets of the eleven recessions in my review of all the timely “business outlook” sections of BusinessWeek. Of course, there were likely some private forecasts of recessions of two or more quarters in advance of an actual recession. And it is possible that the Federal Reserve and the Council of Economic Advisers subscribed to forecasts of economic consulting firms that did predict one or more of the recessions. Some financial firms, in advising their clients on investments in the stock market and the bond market, may have forecasted recessions in letters to their clients. Nevertheless, my research indicated there were probably relatively few forecasts of recessions. With respect to the accuracy of economic forecasts, Stephen McNees has assessed several aspects of macroeconomic forecasts by the Federal Reserve, Council of Economic Advisers, Congressional Budget Office, and private forecasting organizations from the 1950s to the early 1990s.24 His assessments in regard to the cyclical turning points of recessions and recoveries, which is the focus of this book, were confined to the 1973–75, 1980, and 1981–82 recessions. A principal conclusion of that study was that the least accurate forecasts of the economy occur at cyclical turning points. In a unique approach aimed at making specific forecasts of recessions, James Stock and Mark Watson developed an experimental model in the late 1980s based on the leading indicator approach.25 The model assessed the probability of future recessions six months ahead, with one version of the model including financial variables and one version excluding financial variables. This differs from the traditional leading indicator system of forecasting cyclical turning points that warns of a coming recession, but does not give a specific time of its onset. These “experimental recessions indexes” showed low probabilities of the future recessions before the onset of both the 1990–91 and the 2001 recessions.26 After fifteen years of experience with the model, Stock and Watson concluded that it required a major overhaul, and they discontinued the preparation of the indexes in 2005. It is also possible that, at times, the staffs and/or the members of the Federal Reserve and the Council of Economic Advisers forecasted a recession. If such forecasts were made, they would ultimately have been reported to the Federal Open Market Committee (FOMC) of the Federal Reserve and to the president for their consideration. The forecasts, then, would have been made public only if the FOMC and/or the president adopted them. Policy Implications I believe there are unstated institutional and political factors contributing to the failure to forecast recessions, or to at least acknowledge that weaknesses

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are appearing in the economy. These warning signs require constant attention if the chances of a recession are to be lessened. The Federal Reserve Governors and the Federal Reserve Bank presidents, who together comprise the FOMC, the organization that sets monetary policies affecting bank loans and interest rates, would be reluctant to adopt such forecasts due to two concerns. One concern is that such a forecast would roil the financial markets, in which case the resultant sharp declines in the stock market with capital losses sustained by investors could spread to other financial markets that then could spiral into a recession. The other concern is that a forecasted recession would undermine the fight to contain inflation. This is based on the premise that there is a tradeoff between inflation and unemployment, with lower unemployment leading to higher inflation, and higher unemployment leading to lower inflation. Consequently, containing inflation before it becomes excessive prevents the need to later restrain economic growth more drastically. That restraint would result in much greater increases in unemployment than would otherwise have occurred. I address the premise of an inflation/unemployment tradeoff in Chapter 13. In the case of the Council of Economic Advisers, if the council advises the president of an expected recession, the president’s political advisers would most likely regard such a forecast as having the potential to lower the president’s public approval rating. Ultimately, the president decides what advice to accept. And only if the president accepts the council’s forecast of a recession is that forecast made public. There is of course the possibility that the president would accept the forecast in private while not acknowledging it publicly. But if this were to occur, it probably would lead to policy actions to stimulate the economy. I did not find any evidence of this in my review of the eleven recessions. For the president’s part, the failure to forecast a recession delays the process of initiating the spending of funds for programs that already had been vetted and appropriated by Congress. In federal budget procedures, though Congress passes legislation signed into law by the president or that becomes law by Congress’s overriding a presidential veto, specifying that certain funds are to be spent for certain programs, such funds are spent only if they are “obligated” by the president. This requires a relatively lengthy procurement process of buying materials, hiring contractors, and the like. The process includes government solicitations of competitive bids from industry to provide goods and services. Even if the process is expedited, it is time consuming and might have its initial impact on the economy only shortly before the recession begins, after the recession begins, or even after the recession ends. But the record of jobless recoveries following the 1990–91 and 2001 recessions, as discussed above, makes spending funds for useful programs an

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efficient way of stimulating the economy with more jobs and benefiting the American people, even if such spending first impacts the economy during the recovery. I focused above on speeding up federal spending for programs that have already been mandated in existing legislation. Another approach for stimulating the economy is to lower federal income taxes. My focus on federal spending reflects a view that changes in the tax structure should be made with longer periods of economic growth in mind that span the shorter cyclical movements, rather than be guided by the more volatile cyclical movements in the economy. Taxes, together with federal spending, comprise fiscal policy, which is conducted by the president and Congress. Stability in the tax structure enables individuals and businesses to base their spending, saving, and investments decisions more on their merits than on speculating about future tax changes. This is likely to result in greater economic growth for longer periods than more frequent changes in the tax structure. In addition, taxation ultimately is based on broader political considerations, of which macroeconomic policy is just one. The broader considerations include the role of government in society, fairness in the distribution of taxes, and efficiency in collecting taxes. These, of course, change with the outcomes of presidential and congressional elections, and are best left to those contexts. There are always exceptions, and in some cases lower taxes may be appropriate in response to a cyclical weakness. Notes 1. George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton: Princeton University Press, 2009), p. 1. 2. John Maynard Keynes, The General Theory of Employment, Interest, and Money (New York: Harcourt Brace Jovanovich, 1964 reprint), copyright 1936, pp. 161–62. 3. I define contraction as the rare case of a fourth stage in a business cycle. Thus, I divide the downturn into the separate recession and contraction stages when the trough of the downturn is below the trough of the previous cyclical downturn. It is analogous to the separate recovery and expansion stages of the upturn. This differs from the general literature that defines contraction as comprising the entire downturn in one stage, even if the trough of the downturn is below the trough of the previous cyclical downturn. 4. There are exceptions to everything. Individually, Major League baseball players were, according to a biography of Lou Gehrig, immune to the depression of the 1930s. For a vivid description of the players’ lives during the Depression, see Jonathan Eig, Luckiest Man: The Life and Death of Lou Gehrig (New York: Simon & Schuster, 2005), pp. 166–67. 5. For a humorous newspaper headline, see Robert D. Hershey, Jr., “This Just In: Recession Ended 21 Months Ago,” New York Times, December 23, 1992, p. D1.

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6. William D. Nordhaus, “The Recent Recession, the Current Recovery, and Stock Prices,” Brookings Papers on Economic Activity 1: 2002, pp. 205–6. 7. Economic growth in 1967 was relatively weak (real GDP increased by 2.5 percent), which could qualify as an economic pause, but economic growth in 1963 was relatively strong (real GDP increased by 4.4 percent), which is not an economic pause. 8. James H. Stock and Mark W. Watson, “Has the Business Cycle Changed AND 7HYv NBER Macroeconomics Annual 2002 (Cambridge, MA: MIT Press, 2003). 9. Kevin J. Stiroh, “Volatility Accounting: A Production Perspective on Increased Economic Stability,” Staff Report 245, Federal Reserve Bank of New York, April 2006. 10. Thomas Jabine spoke of this as a chicken and egg problem in my discussion with him. 11. See Victor Zarnowitz, “Theory and History Behind Business Cycles: Are THESTHE/NSETOFA'OLDEN!GEvJournal of Economic Perspectives (Spring 1999). 12. This calculation of the spread of the worker’s job loss to other people is derived as follows: To support two other people, the worker’s job is multiplied by a factor of three, one for the worker plus two for the others; to support three other people, the worker’s job is multiplied by a factor of four, one for the worker plus three for the others. The calculations applied to job losses affecting 2 million workers and 3 million workers are: Increase of a 2-million job loss for its effect on two other people and on three other people: 2 million × 3 = 6 million 2 million × 4 = 8 million Increase of a 3-million job loss for its effect on two other people and on three other people: 3 million × 3 = 9 million 3 million × 4 = 12 million The multipliers of three and four assume that the job loss on average, when combining the various categories of single people, couples with no children, and couples with one child to several children, results in the spread to two and three other people. There are no actual data on the effect of such a spread. Of course, if one assumes the job loss on average affects one other person, the spread would be less than that used here, while if one assumes the job loss on average affects four other people, the spread would be greater than that used here. 13. Victor Fuchs, “Toward a Theory of Poverty,” in The Concept of Poverty (Washington, DC: Chamber of Commerce of the United States, 1965), p. 65. 14. Gordon Fisher, “From Hunter to Orshansky: An Overview of (Unofficial) Poverty Lines in the United States from 1904 to 1965,” revised 1997, p. 15. This paper can be accessed online at www.census.gov/hhes/www/povmeas/papers/hstorsp4.html, or obtained from Gordon Fisher at the Office of the Assistant Secretary for Planning

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and Evaluation, U.S. Department of Health and Human Services. This paper is not an official government document. See also Linda Barrington and Gordon M. Fisher, “Poverty,” Historical Statistics of the United States: Earliest Times to the Present, Millennial Edition, ed. Susan B. Carter et al., (New York: Cambridge University Press, 2006), vol. 2, pp. 625–651. 15. Constance F. Citro and Robert T. Michael, eds., National Research Council, Measuring Poverty: A New Approach (Washington, DC: National Academy Press, 1995). 16. In the past, the president has decided on the definition of the poverty standard, as the adoption of a poverty standard has been an executive branch function. But this does not preclude the use of another procedure in the future if a new poverty measure is adopted. 17. Frank Stricker, Why America Lost the War on Poverty—And How to Win It (Chapel Hill: University of North Carolina Press, 2007), p. 60. 18. Stacey L. Schreft and Aarti Singh, “A Closer Look at Jobless Recoveries,” Economic Review, Federal Reserve Bank of Kansas City, second quarter, 2003. 19. Erica L. Groshen and Simon Potter, “Has Structural Change Contributed to a *OBLESS2ECOVERYvCurrent Issues in Economics and Finance, Federal Reserve Bank of New York, August 2003. 20. Henry S. Farber, “Job Loss in the United States, 1981–2001,” NBER Working Paper 9707 (Cambridge, MA: National Bureau of Economic Research), May 2003. 21. See Ryan Helwig, “Worker Displacement in 1999–2000,” Monthly Labor Review (June 2004), Appendix: Survey Methods and Data Limitations, p. 68. 22. This is based on my review of the following during the expansion periods preceding all eleven recessions: the articles by the staffs of the Federal Reserve Board, the testimonies of the Governors of the Federal Reserve to congressional committees, and the minutes of the Federal Open Market Committee of the Federal Reserve published in the Federal Reserve Bulletin; the Economic Report of the President, which includes the Annual Report of the Council of Economic Advisers; and the Budget and the Economic Outlook of the Congressional Budget Office. 23. Lakshman Achuthan and Anirvan Banerji, Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy (New York: Random House, 2004). 24. Stephen K. McNees, “Forecasting Cyclical Turning Points: The Record in the Past Three Recessions,” New England Economic Review, Federal Reserve Bank of Boston, March/April 1987. 25. James S. Stock and Mark W. Watson, “A Procedure for Predicting Recessions with Leading Indicators: Econometric Issues and Recent Evidence,” in Business Cycles, Indicators, and Forecasting, ed. James S. Stock and Mark W. Watson (Chicago: University of Chicago Press, 1993). 26. For example, based on revised data, in the months leading up to the July 1990 recession, the recession index that included the financial indicators peaked in April at a 24 percent probability that the economy would be in recession in October 1990, while the probability for the index excluding financial variables peaked at 28 percent that the economy would be in recession in October 1990. Thus, the recession index excluding financial variables had a superior, though still weak, indication of an oncoming recession. Both indexes declined from the peak probabilities in the next few months.

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An even lower probability of a recession appeared in the months leading up to the March 2001 recession, using revised data. The recession index that included the financial indicators peaked at a 12 percent probability in November 2000 that the economy would be in a recession May 2001, while the probability for the index excluding financial variables peaked at 13 percent in December 2000 that the economy would be in a recession in June 2001. Both indexes declined from the peak probability in the next few months. Thus, there was little difference in the likelihood of a recession in the two indexes, contrary to the experience in the 1990 recession noted above.

2 The Recession of 1948–49

The recession of 1948–49 began in November 1948 and ended in October 1949. This was the first recession independent of World War II, which had ended in August 1945. There had been a previous recession from March 1945 to October 1945 that began in what turned out to be the last phases of the war. That recession is not included in this analysis because it was dominated by the beginning of the transition from a wartime to a peacetime economy, in contrast to the recessions included here that reflect cyclical movements dominated by the production of household goods, housing, and business equipment and structures, for civilian markets (see the Preface, note 1). There were two dominant features of the U.S. economy at the end of 1947. One was the conversion from military to civilian production beginning with the end of World War II in August 1945. An important aspect of the conversion was working down the backlog of household and business needs that were unaffordable during the Depression of the 1930s, as well as the deferment of producing those needs during the war, when the production of goods for the war was paramount (see Appendix 2.1 below). Because of the lack of items to buy during the war, households and businesses saved a higher-than-usual share of their employment incomes and profits in liquid assets, such as cash, bank deposits, and U.S. government securities, which had an important role in financing their postwar purchases. The other main feature of the economy at the end of 1947 was the persistently high rate of inflation. Inflation is discussed below in the background section on the 1948–49 recession, and later consumer and wholesale prices are covered as economic indicators of inflation. Backlog of Household Durable Goods, Housing, and Business Capital Needs at the End of 1947 Production during the postwar years of 1946 and 1947 of household appliances, cars, and business equipment, and the construction of new housing and of commercial and industrial buildings, had considerably reduced the backlog 52

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of the demand for those items that had been deferred during the Depression and the war. Thus, the economy converted after the war from producing tanks, guns, airplanes, ships, radar equipment, food, clothing, medical care, barracks, and other goods and services needed by the military in fighting a two-front war in Europe and Asia on the one hand, to the production of civilian goods in 1946 and 1947 on the other. Working down that backlog of needs was a major prop to the economy in 1946 and 1947. Backlog of Household Durable Goods While the backlog demand for household durable goods stemming from the lack of production of these items during the Depression and the war had been greatly reduced by the end of 1947, there still remained unfilled needs and the ability to afford them as a result of incomes saved during the war. Jay Atkinson estimated the backlog for cars, vacuum cleaners, refrigerators, washing machines, and radios.1 He concluded that for this selected group of cars and household appliances, the backlog of households purchasing these items for the first time plus the replacement demand by households for their aged existing items would be met in a few years, with some met more quickly than others. As Atkinson’s study was published in 1948, it suggested that backlogs of demand would continue into the early 1950s. However, no quantitative estimates of these expected trends were given. Backlog of Housing There was also a considerable backlog need for new housing following the end of the war. This stemmed from the Depression years of the 1930s when people had to double up in living with relatives or friends because they could not afford to own or rent housing alone, and also from the sharp decline in new residential construction during the war and from the returning service men and women forming new households. Therefore, housing starts, which represent the beginning of construction on privately owned single-family houses and each separate apartment in apartment buildings, rose from 325,000 in 1945 to 1,015,000 in 1946 and 1,265,000 in 1947. Moreover, this trend continued upward to 1,908,000 starts in 1950, before it dropped during the Korean War to 1,400,000 starts in 1951. Backlog of Business Equipment and Structures Additional investment in the equipment and structures of U.S. manufacturing and transportation facilities was necessary during World War II in order to produce and transport the goods and services used in the war. But while these

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investments in capital facilities first recovered from their 1930s Depression lows in 1941, they were pared down by 45 percent during 1942–44 because of the focus on producing only those items essential to the war effort. These cutbacks created a backlog for modernizing and expanding the industrial capacity of the economy. Following the war, the sharp increase in these investments in 1946 and 1947 led to the peak 1941 pre-war investment levels being exceeded an average of 33 percent. Manufacturing industries accounted for about one-half of these investments, followed by commercial industries, transportation industries, electric and gas utilities, and mining industries. Company profits derived from the wartime production were an important source of financing the needed capital investments after the war. For example, Irwin Friend noted the effect of the restrictions on investing in new equipment and structures during the war and the financial position of businesses after the war.2 He estimated that from the end of 1939 to the end of 1945, the net working capital of nonfinancial corporations in the highly liquid form of cash and government securities increased by $27.5 billion, close to 75 percent of which occurred after the December 1941 attack on Pearl Harbor. Inflation at the End of 1947 Following the end of wartime price controls in mid-1946, the shortages of household and business goods created a seller’s market. Annual price increases in the consumer price index accelerated from 2.3 percent in 1945, to 8.3 percent in 1946, to 14.4 percent in 1947. The price increases slowed in the spring of 1947, as households and businesses expected a future decline in prices and so held off in some purchases. But then price increases accelerated in the last half of the year, as shortages of steel, automobiles, building materials, coal, food grains, and meats, plus increased railroad freight rates, appeared.3 Proposals to Contain Inflation In his annual economic report to the Congress in January 1948, President Harry Truman highlighted the problem of inflation due to the limits on increasing production sufficiently to accommodate increasing household and business demands, and he called for needed anti-inflation economic measures. As apparent from the anti-inflation measures listed below, several would be carried out only if Congress passed the necessary legislation. The recommendations included:4 s +EEPINGTHEFEDERALBUDGETINITSCURRENTSURPLUSPOSITIONTHROUGHBOTH spending restraints and maintaining a neutral tax structure by offsetting tax decreases for individuals with tax increases for corporations.

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s 0ROVIDINGTHE&EDERAL2ESERVEWITHLEGISLATIVEAUTHORITYTORE REGULATE consumer credit (the previous authority had expired on November 1, 1947). The Federal Reserve also requested this authority.5 s 0ROVIDING THE &EDERAL 2ESERVE WITH LEGISLATIVE AUTHORITY TO INCREASE the reserve requirements of commercial banks in order to restrain the amount of increases in all types of bank loans. The Federal Reserve also requested this authority.6 s 0ROVIDINGTHEPRESIDENTWITHLEGISLATIVEAUTHORITYTOBOTHRATIONCOMmodities in short supply such as meat, and to institute price controls on agricultural and industrial commodities where shortages could lower production or raise prices unduly. s 0ROVIDINGTHEPRESIDENTWITHLEGISLATIVEAUTHORITYTOPREVENTWAGEINcreases where it was necessary to maintain any price ceiling that has been established. s 6OLUNTARYRESTRAINTINSPENDINGBYHOUSEHOLDSFORSCARCEPRODUCTSAND by businesses on capital facilities that did not immediately increase production. s 6OLUNTARYRESTRAINTBYBUSINESSESINHOLDINGPRICESSTEADYORREDUCINGPRICes where possible, and by labor unions in moderating wage demands. Actions Taken on the Anti-Inflation Proposals With respect to fiscal policy in maintaining a surplus in the federal budget, the federal government deferred spending on many public works projects. However, it was different with taxes, as the Congress passed legislation for a reduction in individual income taxes in April 1948, which was retroactive to the beginning of 1948.7 There was no offsetting increase for business taxes to make the total effect on tax revenues neutral, which had been proposed by the president as noted above. President Truman, a Democrat, vetoed the legislation, but the predominantly Republican Congress overrode the veto, and so the tax reductions became law.8 This action on taxes was of course inflationary, because it increased the income of households that was available for spending. Yet, with the subsequent deterioration of the economy into a recession in November 1948 and the problem of inflation receding, the tax reduction turned out to be good for reviving economic growth from the recession because of its stimulus to spending. With respect to the surplus/deficit position of the federal budget for 1947, 1948, and 1949, the surplus increased substantially from 1947 to 1948, and declined to being close to a balanced budget in 1949, which by this shift was a stimulus to the economy.9 The Congress passed legislation giving the Federal Reserve authority to

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regulate consumer credit and to raise commercial bank reserve requirements. The Congress did not give the president authority to ration goods or to institute price and wage controls. Overview of the Economy During 1948 The course of economic activity during 1948 was uneven. Monthly and quarterly slowdowns in economic growth alternated with periods of accelerated economic growth. There was also a backdrop of two different views of the economy. One view was the expectation that economic growth after World War II would slacken considerably once the increase in civilian production during 1946, 1947, and 1948 substantially reduced the backlog of needs for household durable goods, housing, and business capital equipment and structures that had accumulated from the Depression and the war. These backlogs were discussed above. The other view was that the persistently high postwar inflation was the overriding problem, and that unless the inflation was substantially reduced, it would lead to a severe recession. While the rate of price increases declined from 1946 to 1948, inflation still continued to be high during those years for several reasons. These included continued shortages in certain materials, the greater savings that households and businesses had accumulated during the war because of limited items on which to spend, and increases in worker incomes from wage increases of union workers, all of which created the potential to bid up prices. There was also an expectation of intensifying inflation because the intensification of the Cold War with the Soviet Union would lead to a large increase in military spending, there would be additional federal spending to help the war-torn countries under the European Recovery Plan, and the reduction of individual income taxes passed in May 1948 (noted above) would give households more income for spending. The effects of these developments on the federal budget were seen as shifting the budget surplus to a budget deficit position. And because the previous budget surplus removed money from the income stream, it was viewed as a major tool in containing inflation, while the prospective budget deficit that would put more money into the income stream was viewed as undermining the fight against inflation. In emphasizing on the danger of inflation, the president and the Federal Reserve argued that unless credit restraints were put on household and business borrowing, the additional spending provided by the civilian loans would create more inflation, in the sense that more money chasing a limited supply of goods would only bid up prices. Overlaid on the reduction in the backlogs of accumulated needs and the

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persistent high inflation, the Employment Act of 1946 introduced a new factor affecting the economy. The act called for the federal government as its policy and responsibility to “use all practicable means . . . to promote maximum employment, production, and purchasing power.”10 It created the Joint Economic Committee of Congress and the Council of Economic Advisers to the president as the focal points for carrying out the purposes of the act, with the president required to submit a report on the economy and its prospects to the Congress every year. The act stemmed from the lingering memory of the Depression. The concern was that after the postwar burst in civilian production had eliminated the backlog of needs resulting from the Depression and the war as noted above, the economy would fall back into sluggish economic growth and high unemployment. This was reflected by the fact that the American economy fully recovered from the Depression of the 1930s only with the huge production of military goods during World War II. Thus, the act fostered the idea that the federal government should take an active role in pursuing policies and programs that lead to a prosperous economy as its policy and responsibility. The act did not give the president authority to take specific actions. Instead, it provides a forum for both the Congress and the president to present views on the direction the government should take in achieving the goals of the act. The term “purchasing power” in the act refers to the need to contain inflation while pursuing maximum employment and production. Because the 1948–49 recession was the first postwar recession driven by a market-based civilian economy, it was the first test of the resiliency of the economy no longer propped up by large military spending. However, the recession did not spiral down precipitously as it began to bottom out in the summer of 1949.11 Economic Indicators in Real Time During 1948 The economic data on employment, production, and prices and other economic indicators that were available to policy makers before the onset of the recession in November 1948 are referred to as real-time data. Because these data have been revised several times since the run-up to the 1948–49 recession, use of such revised data would give an inaccurate picture of what the policy makers at the time used in making their analyses, forecasts, and policy recommendations, if indeed the revised data subsequently does give a different picture of the economy. Thus, for the purposes of this book, the real-time data are essential for assessing the economic policies and programs that were acted on at the time. Sources of the real-time data are given in the Preface. The economic indicators discussed here are:

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s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s #ONSUMERPRICES s 7HOLESALEPRICES s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINMANUFACTURING s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT National defense is included in a supplementary note to the economic indicators. The last section of the chapter is an assessment of the economic policies preceding the 1948–49 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are complex, and I do not mean to suggest that the economy flows in the order of this sequence, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are only available quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1948–49 recession is dated as beginning in November 1948. So in the figures that follow, November and December 1948 were the first two months of the recession. To assess what was available to policy makers in 1947 and as 1948 progressed, the figures chart the real-time data from May 1947 to December 1948. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in August 1948. Because economic data became available one month after the month to which they refer, the July 1948 data first appeared in August. Thus, the August 1948 starting point provides the most reliable data, including previous revisions up to that time, from May 1947 to July 1948. The data for August to December reflect the real-time data on a monthly and quarterly basis as they were produced. Revisions that occurred to the August to December data as of January 1949 changed the monthly and quarterly patterns at most slightly. I chose August 1948 as a breakpoint for the most recent best data because it provided a late look at current economic conditions to see whether a change in economic policy direction, from a concern about inflation to a concern about

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unemployment, was warranted. Of course, even if economic policies had been promptly changed in August, it would have been too short a lead time for changes to occur in the civilian market economy to prevent the recession from beginning in November. At best, such a reversal in policies at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see from May 1947 through INWHATTURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. The data include workers of all ages. All jobs are counted equally, from the lowest pay scales to company executives and officers, as are full-time and part-time jobs. The number of jobs exceeds the number of workers since some workers have more than one job. This measure of employment excludes farm workers, people who are selfemployed, those employed by private households or by religious organizations, and military personnel on active duty in the armed forces. The Bureau of Labor Statistics in the U.S. Department of Labor prepares the employment data. Figure 2.1 shows the monthly percentage change in jobs from May 1947 to December 1948 on a real-time basis. Employment during the period fluctuated around 43 million to 45 million jobs. On this basis, a 1 percent change in employment affected 430,000 to 450,000 jobs. There was a clear increase in the volatility of job movements from 1947 to 1948. From May to December 1947, the number of jobs increased every month, except for a decline of 0.01 percent in July. Another measure of volatility was the change in percentage points of the growth rate from one month to the next, as seen by the length of the line between each two months in the figure. These differences in 1947 were 0.6 percentage point from May to June and from June to July, 0.4 percentage point from August to September and from October to November, and 0.1 to 0.3 percentage point between the remaining two-month periods. By contrast, during 1948, jobs declined by 0.6 percent in February and 0.5 percent in April, considerably greater than the decline of 0.01 percent in July 1947. The monthly changes in percentage points between two months from the January to July 1948 period were also much greater than those from the May to December 1947 period. Thus, the 1948 differences were: 1.1 percentage point from January to February, 0.8 percentage point from April to May, and 0.5 percentage point from March to April, and May to June. The differences from August to November 1948 were also greater than those in

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Figure 2.1

Jobs in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. The Federal Reserve seasonally adjusted the data. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August to December 1948 represent data when they first became available one month after each data month. The monthly patterns of the August to December 1948 data are similar to the later data for those months that became available in January 1949.

1947, though they are not detailed here because I am emphasizing what the policy makers only had available to act on up to a few months before the onset of the recession. This record of job declines and job volatility during 1948, in contrast to the steady job growth during 1947, was an important change in the momentum of the economy. At a minimum, it should have given policy makers pause in their assessment that the economy was near its capacity to greatly produce more goods, and that any substantial increase in household business, and government demand for goods, would only drive up prices. Unemployment The unemployment data used here represent the number of persons without jobs each month who were actively seeking work in the civilian sector of the economy. The data cover nonfarm and farm workers aged fourteen years

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and older.12 The Bureau of Labor Statistics in the U.S. Department of Labor prepares the unemployment data based on surveys of households. The unemployment data are not seasonally adjusted. The unemployment rate is the number of unemployed persons as a percentage of the labor force (the labor force is the sum of employment and unemployment). The nature of these data is detailed in Chapter 1 under unemployment. Mathematically, the unemployment rate is calculated as: (Unemployed persons) ____________________________________________ × 100 Employed persons + unemployed persons (labor force) Figure 2.2 shows the unemployment rate (UR) on a real-time basis from May 1947 to December 1948. The UR fluctuated in a range of 2.7 to 4.4 percent over the period. Actual unemployment fluctuated around 1.5 million to 2.5 million workers. Thus, a one-percentage-point change in the unemployment rate affected 15,000 to 25,000 workers. The monthly changes in the UR declined from over 4 percent in June and July 1947 to under 3 percent during October to December 1947. Unemployment then fluctuated considerably during 1948, with sharp rises in January and February to over 4 percent, a sharp three-month decline to under 3 percent in May 1948, and then rising, falling, and rising within a band of 2.7 to 3.5 percent from June to December 1948. Thus, the UR was far more volatile from January to May 1948 than from June to December 1948. These fluctuations no doubt caused uncertainty over the period. Yet there was no general upward or downward trend in unemployment. Unemployment showed a prosperous economy with relatively low levels, with the monthly movements typically keeping the rate within 3 to 4 percent. But it was not an economy of general shortages of workers, as distinct from commodities. Though shortages of workers may have occurred for selected skills or industries, I did not see references to general shortages in articles in the Survey of Current Business, Federal Reserve Bulletin, and BusinessWeek. Inflation and Deflation Two measures of inflation are used here: the consumer price index for all goods and services, and the wholesale price index excluding farm and food products. The Bureau of Labor Statistics in the U.S. Department of Labor prepares both price measures. Inflation is the general term given to a rise in prices for the aggregate of all prices of goods and services on an ongoing monthly, quarterly, and annual basis. Deflation represents a decline in overall prices of goods and services.

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Figure 2.2

Unemployment Rate in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August to December 1949 represent data when they first became available one month after each data month. The monthly data from August to December 1948 were unchanged when the later data for those months became available in January 1949.

Zero inflation occurs when there is no change in overall prices. These overall movements are the net result of price increases and decreases among the individual items—food, housing, transportation, health, and so forth. There are also variations on these terms. Core inflation excludes food and energy prices from the overall totals because they tend to be more volatile from period to period than the other items in the indexes. Part of this volatility reflects weather changes and their effect on crop harvests. Looking ahead, the control of oil supplies by the cartel power of the Organization of Petroleum Exporting Countries, which had been established in 1960, first became a potent factor in the volatility of energy prices with the Arab oil embargo in October 1973. Accelerating inflation occurs when the rate of inflation increases, such as from 2 percent in period one to 3 percent in period two. Disinflation is the opposite, as it occurs when the rate of inflation decreases, such as from 3 percent in period one to 2 percent in period two.

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Qualitative terms are creeping inflation, hyperinflation, and tolerable inflation. Creeping inflation refers to rates of 1 to 2 percent annually, which some analysts consider as price stability. Hyperinflation refers to increases approaching or exceeding 10 percent annually, such as occurred in the late 1970s and early 1980s. These pale, of course, in comparison with the hyperinflation in industrially developing countries of 1,000 percent and more annually. Tolerable inflation of around 3 to 5 percent annually implies the rate should be lower, so the incomes of workers, businesses, and investors do not erode, but it is not thought to result in spiraling increases in interest rates. The monthly percentage changes in prices used in the figures here depict the progression of price change on a current basis. But annual rates of price change are the usual way price movements are assessed. To illustrate the monthly and annual relationship, the tabulation below shows the effect of raising a sample of monthly percentage price changes to an annual rate. Monthly change (%) 0.1 0.2 0.3 0.4 0.5 1.0 –0.1 –0.2 –0.3 –0.4 –0.5 –1.0

Annual change (%) 1.2 2.4 3.7 4.9 6.2 12.7 –1.2 –2.4 –3.5 –4.7 –5.8 –11.4

Consumer Price Index The consumer price index (CPI) provides an overall measure of the change in prices that households pay for the goods and services they buy. The household purchases represent the items typically bought by employed urban wage workers in blue-collar and clerical occupations.13 The CPI covers monthly price changes for food and beverages, housing, apparel, transportation, medical care, education, communication, recreation, and other goods and services. The index is weighted to represent the proportion of the dollar expenditures of each good and service item to the total household expenditures. The price data are obtained from surveys of retail and service establishments, utilities, and households. The surveys are conducted by personal visits and telephone, and beginning with the 1990s, online reporting.

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Quality adjustments are made for changes in the functional and performance characteristics of an item, as well as of the quantity of each item that is typically sold. For example, when the safety features on a car are improved from the previous model to the current model—say, better brakes—the cost to the car manufacturer of providing the better brakes is compared with the market price of the car to the purchaser associated with the better brakes. If the market price increase attributable to the better brakes is less than the additional cost to the manufacturer, the CPI registers a price decline; if the market price increase is the same as the additional cost to the manufacturer, there is no change in the CPI price; and if the market price increase is more than the additional cost to the manufacturer, the CPI registers a price increase. In the case of quantity changes in the price of each item, I use as an example a loaf of bread. Assuming there are no changes in the ingredients contained in the bread, if the bread that is usually one pound is reduced to 14 ounces and there is no change in the market price to the purchaser, the CPI registers a price increase; if the market price decreases by the same amount as the decreased cost to the bakery, there is no change in the CPI price; and if the market price decreases more than the decreased cost to the bakery, the CPI registers a price decline. Figure 2.3a shows the monthly percentage change in the CPI on a realtime basis from May 1947 to December 1948. It fluctuated sharply in up and down movements, with outsized shifts in percentage points from one month to the next, including declines of over two and under two percentage points from September to October 1947 and from January to February 1948, and an increase of less than two percentage points from March to April 1948. With all of these gyrations, the monthly increases and decreases showed no discernible upward or downward trend over the span of fourteen months from May 1947 to July 1948, with typical movements in the 0.5 to 1.5 percent range. As late as August 1948, when the July 1948 data became available, the increase in July was 1.2 percentage points, indicating no letup in the continuing inflation. But then the rate of increase in the CPI lessened steadily through the rest of 1948, falling to 0.5 percent in August, 0.0 percent in September, and actual declines (below the zero line) from October to December. While the high inflation rates continued through August 1948, there was no acceleration in the rate of inflation. In fact, other economic indicators in this chapter on main factors driving the economy—employment, unemployment, wholesale prices, industrial production, housing starts, consumer durable goods spending, and the gross national product—depicted considerable quarter-toquarter volatility. But those indicators suggested only modest increases in demand, which could just as easily have been seen as pointing to future decreases in the rate of inflation. And that is what happened for the rest of 1948.

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Figure 2.3a Consumer Prices in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August to December 1948 represent data when they first became available one month after each data month. The monthly data from August to December 1948 were unchanged when the later data for those months became available in January 1949.

Wholesale Price Index Wholesale prices provide an overall measure of the change in prices of commodities before they reach retail or other end-use markets. The wholesale price index (WPI) comprises goods that are refined and fabricated from the raw material stage, into semi-manufactured articles, and lastly into finished goods. The WPI represents goods produced in the United States, in which imports appear only as intermediate ingredients or components used in producing the raw material, semi-manufactured article, or finished good. Raw materials represent products that are mined, like metals, coal, and petroleum; grown on farms like grains and cotton, cattle and poultry raised in feedlots or on farms, and lumber logged from trees in forests. Semi-manufactured articles are a stage above raw materials, which become part of or are consumed in producing more industrially advanced items, such as textiles and

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clothing, building materials, fuels, chemicals, and fabricated metal products. Finished goods—such as processed foods, clothing, appliances, furniture, cars, turbines, and generators—are ready for use by households, businesses, and governments. The index is weighted to represent the proportion that the dollar sales of each good represents of the total sales of all goods in the index. The price data are obtained from sellers of the products. The price data represent the transaction price of the item to the buyer, including premiums and discounts from list prices, except when list prices are used because transaction prices are not available. The same quality and quantity adjustments as noted above for the consumer price index are used in the wholesale price index. The WPI is not seasonally adjusted. Figure 2.3b shows the monthly percentage change in the WPI, excluding farm and food products, on a real-time basis from May 1947 to December 1948. Farm and food products are excluded because industrial prices were the main sources of inflation during the period. From May 1947 to January 1948, the monthly percentage changes in the WPI mostly fluctuated within, or around, a band of 1.5 to 2.0 percentage points. The exceptions were May 1947 with a slight increase of just above zero change, and June 1947 with an absolute decline of close to 0.5 percent (below the zero line). Following a sharp 0.5 percent decline in February 1948, there was a general upward movement that peaked in August 1948 at 1.3 percent. This fell to fluctuations around zero change from September to November, and then to an absolute decline of 0.3 percent in December 1948. Wholesale prices are one harbinger of future price movements. The experience of wholesale price movements from April to August 1948 suggested that inflation continued to be a problem for future months, though at a lower rate than earlier in the year and in 1947. This, together with the continued inflation in the consumer price index, the expected larger military spending for the cold war with the Soviet Union, and future increased federal spending for civilian goods as part of the European Recovery Plan, was the scenario that led economic policy makers at the time to see no letup in inflation. The missing element in this outlook was the other economic indicators reviewed in this chapter, which showed only modest future increases in demand, as noted above in the consumer price index section. Industrial Production The industrial production index (IPI) represents the monthly percentage change in the production of manufacturing and minerals (mining) industries (utilities industries were added to the IPI in 1959). Manufacturing covers durable goods (items lasting three or more years) and nondurable goods (items

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Figure 2.3b Wholesale Prices in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data, excluding farm and food prices. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1949 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August to December 1948 represent data when they first became available one month after each data month. The monthly data from August to December 1948 were unchanged when the later data for those months became available in January 1949.

lasting less than three years). Minerals cover coal, petroleum, and metals. The Federal Reserve prepares the IPI. The IPI measures the physical quantity of the output of the manufacturing and minerals industries, as distinct from sales value, which covers both the quantity and the price of the items produced. The IPI is weighted by the value added (wages, profits, depreciation of capital facilities) of each industry. The monthly data used in preparing the index are based on the production of actual manufactured and minerals items and production worker hours in the producing industries. Figure 2.4 shows the monthly percentage change in the IPI on a real-time basis from May 1947 to December 1948. The IPI declined from May to July 1947 in showing absolute declines (below the zero line) from the previous month. Then, after rising sharply to a monthly increase of over 3 percent in August, the rate of increase in the IPI declined through November, and fell to an absolute decrease in December 1947.

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Figure 2.4

Industrial Production in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from August to December 1948 represent data when they first became available one month after each data month. The monthly patterns of the August to December 2008 are similar to the later data for those months that became available in January 1949.

The IPI fluctuated sharply from January to July 1948, with three of the seven months having absolute declines. After rising sharply to increases of almost 3 percent in August and September, the IPI fell to absolute declines in November and December. The IPI fluctuated considerably over the 1947–48 period preceding the beginning of the 1948–49 recession. These movements included several months with absolute declines in production (monthly movements below the zero line). This volatile monthly pattern of industrial production did not indicate a future steady rate of growth likely to increase inflation. Housing Starts New housing construction generates an important secondary production in the economy beyond the materials and labor used in the construction. This is the induced spending for household appliances, furniture, house furnishings, and garden equipment that occurs when a household moves into a new house.

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69

The housing starts data represent the beginning of construction on privately and publicly owned nonfarm single-family and multifamily housing. Each single-family house and each apartment within an apartment building is referred to as a housing unit, which in turn is counted as a separate housing start. The Bureau of Labor Statistics in the U.S. Department of Labor prepared the housing start data (this function was transferred to the U.S. Census Bureau in 1959). The monthly housing start data are based on surveys of local areas that issue building permits plus surveys of local areas that do not issue building permits. The month specified for the start is when construction was scheduled to start on the excavation or rebuilt on an existing foundation. There probably was a typical divergence of a few months between the “schedule to start” and the actual start. The housing start data are not seasonally adjusted. Figure 2.5 shows the monthly percentage change in housing starts on a real-time basis from May 1947 to December 1948. Because housing construction is affected by changes in the weather, starts are highest in the spring and summer, and lowest in the fall and winter. Because the housing start data were not yet seasonally adjusted at this time, it is important to account for these weather patterns in assessing the monthly movements in the figure. Seasonally adjusted housing start data first became available in 1955. From May to September 1947, housing starts increased substantially each month. Housing starts then declined sharply in absolute terms from October 1947 to February 1948, as these months are all below the zero line on the figure. This decline that began in October followed the typical seasonal pattern. The next upturn in housing starts began with extraordinarily large increases in March and April 1948, and then a smaller but still substantial increase in May. But then absolute declines began in June and continued through the rest of 1948. This decline occurred during the peak summer months of 1948, and thus departed significantly from the normal seasonal pattern, indicating a weakness in housing markets. Earnings of Manufacturing Workers Worker average weekly earnings represent money wages of production workers in private manufacturing. The data are limited to manufacturing industries because weekly earnings data are not available for the total of all private nonfarm industries. The wages are for time at work and for paid vacations, sick leave, holidays, and overtime. They exclude noncash fringe benefits such as health and retirement benefits. Monthly movements of the data reflect the effects of shifts in employment among high-paying and low-paying industries

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Figure 2.5

Housing Starts in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for privately owned nonfarm housing units. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August to December 1948 represent data when they first became available one month after each data month. The monthly patterns of the August to December 1948 data are similar to the later data for those months that became available in January 1949.

and occupations. The Bureau of Labor Statistics in the U.S. Department of Labor prepared the earnings data. The earnings data are based on payroll records of employer establishments that are obtained as part of a survey of the establishments. More information on the survey is provided in Chapter 1 under employment. The earnings data are not seasonally adjusted. Figure 2.6 shows the monthly percentage change in worker earnings in manufacturing industries on a real-time basis from May 1947 to December 1948. Earnings fluctuated considerably over the period, with large upward and downward monthly shifts from June to July 1947, August to September 1947, November to December 1947, December to January 1948, May to June 1948, and June to July 1948. The monthly changes in earnings were typically larger in 1947 than 1948. For example, monthly changes during May to December 1947 ranged from approximately 0.5 to 2.5 percent, with one absolute decline (below the zero line) in July 1947. But monthly changes during 1948 were below 1 percent

THE RECESSION OF 1948–49

Figure 2.6

71

Job Earnings in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all manufacturing industries. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data became available in August 1948). Data from May 1947 to July 1948 represent data available as of August 1948. Data from August 1948 to December 1948 represent data when they first became available one month after each data month. The monthly patterns of the August to December 1948 data are similar to the later data for those months that became available in January 1949.

in all months except June and August. From January to July 1948, absolute declines occurred in January, February, and April, while June and July hovered around zero change. The volatility continued from August to December, with absolute declines occurring in three of the five months. This pattern of relatively small earnings increases, along with absolute declines and zero changes during 1948, does not indicate that wage increases were a source of inflation. The wage increases would have been inflationary if wage cost increases were large, leading businesses to pass on the wage increases into higher prices in order to maintain profit margins. Interest Rates and Bank Loans In reading this section on interest rates and bank loans, one should keep in mind that at the time of the 1948–49 recession, the Federal Reserve kept interest rates artificially low in order to keep interest payments on the federal govern-

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Figure 2.7

Interest Rate on Three- to Five-Year U.S. Securities in Expansion Preceding the 1948–49 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only November and December 1948 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, July 1948 data first became available in August 1948). Interest rate data are not normally revised. The exception is when an error is found, such as in a rounding calculation.

ment debt low. This policy began during World War II in 1942 when federal borrowing increased considerably because taxes were insufficient to finance the huge increase in war spending. Thus, the burgeoning federal debt during the war would have resulted in much higher interest rates if financial markets were allowed to function normally. This policy was reversed in 1951 and so did not affect the subsequent 1953–54 recession, as discussed in Chapter 3. Interest rates on three- to five-year U.S. securities represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds based on the new issue price. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 2.7 shows the monthly interest rates of three- to five-year U.S. securities from May 1947 to December 1948. Interest rates rose from around 1.3 percent during May to September 1947 to over 1.6 percent in January and February 1948. They then dropped to 1.5 percent in May and June 1948, and rose again, peaking at 1.7 percent during September to November 1948.

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73

While interest rates moved upward over the entire period in the figure, though with a decline from January to June 1948, they were still exceptionally low, fluctuating within a band of 1.3 to 1.7 percent. This reflected the policy of maintaining low interest rates on the federal debt noted above. Thus, interest rate levels were not a disincentive to borrowing over the period, and so were not an anti-inflationary vehicle. However, the Federal Reserve used other means of restraining bank loans during 1948. It raised reserve requirements of large city banks in New York and Chicago in February and in June 1948, and at all Federal Reserve member banks in August 1948. Then, the Federal Reserve obtained a new authority to restrict consumer credit, which had been requested by the president and the Federal Reserve, and which was approved by Congress in August. Consumer credit controls, which had been imposed in 1941 as an anti-inflationary measure, expired in November 1947 as a result of legislative action.14 This tripartite support of the president, Congress, and the Federal Reserve for the new authority to restrict consumer credit is indicative of the overriding importance of inflation in the minds of the economic policy makers. Under the new authority, the Federal Reserve reimposed consumer credit controls that prescribed minimum down payments and maximum maturities on installment loans in September 1948.15 In January and August 1948, the Federal Reserve also raised the discount rate at which member banks could borrow from the regional Federal Reserve Banks.16 And together with federal and state bank supervisory agencies in November 1947, the president in the Economic Report to Congress in 1948, and the American Bankers Association, the Federal Reserve encouraged banks to engage in voluntary restraint on bank loans.17 Because interest rates were so low during 1948, they were no deterrent to household and business borrowing, even while the rates were rising. Federal Reserve actions in 1948 in raising reserve requirements of commercial banks seemed to have little effect on the banks’ capacity to lend because they had a large inventory of Treasury securities that they sold, which released further funds for lending. At most it may have slowed the increase in loans. The impact of attempts to lessen bank lending through requests to banks for voluntary restraints on lending is hard to evaluate. But the reimposition of consumer credit controls in September 1948 was a critical factor in tipping the demand downward for consumer durable goods shortly before the onset of the recession, as discussed further in the following section on consumer durable goods.18 On balance, the financial restraints on bank loans pursued by the Federal Reserve in containing inflation at most lessened the increase in household and business borrowing during 1948. And the low interest rates during 1948,

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though rising, were no disincentive to borrowing. But the revival of consumer credit controls in September, obtained with the support of the president, Congress, and the Federal Reserve, had a stronger effect on slowing borrowing for consumer durable goods. Consumer durables were a highly cyclical component of the economy, and except for automobiles, they were no longer in short supply stemming from the lack of production during World War II. While other elements of the economy can offset the cyclical nature of durable goods, in this case the restrictive credit controls, which reappeared just two months before the onset of the recession in November, appear as a tipping point leading to the recession. Consumer Durable Goods Spending The Office of Business Economics in the U.S. Department of Commerce (subsequently OBE was renamed the Bureau of Economic Analysis) prepared the data on consumer durable goods spending as part of the gross national product data discussed in the section below. Unlike most of the other economic indicators used in the book, these data are provided quarterly, not monthly. Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. Their durability means that sales of these goods can be deferred during periods of rising or high unemployment more readily than sales of items such as food and utilities. Therefore, household spending for durable goods is more cyclical than household spending for nondurable goods and services. Consumer durable goods fluctuated around 9 percent of the gross national product (GNP) during the 1947–48 period. The GNP is the overall measure of economic growth, as discussed in the next section. Figure 2.8 shows the quarterly percentage change at an annual rate in consumer durable goods spending reported on a real-time basis from second quarter of 1947 to the fourth quarter of 1948. These ranged from –12 to 25 percent, except for the second quarter of 1947, which was 81 percent. The quarterly movements were volatile. After the sharp drop of 81 percent in the second quarter of 1947 to zero change in the third quarter, the movements shifted to a 20 percent increase in the fourth quarter, an absolute decline (below the zero line) of 12 percent in the first quarter of January–March 1948, increases of 18 percent and 25 percent in the second and third quarters of 1948, and an absolute decline of 11 percent in fourth quarter. The demand backlogs of consumer durables were reduced considerably from World War II, as discussed in the beginning of the chapter. There was also a lessening of the high rates of marriage, births, and family geographic migration that occurred in the immediate postwar period, which had been propping

THE RECESSION OF 1948–49

Figure 2.8

75

Consumer Durable Goods Spending in Expansion Preceding the 1948–49 Recession, Plus One Recession Quarter, in Real Time

s 2ECESSION QUARTER4HE /CTOBERn$ECEMBER  QUARTER INCLUDED TWO MONTHS OF recession (November and December 1948). Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. The data are not deflated for price change. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only the fourth quarter of 1948 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, the second quarter of 1948 first became available in July 1948). The second quarter of 1947 to the second quarter of 1948 represent data available as of August 1948. The third and fourth quarters of 1948 represent data when they first became available one month after each data quarter. The quarterly patterns of the third and fourth quarters of 1948 are similar to the later data for those quarters that became available in January 1949.

up the demand for consumer durables. As noted in the earlier section on housing starts, when a household moves into a new house, it stimulates purchases of appliances, furniture, house furnishings, and garden equipment. The exception to this was the continued short supply of automobiles, which resulted in steady increases in auto prices over the 1947–48 period. This strong demand for automobiles led to a higher rate of spending for the total of all consumer durables than otherwise would have occurred. Autos accounted for one-third of consumer durable spending during the period. It is also relevant that spending for consumer durables is fostered by the construction of new housing. In addition to the economic conditions affecting consumer durables noted above, households had an increased demand for new consumer durable products that came on the market after World War II. Television sets, room air conditioners, and electric blankets are examples of such new products that had strong growth trends in 1948.19 The appeal of such new products promised

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to lead to much higher sales in the years ahead because the vast majority of households did not yet have them. For example, sales of television sets increased at an annual rate of 76 percent from 1948 to 1951. But despite such growth, even a highly desired, but ultimately discretionary, new product is subject to a delay in its purchase during a recession, as occurred then. Consumer durables expenditures were generally growing, but volatile, in the period preceding the 1948–49 recession. Except for automobiles, there were no remaining shortages of consumer durables from the lack of production during World War II. Another factor contributing to the slowdown in demand for consumer durables was the drop in population and household growth and in geographic migration around the country. Overlaid on these trends was the reimposition of consumer credit controls in September 1948, which sparked the cutback in consumer durables spending in the fourth quarter of 1948, as noted in the above section on interest rates and bank loans. Gross National Product The gross national product is the most comprehensive measure of economic growth.20 It represents the goods and services produced and consumed in the household, business, government, and international components of the U.S. economy. The GNP is valued in dollars, and in the 1940s, there was no adjustment for price change. The GNP combines into a single aggregate both quantity and price in the movement from period to period. Adjustments for price change that provide changes only in the quantity of goods and services produced, referred to as constant dollars, first began on a real-time basis annually in 1951 and quarterly in 1958. The Office of Business Economics in the U.S. Department of Commerce prepared the GNP data. Unlike the other economic indicators used in the book, the GNP data are only provided quarterly, as noted previously under consumer durable goods spending. Figure 2.9 shows the quarterly percentage change at an annual rate in the GNP on a real-time basis from the second quarter of 1947 to the fourth quarter of 1948. These movements were sharply volatile from the second quarter of 1947 to the first quarter of 1948, ranging from –1 percent to 31 percent. From zero change in the first quarter of 1948, increases of 7 percent, 13 percent, and 15 percent appeared in the second to fourth quarters of 1948, respectively. Because the GNP data were in market prices, they included the continuing inflation over the period, though with lesser price increases beginning in September 1948. This continuing inflation also raised the quarterly movements in the GDP to a greater rate than what they would have been if the data had been

THE RECESSION OF 1948–49

Figure 2.9

77

Gross National Product in Expansion Preceding the 1948–49 Recession, Plus One Recession Quarter, in Real Time

s 2ECESSION QUARTER4HE /CTOBERn$ECEMBER  QUARTER INCLUDED TWO MONTHS OF recession (November and December 1948). Source: Based on U.S. Office of Business Economics data. The data are not deflated for price change. Note: The 1948–49 recession began in November 1948 and ended in October 1949, so only the fourth quarter of 1948 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, the second quarter of 1948 first became available in July 1948). The second quarter of 1947 to the second quarter of 1948 represent data available as of July 1948. The third and fourth quarters of 1948 represent data when they first became available one month after each data quarter. The quarterly patterns of the third and fourth quarters of 1948 are similar to the later data for those quarters that became available in January 1949.

adjusted for price change, which, as noted above, would show only changes in the quantity of goods and services produced. The GNP showed a generally growing economy over the period in the figure. But it also was very volatile, with one quarter in 1947 having an absolute decline and one quarter in 1948 having no change in the GNP. Also, growth over the period was exaggerated because it included the effects of price inflation. Note on National Defense Following the victory in World War II over Germany and Japan in 1945, the United States had increasing Cold War clashes with the Soviet Union beginning in 1946 over its imposition of socialist governments in Eastern Europe, as well as its attempts to influence the types of governments in Greece and

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Turkey. The United States responded with economic and military aid to Greece and Turkey (Truman Doctrine), the European Recovery Plan (Marshall Plan), and creation of the North Atlantic Treaty Alliance (NATO). But despite this heating up of the Cold War, U.S. spending for national defense did not increase from its post–World War II low levels until after the Korean War began in June 1950. Table 2.1 shows the national defense expenditures and its share of the gross domestic product annually from 1945 to 1951. Both measures are derived from data in the current dollars of all the periods, which are not adjusted for inflation. I have used gross domestic product, which was adopted as the preferred indicator of the overall economy in 1991, rather than the gross national product, for two reasons: (a) to get the best measure of the actual impact of defense on the economy, and (b) there was little or no difference in the shares on both definitions.21 The data are based on the best statistical measures of national defense and the GDP at the time of this writing in 2009. Here I diverge from the “realtime” data highlighted in the chapter, because this focus is on the actual amount of defense spending and its relation to the total economy, not on what was available to the economic policy makers at the time as reflected in the real-time data. National defense expenditures dropped sharply from $82 billion in 1945 to $25 billion in 1946, and dropped to $18 billion in 1947 (Table 2.1). They then leveled at $18 to $20 billion from 1948 to 1950, and jumped to $39 billion as 1951, as the mobilization buildup for the Korean War progressed. It is also noteworthy that because the expenditure data in the table were in current dollars, the real increases were smaller and the real decreases were larger than the numbers in the table suggest, because the current dollar data included the effects of inflation. National defense as a share of the GDP showed the same pattern as defense expenditures during the 1945–51 period. This was the fall from 36.8 percent in 1945 to 11.3 percent in 1946, and a further fall to 7.5 percent in 1947. Then the share fluctuated around 7 percent from 1947 to 1950, and increased sharply to 11.6 percent in 1951 in the mobilization buildup. The defense share of the GDP on a quarterly basis from 1947 to 1950 mirrored the annual movements (Figure 2.10). The measures based on shares include both the movements of national defense in the numerator and the GDP in the denominator. Consequently, the within-year movements are more volatile than the annual movements, because the rates of change of defense spending and of the GDP vary from quarter to quarter. Thus, there was no spurt in defense spending impacting the economy preceding the recession of 1948–49. In fact, it was not until the last half of

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Table 2.1 National Defense Expenditures and National Defense Share of Gross Domestic Product (in current dollars of each year)

1945 1946 1947 1948 1949 1950 1951

National Defense Expenditures (billions of dollars)

National Defense Share of GDP (percent)

82.0 25.2 18.2 18.3 19.8 19.6 39.3

36.8 11.3 7.5 6.8 7.4 6.7 11.6

Source: Bureau of Economics, U.S. Department of Commerce, 2007. Note: The data are part of the national income and product accounts. They represent the best statistical measures of the period as of 2007. They differ from the real-time data highlighted elsewhere in Chapter 2.

Figure 2.10 National Defense Expenditures as a Percentage of the Gross Domestic Product

Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. The data are not deflated for price change. Note: The percentages are derived from data in the current dollars of each quarter. These measures represent the best statistical estimates of the period as of 2008. They differ from the real time data highlighted elsewhere in Chapter 2.

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1950 that defense spending resulting from the Korean War increased both absolutely and relative to the overall economy. The economy in the aftermath of World War II was dominated by the demobilization to a civilian economy, both during the expansion preceding the recession and during the recession itself. And then it was only after the first eight months of the recovery from October 1949 to June 1950, that the outbreak of the Korean War in June 1950 caused the remobilization to begin. Assessment of Economic Policies Preceding the 1948–49 Recession There were several crosscurrents in the American economy from the spring of 1947 through the summer of 1948. The major economic indicators were rising, though with a modest rate of growth, which in some cases showed no monthly accelerating or decelerating trend, while experiencing considerable volatility. Employment continued to increase, unemployment was low, interest rates were low, and bank credit was available to households and businesses. Inflation was high, but not accelerating, and wholesale prices as a harbinger of future inflation pointed to a deceleration in future price increases. There were also absolute, not just relative declines, from month-to-month or quarter-to-quarter, in industrial production, housing starts, manufacturing worker earnings, consumer durable goods spending, and the gross national product. There was no overall shortage of workers, though shortages may have existed in selected industries or skills. Increases in worker earnings were modest and were not a source of inflation. With the notable exception of housing and cars, the backlogs of demand for household goods and business equipment and structures that had developed during World War II had largely been eliminated, which considerably reduced the previous sources of demand. Overarching these crosscurrents for the economic policy makers—the Federal Reserve, the president, and the Congress—was their continuing concern that inflation was the major economic problem. This stemmed from shortages of selected goods like metals, building materials, and cars that still remained three years after the conversion to a civilian economy following the end of World War II in 1945. It was accompanied by the fact that households and businesses accumulated considerable savings from their incomes during the war because the emphasis on war production excluded all but the basic necessities being produced for the civilian economy. Then after the war these savings were a potential for spending that would bid up prices for the limited supply of civilian goods until those needs were met. For example, personal saving rose from $11.5 billion in 1941 to approximately $30 to $40 billion from 1942 to 1945, and then dropped sharply in 1946 and later years. The reduction in individual income taxes passed by Congress in April 1948

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further exacerbated what was seen as a future inflation potential. The tax cuts were retroactive to the beginning of 1948, and were sustained over President Truman’s veto. They were seen as inflationary because they increased the money available for household spending. In light of the fact that inflation was widely accepted as the main economic problem across the political spectrum, the tax cuts appear more as an example of political philosophy than of economic need, in order to distinguish Republicans from Democrats that would be used in the upcoming presidential election in November 1948. Economic policy makers were also concerned that international developments, the heating up of the Cold War with the Soviet Union with its attendant buildup of the armed forces and military spending, and the U.S. commitment to finance the European Recovery Plan to help Western Europe overcome the devastation of World War II, were inflationary. (The Soviet Union and the Eastern European satellite countries rejected the U.S. offer to help with their economic recovery.) Both of these obligations, the Cold War and European recovery, portended increased federal government spending, and together with reduction in individual income taxes in 1948, pointed to a shift in the federal budget from a surplus to a deficit position. This shift would undermine what was considered the major anti-inflationary tool in the economy, because the existence of the budget surplus in 1947 and 1948 removed money from the income stream that otherwise would have been spent in a shortage economy and thus bid up prices. While the Federal Reserve raised reserve requirements of commercial banks, and the president supported and Congress passed legislation enabling the Federal Reserve to raise the requirements in 1948, banks still had adequate funds for lending by selling their inventory of U.S. Treasury securities. Also, interest rates were low, though rising during 1948, and so were not a disincentive for household and business borrowers. Consequently, I do not believe that these anti-inflationary policies actually restrained overall spending in the economy. A policy-driven area that I believe led to reduced consumer durable goods spending was the reimposition of consumer credit controls in September 1948 by the Federal Reserve, after Congress passed legislation authorizing these controls that the president had supported and the Federal Reserve had requested. As noted at the beginning of this assessment, the economy was growing at a modest rate during 1948, and showed considerable volatility in the monthly and quarterly movements of the various economic indicators. Also, much of the backlog needs from the lack of civilian production in the war years had been worked down. Following the new consumer credit controls, household spending for consumer durable goods declined sharply. Factors other than the consumer

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credit controls no doubt contributed to the decline in spending for consumer durables, such as the slowdown in marriages, birthrates, and family geographic migration, as well as the working off of the backlogs from World War II. The various economic indicators throughout the expansion period preceding the recession also showed modest growth, with considerable volatility. But economic growth was not increasing at a rate that threatened to bump along production capacity levels, and thus bid up prices. Inflation was high, but there was no acceleration in the rate of price increases. In fact, it was this overall economic environment that put the economy at risk of a tightening of consumer credit. The experience of wholesale price movements from April to August 1948 suggested that inflation continued to be a problem for future months, though at a lower rate than earlier in the year and in 1947. The individual income tax cut passed by Congress in April 1948, retroactive to January 1948 and over President Truman’s veto, was counter to the anti-inflationary policy of the time. Though a political statement at the time by the Republican Congress in looking toward the upcoming elections in November, the tax cuts were a better economic policy than the reimposition of consumer credit controls. However, the tax cut was a double-edged sword, as it heightened the fear of future inflation, which in turn helped forge the tripartite coalition of the president, Congress, and the Federal Reserve that brought on the consumer credit controls. Unfortunately, the economic stimulus of the tax cut was not sufficient to stave off the recession beginning in November 1948. Consumer durables are a highly cyclical component of the economy. Consumer durables fluctuated around 8 percent of the GNP during 1947 and 1948, a significant but not dominant share of the economy. Other elements of the economy can offset a weakness in durable goods spending. However, in this case, I believe the new restrictive credit controls, which went into effect just two months before the onset of the recession in November, appear as a tipping point in the economy leading to the recession. In addition to consumer durables, construction for new single-family and multifamily housing was another important element leading to the recession. This reflects both the direct construction expenditures for building materials and labor, and the secondary spending for household appliances, furniture, house furnishings, and garden equipment that occurs when a household moves into a new house. The direct spending for new housing construction accounted for 3 and 4 percent of the gross domestic product in 1947 and 1948, respectively. As indicated in the section on housing starts, housing starts generally were rising, though volatile in their monthly movements. Then absolute declines appeared from June to December 1948. In contrast to consumer durables, this

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decline in housing starts was not triggered by an economic policy change. Thus, it appeared as a market-driven phenomenon, as noted in Chapter 1 under Business Cycles and Recessions. I consider the weakness in new housing construction, and its secondary effects on spending for consumer durables, an important contributing factor to the onset of the recession, though no economic policy change contributed to the decline in new housing construction. Also, demographic changes in the population appeared in slowdowns in marriage and birthrates, which lessened population growth, and in family migration around the country. I believe the decline in population growth and in family geographic migration lessened inflationary pressures and the demand for goods, services, and housing, which contributed to bringing on the recession. These demographic changes reflected market and social changes, but were not driven by economic policy changes. Appendix 2.1. The Economy Before 1948 As a general note of historical background, I discuss three aspects of the U.S. economy preceding the onset of the 1948–49 recession: s %VOLUTIONOFTHE.EW$EALECONOMICPOLICIESDURINGTHES s -ILITARYENORMITYOF7ORLD7AR))INRELATIONTOTHE53ECONOMY s 0OSTWARECONOMY Evolution of New Deal Economic Policies The New Deal under President Franklin Roosevelt evolved during the 1930s in three stages. The National Industrial Recovery Act (NIRA) epitomized the “First New Deal.” The NIRA authorized industry codes sanctioning agreements among businesses not to lower prices on particular products below an established rate. The floor on prices was intended to encourage businesses to invest, thereby stimulating economic growth and employment. This program, by its nature, ignored enforcement of the antitrust laws, thus lessening price competition among companies. In short, it was monopolistic. The Supreme Court ruled the NIRA unconstitutional in 1935 on the grounds that the NIRA delegated undue power to the federal government in relation to the state governments. Despite the legal end of the NIRA, businesses maintained informal agreements among themselves in using the codes to limit competition because of the continued lack of antitrust enforcement. The “Second New Deal” was associated with passage in 1935 of the National Labor Relations Act, establishing the right of unions to bargain collectively, the Social Security Act, and the Works Progress Administration.

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Unemployment declined from the high of 12.8 million workers and an unemployment rate of 24.9 percent in 1933, to 7.7 million workers and an unemployment rate of 14.3 percent in 1937.22 The drop in unemployment between 1933 and 1937 was sluggish, although a step in the right direction. But the further shock of the recession of 1937–38 resulted in a sharp jump in unemployment to 10.4 million workers and an unemployment rate of 19.0 percent in 1938, wiping out a large part of the improvement from the depths of 1933. Unemployment then fell to 9.5 million workers and an unemployment rate of 17.2 percent in 1939, and to 8.1 million workers and an unemployment rate of 14.6 percent in 1940. The recession of 1937–38 has been attributed to several causes: the restrictive monetary policy by the Federal Reserve in raising reserve requirements of commercial banks in 1936, the disincentive effect on business investment when the undistributed profits tax was added to the tax code in June 1936, and the cutback in federal spending in 1937.23 The “Third New Deal” emerged from President Roosevelt’s great disappointment with the retrogression of the economy in the 1937–38 recession. This led him to a 180-degree turn from the philosophy of the initial economic program under the NIRA. The new policy revitalized the federal antitrust program in 1938 in order to bring more competition into industry. The idea was that the greater competition would lower prices of products, increasing the purchasing power of householders’ income, and so stimulate spending, economic growth, and employment. Thurman Arnold, who wrote Folklore of Capitalism and Bottlenecks of Business, spearheaded the antitrust program in the Department of Justice. Also in response to the 1937–38 recession, President Roosevelt reversed the reduction in federal spending that had occurred during 1937 by increasing federal expenditures in the spring of 1938 as a means of invigorating the economy. In addition, the 1937–38 recession sparked an innovation in macroeconomic forecasting. Henry Morgenthau, secretary of the treasury, asked Wesley Clair Mitchell of the National Bureau of Economic Research in 1937 to compile a list of statistical indicators that would give clues about when the recession that began in 1937 would turn into recovery, and Mitchell did so in collaboration with Arthur Burns. These economic statistics on “recovery” led to the development of the leading indicator system as an economic forecasting tool in the 1950s and later decades. Today, practitioners in the field follow closely the report on the leading economic indicators released each month. The latest report is used for assessing strengths and weaknesses in the economy on an ongoing basis. However, the leading indicator system is not reliable for anticipating recessions on a real-time basis. It is only with revised data that are recalculated retrospectively

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that the leading indicator system consistently leads the onset of recessions by several months, and the lead times vary in length among the recessions.24 Also, the system sometimes gives false signals of recessions that never occur. Military Enormity of World War II in Relation to the U.S. Economy The enormity of World War II is evident in at least two comparisons: s .ATIONALDEFENSESPENDINGASASHAREOFTHEOVERALLECONOMYREPRESENTED by the gross domestic product reached 43 percent in World War II (1944). Its peak share of the GDP declined in each subsequent war: World War II (1944) Korean War (1953) Vietnam War (1968) Iraq War I (1991) Iraq War II (2008)

43.0% 14.7% 10.0% 6.4% 5.1%

s 4HEREWEREMILLIONMENANDWOMENONACTIVEDUTYINTHEARMEDFORCES in 1945. By 1946, 9 million of these had returned home. The peak armed forces levels were vastly lower in subsequent extended wars:

World War II Korean War Vietnam War Iraq War I Iraq War II

(in millions) 12.1 3.6 3.5 2.0 1.4

Postwar Economy The perception during the war was that it was only after the buildup of war production beginning in 1940, even before the United States entered World War II in December 1941, and the subsequent absorption of millions of men and women into the armed forces, that unemployment fell to prosperous, pre-Depression levels. Thus, in the wake of the Depression, there was considerable apprehension during World War II of a return to high unemployment after the war. The devastation of the Depression and the 1937–38 recession was a grim reminder of the economic challenge facing the nation coming out of World

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War II. However, despite this apprehension, the postwar economy was resilient. Undergirding the high-performing economy were the production of household durable goods, new housing construction, and business investment in equipment and structures. Spending for these needs stemmed from the backlog accumulated from the Depression and the war, and was financed by the household and business savings accumulated during the war. The economy was also bolstered by the GI bill for education, which enabled veterans to go to school full time or part time while working, and by the Veterans Administration (VA) low-interest mortgage loans, which enabled veterans to buy homes. In addition, there was a better grasp of the federal government’s active role in influencing the economy so as to avoid a depression, as well as the political will to involve the federal government in the macro economy, evidenced by passage of the Employment Act of 1946, discussed earlier in the chapter under Overview of the Economy During 1948. Notes 1. L. Jay Atkinson, “Backlog Demand for Consumers’ Durable Goods,” Survey of Current Business, April 1948, p. 21. 2. Irwin Friend, “Business Financing in the Postwar Period,” Survey of Current Business, March 1948, p. 10. 3. “Demand, Production, and Prices in 1947,” Federal Reserve Bulletin, January 1948, pp. 1, 2, and 7. 4. Economic Report of the President, January 1948, pp. 47–52. 5. “Treasury Surplus, Bank Reserves, and the Money Supply,” Federal Reserve Bulletin, May 1948, pp. 496–97; letter from M.S. Eccles, chairman pro tem of the Board of Governors of the Federal Reserve System, to Senator Charles W. Tobey, chairman of the Committee on Banking and Currency, April 5, 1948, Federal Reserve Bulletin, July 1948, pp. 764–65; statement of R.M. Evans, member of the Board of Governors of the Federal Reserve System, before the House Banking and Currency Committee, August 2, 1948, “Regulation of Consumer Installment Credit,” Federal Reserve Bulletin, August 1948, pp. 912–13; and “Bank Credit Developments,” Federal Reserve Bulletin, October 1948, pp. 1205–6. 6. Ibid. 7. “The Revenue Act of 1948,” Survey of Current Business, April 1948, p. 6. 8. Benjamin Caplan, “A Case Study of the 1948–1949 Recession,” Policies to Combat Depression: A Conference of the Universities—National Bureau Committee for Economic Research, A Report of the National Bureau of Economic Research (Princeton: Princeton University Press, 1956), p. 41. 9. The federal fiscal surplus/deficit position is shown below: Fiscal year 1947 1948 1949

Billions of dollars 4.0 11.8 0.6

Source: Economic Report of the President, February 2008, Table B-80, p. 321.

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10. Excerpt from the Employment Act of 1946 (U.S. Code, Title 15, Section 1021). The Congress hereby declares that it is the continuing policy and responsibility of the Federal Government to use all practicable means consistent with its needs and obligations and other essential considerations of national policy, with the assistance of and cooperation of industry, agriculture, labor, and State and local governments, to coordinate and utilize its plans, functions, and resources for the purpose of creating and maintaining, in a manner calculated to foster and promote free competitive enterprise and the general welfare, conditions under which there will be afforded useful employment opportunities, including self-employment, for those able, willing, and seeking to work, and promote maximum employment, production, and purchasing power. 11. Benjamin Caplan, who was on the staff of the Council of Economic Advisers in the period preceding, during, and after the 1948–49 recession, later referred to the recession as a limited test of the effectiveness of the Employment Act of 1946, because he considered the problems of the recession to be relatively minor, though without explaining why. See Caplan, Policies to Combat Depression, p. 27, note 7 above. 12. The age definition of workers who make up the labor force was raised in 1967 from 14 years and older to 16 years and older (Employment & Earnings, April 2007, p. 201). The unemployment rate for 1947 based on revised data for the two age definitions rounded to 3.9 percent in both cases (in thousands of workers): 14 years and older A Employment 57,812 Unemployment 2,356 Labor force 60,168 Unemployment rate 3.9%

16 years and older B 57,038 2,311 59,350 3.9%

Difference B–A –774 – 45 –818 —

Source: Economic Report of the President, February 2008, Table B-35, p. 268. Note: Components do not sum to totals, due to rounding. 13. The consumer price index for employed urban wage workers in blue-collar occupations and clerical workers is called CPI-W (it had been called the consumers’ price index during the 1948–49 recession period). The CPI-W currently covers about 32 percent of the noninstitutionalized population. A new CPI was added beginning in January 1978 that covers a larger population of households—urban workers in all occupations, the unemployed, and retired persons. It is called CPI-U, and currently covers about 87 percent of the noninstitutionalized population. Both CPIs exclude rural households, military personnel, and persons in institutionalized housing such as prisons, old-age homes, and long-term hospitals. The annual change in the two CPIs typically differs by 0.1 percentage point. 14. “Bank Credit Developments,” Federal Reserve Bulletin, October 1948, p. 1214. 15. Ibid., p. 1214. 16. Ibid., pp. 1213–14.

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17. “Treasury Surplus, Bank Reserves, and the Money Supply,” Federal Reserve Bulletin, May 1948, pp. 495–96. 18. “Recent Developments in Installment Credit,” Federal Reserve Bulletin, April 1949, pp. 336–37. 19. Louis J. Paradiso and Francis L. Hirt, “Growth Trends in the Economy,” Survey of Current Business, January 1953. 20. While the gross national product (GNP) is still used in economic analysis, it has been largely replaced by the gross domestic product (GDP). The GNP was the sole measure provided during the 1948–49 recession. The GDP was first featured as the main overall indicator of the economy in 1991, though it had been provided beginning in 1974. There is little difference between the two from the standpoint of this book. The differences are the treatment of earnings of multinational corporations in the United States and abroad, interest income and payment from foreign investments, and the wages and salaries of nationals working in the United States and abroad. For the specific treatment of these items, see Chapter 11, note 14. 21. Ibid. 22. The unemployment data cited here were prepared by the Bureau of Labor Statistics, U.S. Department of Labor. See the 1980 Supplement to Economic Indicators, printed for the Joint Economic Committee of Congress, U.S. Government Printing Office, 1980, pp. 35 and 38. 23. Kenneth D. Roose, The Economics of Recession and Revival: An Interpretation of 1937–38 (New Haven: Archon Books, 1969), copyright 1954, Yale University Press, reprinted with permission of Yale University Press. %VAN&+OENIGAND+ENNETH-%MERY h-ISLEADING)NDICATORS5SINGTHE Composite Leading Indicators to Predict Cyclical Turning Points,” Economic Review, Federal Reserve Bank of Dallas, July 1991; and H.O. Stekler, “Interpreting Movements in the Composite Index of Leading Indicators,” Business Economics, July 2003.

3 The Recession of 1953–54

The recession of 1953–54 began in July 1953 and ended in May 1954. Two general conditions affected this recession that were not present in recession of 1948–49. One was the continuation of the Korean War, which began in June 1950 and was ongoing for three years until the Armistice in July 1953 ended the fighting on the eve of the recession. The other changed condition was the shift in economic policy in 1951 that allowed the Federal Reserve to influence interest rates based on its view of the economy’s needs. This reversed the policy adopted in 1942 in the early part of World War II in which the Federal Reserve acted to ensure low interest rates for U.S. Treasury securities as a means of lessening the government costs of financing the federal debt. Korean War and the Economy The Korean War began with a surprise attack by North Korea on South Korea, and was the first surrogate hot war of the Cold War. In addition to the surprise element, the United States had a relatively low level of national defense in the aftermath of World War II, as discussed in Chapter 2. Table 3.1 shows the annual defense spending and its share of the gross domestic product (GDP) from 1949 to 1953. The annual data in this summary of the Korean War are based on the statistics available in 2008 to best reflect the actual impact of the war on the economy, as distinct from the quarterly real-time data on the gross national product (GNP) during 1952 and 1953 in the economic indicator sections below. Substantial increases occurred in both defense and the GDP in 1951 and 1952, following the initial focusing on the war in the last half of 1950 that was taken up with increasing the orders for defense goods and the beginning of defense production in civilian and defense factories. Defense spending nearly tripled from $20 billion in 1950 to $56 billion in 1953, with the defense share of the GDP rising from 6.7 percent in 1950 to 14.7 percent in 1953. The high level of mobilization reached in 1952 ($52 billion) was maintained in 89

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Table 3.1 National Defense Expenditures and National Defense as a Share of the Gross Domestic Product (in current dollars of each year)

1949 1950 1951 1952 1953

National Defense Expenditures (billions of dollars)

National Defense Share of the GDP (percent)

19.8 19.6 39.3 52.4 55.9

7.4 6.7 11.6 14.6 14.7

Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2007. Note: The data are part of the national income and product accounts. They represent the best statistical measures of the periods as of 2007. They differ from the real-time data highlighted in Chapter 3.

1953 ($56 billion), with much of the $4 billion increase probably absorbed by higher prices rather than a greater quantity of military output. There also was only a slight increase in the defense share of the GDP from 1952 to 1953 (14.6 percent to 14.7 percent). The outbreak of the war also brought a surge of inflation. Households rushed to buy consumer durable goods, such as cars, household appliances, and television sets; businesses rushed to buy building materials and various equipment items; and there was a rise in speculation in commodity markets for raw materials. The buying spree reflected the perception that such items would be in short supply due to the expected conversion of civilian goods production to military goods production, similar to the experience during World War II. The resultant bidding up of prices also led to wage inflation, with workers bargaining for wage increases to maintain the purchasing power of their earnings. The wage inflation also reflected the increased demand for workers.1 Table 3.2 shows the annual price and wage inflation during the Korean War. The data reflect the price and wage movements during each calendar year of 1950, 1951, 1952, and 1953 by calculating the annual changes from December to December. This differs from calculating annual changes from averages of one year to the next, which results in overlapping part of one calendar year with part of the following year. To illustrate: Suppose prices rise at a steady 10 percent annual rate throughout Year 1, but are unchanged throughout Year 2. The year-over-year increase in prices would be about 5 percent, but the more meaningful December-to-December change for Year 2 would be zero.

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Table 3.2 Price and Wage Inflation (annual percentage change)

December to December 1949 to 1950 1950 to 1951 1951 to 1952 1952 to 1953

Consumer Price Index for Average Hourly Earnings Urban Households Workers for Manufacturing 5.8 6.0 0.9 0.6

11.2 7.2 6.0 4.4

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: The data represent the best statistical measures of the periods as of 2008. They differ from the real-time data highlighted in Chapter 3.

The data represent the best statistical measures of prices and wages of the period as of 2008, in order to assess the actual impact of inflation on the economy. They differ from the real-time data available to policy makers at the time that are highlighted below for 1952 and 1953 in the discussion of the monthly movements of several economic indicators. The consumer price index (CPI) for urban and clerical workers increased by 5.8 and 6.0 percent in 1950 and 1951, and by 0.9 and 0.6 percent in 1952 and 1953. However, the twelve-month data for 1950 in the table do not capture the fact that practically all of the inflation for 1950 occurred after the outbreak of the Korean War in June 1950. From June 1950 to December 1950, the CPI increased at an annual rate of 9.4 percent, compared with the annual increase from December 1949 to June 1950 of 2.3 percent. Average hourly earnings for manufacturing workers increased by 11.2 percent in 1950, followed by decelerating increases of 7.2 percent in 1951, 6.0 percent in 1952, and 4.4 percent in 1953 (data on hourly earnings for workers in all industries first became available in the 1960s). From June 1950 to December 1950, hourly earnings increased at an annual rate of 14.3 percent, compared with the annual increase from December 1949 to June 1950 of 8.2 percent. This acceleration showed the effect of the Korean War, though large increases in wage rates had already been occurring before the outbreak of the War. Overall, the wage increases were significantly greater than the price increases during the Korean War period. Economic Regulations During the Korean War President Harry Truman instituted price and wage controls in January 1951 to dampen the rapid increases in prices and wages, such as occurred immediately

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following the outbreak of the war in 1950. Price controls for many products were removed during 1952, while wage controls remained in effect for all of 1952. A general decontrol began in 1953, with all wage controls removed early in 1953 and all price controls removed by October 1953. Controls were also placed on the allocation of scarce and critical metals and other materials and products needed for defense under the Controlled Materials Plan, which went into effect in July 1951. Most of the controlled items were freed during 1952, and all items were decontrolled by the end of June 1953. Federal income taxes were increased on individuals and on businesses in 1950 and 1951, as a way of both raising revenues and curbing inflation. Federal excise taxes on certain items were increased in 1951. The business tax was an excess profits tax. An excess profits tax has been used in the United States during wartime—World War I, World War II, and the Korean War. The rationale for the tax is that during the extraordinary war circumstances of greater government military spending, and greater household and business spending in anticipation of shortages, wartime “windfall” profits should be taxed. The excess profits tax rate would plausibly be determined in some relation to peacetime earnings, though I have not seen a description of how it was done in the three wars. The Federal Reserve took several actions to restrain credit during the war. The first stemmed from the Treasury-Federal Reserve Accord discussed in the next section, in which the Federal Reserve lessened its purchases of U.S. securities held by banks and other lenders, resulting in lower prices of the principal value of the securities and the associated higher interest rates. This caused lenders to be less willing to sell their securities at the lower price in order to obtain funds to provide loans to borrowers, which led to the postponement, cutback, or cancellation of some corporate and municipal financing programs.2 The Federal Reserve raised reserve requirements on commercial banks, and put stricter limits on consumer installment credit (Regulation W) and on real estate mortgages (Regulation X) that initiated minimum down payments and maximum maturities. In addition, the Federal Reserve established a voluntary credit restraint program by banks and insurance companies to limit their lending for essential uses and lessen their loans for speculation. Federal Reserve Policy Change The Federal Reserve reports to Congress and legally is independent of the president. In April 1942, shortly after the United States entered World War II in December 1941, the Federal Reserve agreed to the request of the U.S.

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Department of the Treasury to maintain low interest rates in order to keep down federal government interest costs in its borrowings to finance the war.3 This policy of maintaining low interest rates to lessen federal interest costs in its sales of bonds and notes hampered the Federal Reserve in its monetary policy, when it felt interest rates should be raised in order to restrain demand and contain inflation. The low-interest policy continued into the first year of the Korean War. Following the surge in inflation after the outbreak of the war, the low-interestrate policy came more into question with a contentious debate, with advocates for both continuing and ending the policy. Then in March 1951, the Treasury Department and the Federal Reserve reached an agreement allowing the Federal Reserve to foster higher interest rates when it considered it desirable for the health of the economy. The agreement was referred to as the Treasury-Federal Reserve Accord. The accord occurred after a contentious debate between President Harry Truman, who wanted to maintain the low-interest policy then in effect, and the governors of the Federal Reserve, who wanted to end the policy.4 The economic expansion preceding the recession of 1953–54 was the first such period after World War II in which the Federal Reserve was free to use its influence in money markets to raise interest rates. Economic Indicators in Real Time During 1952–53 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1953–54 recession in July 1953 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINMANUFACTURING s )NTERESTRATESANDBANKLOANS s 'ROSSNATIONALPRODUCT National defense and the federal government fiscal position are included in supplementary notes to the economic indicators. The last section of the chapter is an assessment of the economic policies preceding the 1953–54 recession.

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I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durables and the gross national product, which are available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1953–54 recession is dated as beginning in July 1953. So August to December 1953 in the figures that follow were the first five months of the recession. To assess what was available to policy makers as 1953 progressed, the figures chart the real-time data from January 1952 to December 1953. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in April 1953. Because economic data became available one month after the month to which they refer, the March 1953 data first appeared in April. Thus, the April 1953 starting point provides the most reliable data, including previous revisions up to that time, from January 1952 to March 1953. The data from April to December 1953 reflect the real-time data on a monthly and quarterly basis from May 1953 to January 1954, as they were produced. Revisions that occurred to the April to December data as of February 1958 changed the monthly and quarterly patterns at most slightly. I chose April 1953 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in April, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in July. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1952–53 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 3.1 shows the monthly percentage change in jobs from January

THE RECESSION OF 1953–54

Figure 3.1

95

Jobs in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. The Federal Reserve seasonally adjusted the data. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly patterns of the April to December 1953 data are similar to the later data for those months that first became available in January 1954.

1952 to December 1953 on a real-time basis. Employment during the period fluctuated around 46 million to 50 million jobs. On this basis, a 1 percent change in employment affected 460,000 to 500,000 jobs. Up to the onset of the recession in July 1953, the monthly employment changes ranged from –0.5 to 0.5 percent. The exceptions were in August and September 1952, when employment increased by 1.7 percent and 0.7 percent, respectively. Absolute declines (below the zero line) or zero change in employment occurred in January, March, April, June, and July 1952, and in January, March, and April 1953. Sharp absolute employment declines occurred during the recession of –0.4 and –0.8 percent from August to December 1953, except for zero change in October. These were highly volatile monthly movements in employment during the nineteen months preceding the onset of the recession, with several months of absolute declines or zero change. It hardly was a period of steady robust growth.

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Unemployment The unemployment data used here represent the number of persons without jobs each month who were actively seeking work in the civilian sector of the economy. The data cover nonfarm and farm workers aged fourteen years and older. The unemployment data are not seasonally adjusted. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 3.2 shows the unemployment rate (UR) on a real-time basis from January 1952 to December 1953. The UR fluctuated in a range of 1.8 to 3.4 percent over the period. Actual unemployment ranged from 1.2 million to 2.1 million workers. Thus, a one-percentage-point change in the unemployment rate affected 12,000 to 21,000 workers. The UR generally ranged from 2 to 3 percent in the nineteen months preceding the recession that began in July 1953, and during the first five months of the recession. Exceptions to this range were 3.3 and 3.4 percent in January and February 1952, and 1.9 and 1.8 percent in August and October 1953, respectively. Within this narrow band of 2 to 3 percent, there was no general upward or downward trend, though the monthly rate fluctuated considerably. In the buildup of the military following the outbreak of the Korean War, women workers replaced some of the employed men going into the military. This is evident in the movements of the labor force participation rates (LFPR) of men and women in 1951 and 1952. The LFPR is the percentage of employed and unemployed workers in the working-age noninstituitonalized population. The LFPR for men hovered around 86.5 percent from the end of 1950 through 1951 and 1952, while the LFPR for women, though fluctuating from month to month, rose from a little above 34 percent at the end of 1950 to close to 35 percent in 1951 and 1952.5 From the last four months of 1950 (as the mobilization for the war took hold) to the last four months of 1952, on average, the male labor force dropped by 550,000 workers, while the female labor force increased by 925,000 workers. The 2 to 3 percent unemployment range was even lower than the 3 to 4 percent rate during the 1948–49 recession. Part of the low unemployment probably reflected the rise in the military draft and military volunteers for the Korean War. This increased the number of military personnel on active duty by 2 million from 1950 to 1953, of which 1.8 million of the increase occurred from 1950 to 1951. The increase in military personnel probably partially reduced unemployment in the civilian sector by lessening the number of men workers in the labor force who otherwise would have been unemployed. I did not see references to overall shortages of workers in articles in the Survey of Current Business, Federal Reserve Bulletin, and BusinessWeek, though shortages were reported in certain professional and technical occupations.6

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Figure 3.2

97

Unemployment Rate in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. The data are not seasonally adjusted. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly data from April to December 1953 were unchanged when the later data for those months became available in January 1954.

Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by employed urban wage workers in blue-collar and clerical occupations. For a discussion of inflation and deflation and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Following the outbreak of the Korean War in June 1950, there was a surge in inflation through February 1951 of 8.4 percent over the eight months. Then, from February 1951 to December 1951, inflation slowed to 3.1 percent over the ten months. And in 1952 and 1953, the annual increases in inflation declined still more, to 1.9 and 0.8 percent, respectively. Figure 3.3 shows the monthly percentage change in the CPI from January 1952 to December 1953 on a real-time basis. These typically ranged from

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Figure 3.3

Consumer Prices in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. The data are not seasonally adjusted. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data first became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly data from April 1953 to December 1953 were unchanged when the later data for those months became available in January 1954.

–0.2 to 0.2 percent, though there were several variations outside this band. The most extreme changes occurred in February 1952 (–0.6 percent) and July 1952 (0.6 percent). There were four months of absolute declines (below the zero line) from September 1952 to February 1953, and two months of small increases of 0.1 percent. In the periods both immediately preceding and after the onset of the recession in July 1953, respectively, monthly increases from May to October hovered around 0.2 and 0.3 percent (0.4 percent in June), and then absolute declines appeared in November and December. The Federal Reserve described prices of consumer goods as stable from January 1952 to June 1953, and wholesale prices as stable from January to June 1953, after having declined though 1952.7 And the Office of Business Economics in the U.S. Department of Commerce described prices as generally stable throughout 1953, with little speculation by businesses in changing their inventory holdings to affect replacement costs, and with keener competition appearing in businesses absorbing freight costs, giving special discounts, and ending the payment of premiums above list prices.8

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Consumer prices increased modestly during 1952 and 1953, with no sign of an accelerating upward trend, while there had been far greater monthly volatility in 1952. There were also several months of absolute price declines in 1952 and early 1953. Inflation was not an overall problem during the runup to the 1953–54 recession. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing and minerals (mining) industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 3.4 shows the monthly percentage change in the IPI from January 1952 to December 1953 on a real-time basis. The IPI was far more volatile during 1952 than in 1953. In 1952, there were absolute monthly declines Figure 3.4

Industrial Production in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly patterns of the April to December 1953 data varied from the later data for those months that first became available in January 1954 in the following main ways: The later data showed increases rather than decreases in April and May, a decrease instead of an increase in June, an increase instead of a decrease in July, and a decrease instead of an increase in August.

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(below the zero line), continually falling from 0.5 percent in March to 5.4 percent in July, large increases of 11 and 6 percent in August and September, and increases of 0.4 to 1.7 percent from October to December. In 1953, the monthly movements of the IPI ranged from –0.4 to 1.3 percent from January to June, and showed absolute declines in all months from July to December, except for a 1.7 percent increase in August. The declines ranged from –2.9 percent in July to –0.4 percent in October, with the other months in the –1.3 to –1.6 percent zone. In the nineteen months preceding the onset of the recession in July 1953, the IPI typically grew at monthly rates below 0.2 percent. This was interrupted by several absolute declines during the first half of 1952, and large increases in August and September 1952. Overall, this was a period of modest growth, until the recession months showed absolute declines. Housing Starts The housing starts data represent the beginning of construction on privately and publicly owned nonfarm single-family and multifamily housing. The housing start data are not seasonally adjusted. For more detail on the attributes of the housing start data, see Chapter 2 under Housing Starts. Figure 3.5 shows the monthly percentage change in housing starts on a real-time basis from January 1952 to December 1953. Housing construction is affected by changes in the weather: construction is highest in the spring and summer, and lowest in the fall and winter. Because the data are not seasonally adjusted, it is important to account for these weather patterns in assessing the monthly movements in the figure. During both 1952 and 1953, housing starts showed similar patterns of rising substantially in the early months of the year, and then falling substantially for the rest of the year. In 1952, housing starts increased by 7, 20, and 34 percent in January, February, and March, respectively, then fell to increases of 2 and 3 percent in April and May. This was followed by absolute declines (below the zero line) from June through December, except for increases of 1.7 and 0.3 percent in September and October. In 1953, housing starts increased by 8.5, 26, and 13 percent in February, March, and April, respectively, following an absolute decline in January. Subsequently, housing starts had absolute declines from May to December. Changes in the demand for particular types of housing during 1952 and 1953 reflected the effects of the additions to the housing supply after World War II.9 By 1952 and 1953, households had wider choices of the types of houses to buy, including both newly constructed and existing housing. There were also reports that in some communities, new and existing houses were

THE RECESSION OF 1953–54

Figure 3.5

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Housing Starts in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for privately owned nonfarm housing units. The data are not seasonally adjusted. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly patterns of the April to December 1953 data varied from the later data for those months that first became available in January 1954 in the following main ways: The later data showed a larger increase in March and a smaller increase in April, and an increase rather than a decrease in September.

taking longer to sell, with lower prices and more generous mortgage terms being offered. The trend toward larger houses with more amenities continued during 1952 and 1953, which raised the house price of each housing start. This demand for higher-priced housing stemmed from both increasing incomes and growing families.10 The pace of housing starts during 1952 and 1953 showed several months of absolute decline during summer months, when construction ordinarily is at the highest levels of the year. The increased housing supply since the end of World War II also gave prospective homeowners more choice in various types of housing, including greater spending on each housing start to accommodate their demand for larger and more upscale housing. Abstracting from the monthly volatility, housing starts continued at high annual levels in 1952 and 1953, but showed weak monthly patterns that were contrary to normal seasonal strength.

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Earnings of Manufacturing Workers I cite money wages of production workers in private manufacturing industries as a measure of average weekly worker earnings. The earnings data are not seasonally adjusted. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 3.6 shows the monthly percentage change in worker earnings in manufacturing industries on a real-time basis from January 1952 to December 1953. From January to July 1952, weekly earnings fluctuated around increases of 1 percent in three months, had absolute declines (below the zero line) in three months, and zero change in one month. Then from August to December, earnings increased by 1 to 3 percent in four months and 0.3 percent in one month. In 1953, weekly earnings had seven months of absolute decline and five months of increase. The declines occurred in the months preceding and after the onset of the recession in July, and the increases were 1 percent at most. Figure 3.6

Job Earnings in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all manufacturing industries. The data are not seasonally adjusted. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Data from January 1952 to March 1953 represent data available as of April 1953. Data from April to December 1953 represent data when they first became available one month after each data month. The monthly patterns of the April to December 1953 data varied from the later data for those months that first became available in January 1954 in the following main ways: The later data showed an increase rather than a decrease in May, no change rather than an increase in June, a much smaller decrease in September, a much smaller increase in October, and a much smaller decrease in November.

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Monthly changes in worker earnings were far more volatile in 1952 than in 1953. But there was no sign that wage increases were sufficient to increase costs of production, which would lead businesses to raise prices. This outlook was reinforced by the absolute declines in earnings that appeared in several months. Interest Rates and Bank Loans Interest rates on three- to five-year U.S. securities represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. Interest rates are not seasonally adjusted. Interest-rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 3.7 shows the monthly interest rates of three- to five-year U.S. securities from January 1952 to December 1953. After declining from 2.08 percent in January 1952 to 1.93 percent in April 1952, interest rates rose to Figure 3.7

Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1953–54 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only July to December 1953 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1953 data became available in March 1953). Interest rate data are not normally revised. The exception is when an error is found, such as in a rounding calculation.

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a peak of 2.92 percent in June 1953, and then declined to 2.20 percent in December 1953. The extended upward and downward movements in 1952 and 1953 were uninterrupted, except for small downward movements from September to November 1952. In a significant policy reversal, the Federal Reserve lowered reserve requirements on commercial banks in June 1953, which made more money available for lending. The reduction in reserve requirements was taken for two reasons, one technical and one policy. The technical reason was the anticipation of increased summer seasonal needs for private borrowing. The policy reason was that the Federal Reserve felt the previous tightening of bank credit had become too restrictive for maintaining the health of the economy.11 Gross National Product The gross national product is the most comprehensive measure of economic growth. The data are provided quarterly, not monthly like the other economic indicators used in the book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 3.8 shows the quarterly percentage change at an annual rate in the GNP on a real-time basis from the first quarter of 1952 to the fourth quarter of 1953. During 1952 and 1953, the GNP increased in all quarters, though by noticeably varying rates. In 1952, following increases in the first and second quarters of 3.1 and 3.5 percent, the increase fell to 0.5 percent in the third quarter, and rose sharply to 21.5 percent in the fourth quarter. In 1953, the increase fell sharply to 1 percent in the first quarter and accelerated to 13.2 percent in the second quarter, but absolute declines (below the zero line) of 3.6 and 8.3 percent occurred in the third and fourth quarters. The volatile GNP movements from the first quarter of 1952 to the second quarter of 1953 were of a growing economy, though not of an overheating economy. In fact, if the GNP had been adjusted for the rising prices, the quarterly growth rates would have been smaller. The absolute declines in the third and fourth quarters of 1953 changed the picture of the overall economy to one of weakness. Note on National Defense The Korean War ended with an armistice in July 1953. The armistice was a cessation of military hostilities that called for withdrawal by troops of both sides from a demilitarized zone between North Korea and South Korea. But military forces, including those of the United States, remain on active alert on both sides in 2009.12

THE RECESSION OF 1953–54

Figure 3.8

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Gross National Product in Expansion Preceding the 1953–54 Recession, Plus Two Recession Quarters, in Real Time

s2ECESSIONQUARTER Source: Based on the U.S. Office of Business Economics data. The data are not adjusted for price change. Note: The 1953–54 recession began in July 1953 and ended in May 1954, so only the third and fourth quarters of 1953 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, the first quarter of 1953 became available in April 1953). Data from the first quarter of 1952 to the third quarter of 1953 represent data when they first became available one month after each data quarter. The quarterly patterns of the second to fourth quarters of 1953 are similar to the later data for those quarters that first became available in January 1954.

Defense spending rose sharply following the outbreak of the Korean War in June 1950, as described earlier in the chapter under “Korean War and the Economy” and in the accompanying Table 3.1. Full mobilization was reached in 1952 and was maintained in 1953. Then defense spending cutbacks in inflation-adjusted dollars began in the third quarter of 1953 and continued through the second quarter of 1955. Table 3.3 shows the quarterly percentage changes in defense spending and the gross domestic product, adjusted for inflation, during 1953 and 1954. The data are based on the best available statistical measures of national defense and the GDP at the time of this writing in 2008, as distinct from the monthly (and quarterly GNP) real-time data in the economic indicator sections above. I have used the GDP here, which was adopted as the preferred indicator of the overall economy in 1991, rather than the GNP, for two reasons: (a) to get the best measure of the actual impact of defense on the economy, and (b) there was little difference in the shares of both definitions.13 Here I diverge from the “real-time” data highlighted elsewhere in Chapter 3, because this

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Table 3.3 Defense Spending and the Gross Domestic Product (percentage change from previous quarter)

1953: I 1953: II 1953: III 1953: IV 1954: I 1954: II 1954: III 1954: IV

Real Defense Spending 12.6 3.2 –5.1 –7.3 –24.4 –15.8 –19.0 –13.2

Real GDP 7.7 3.1 –2.4 –6.2 –2.0 0.2 4.5 8.2

Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008. Note: Real data represent inflation-adjusted dollars.

focus is on the actual amount of defense spending and its relation to the total economy, not on what was available to the economic policy makers at the time, as reflected in the real-time data. The defense cutbacks occurred in the six quarters from 1953: III to 1954: IV. The declines increased from 5 and 7 percent in 1953, to 13 to 24 percent in 1954. The GDP declines occurred in the three quarters from 1953: III to 1954: I, and ranged from 2 to 6 percent. Thus, the defense declines were much greater and of longer duration than the GDP declines. The defense declines beginning in 1953: III corresponded with the Korean War armistice that took effect in July 1953. This linkage led one analysis to conclude that the defense cutbacks largely caused the 1953–54 recession.14 As discussed in the last section on the assessment of economic policies preceding the recession, I disagree with that attribution. .

Federal Government Fiscal Position The federal government fiscal position represents the surplus, deficit, or balance in each year’s budget. In addition, the shift in the position from year to year is relevant for economic analysis. There are two measures of the federal fiscal position. One is derived from the economic transactions data of the national income and product accounts (NIPAs) prepared by the Bureau of Economic Analysis in the U.S. Department of Commerce. The other is the official federal budget prepared by the U.S. Department of the Treasury (receipts) and the U.S. Office of Management and Budget (outlays).

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The NIPAs government economic transactions data differ from the official federal budget data in content and timing. The data based on the NIPAs give a better indication of the federal fiscal relationship to the overall economy than do the official budget data. This reflects the fact that the federal data in the NIPAs are fully integrated statistically with the overall economy, which is not the case for the official budget data. Table 3.4 shows the fiscal position of the federal government for both the NIPAs transactions and the official budget from 1952 to 1954. The data are based on the statistics available in 2008 to best reflect the actual impact of the war on the economy, as distinct from the real-time data in the economic indicator sections above. The NIPAs data were lower in both receipts and expenditures/outlays in all three years (spending is referred to in the NIPAs as “expenditures” and in the budget as “outlays”). The differences between receipts and spending also varied in the two measures. The NIPAs had a surplus of $5.7 billion and the official budget was in balance in 1952, the NIPAs had a surplus of $1.9 billion and the official budget had a deficit of $5.3 billion in 1953, and the NIPAs had a deficit of $1.1 billion and the official budget had a deficit of $0.2 billion in 1954. The increase in federal spending stemming from the military buildup for the Korean War stimulated demand and production in the economy. But the balance between receipts and spending led to only small fiscal surpluses or deficits in relation to the gross domestic product, ranging from –0.3 to 1.6 percent. Thus, in both the NIPAs federal transactions and the official federal budget data, the overall fiscal balance had a neutral effect on prices and inflation. Assessment of Economic Policies Preceding the 1953–54 Recession The pace of the economy in 1952 and 1953 in the run-up to, and onset of, the 1953–54 recession, has a basic theme. Generally, modest growth was interrupted by short-term growth spurts on the one hand and by absolute declines in demand in the civilian economy on the other hand. This picture emerged in employment, unemployment, industrial production, housing starts, worker earnings, and the gross national product. Following the outbreak of the Korean War in June 1950, inflation surged into early 1951, until the sharp increases peaked in February 1951. Prices rose at much smaller rates for the rest of 1951, and at still decreasing rates in 1952 and 1953. No overall shortages of workers appeared to bid up wage costs, though shortages were reported for certain professional and technical occupations.

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Table 3.4 Federal Government Fiscal Position (billions of dollars) National Income and Product Accounts

1952 1953 1954

Receipt

Expenditures

Surplus/ Deficit (–)

Surplus/Deficit as a Percentage of the Gross Domestic Product

63.7 67.9 64.6

58.1 65.9 65.6

5.7 1.9 –1.1

1.6 0.5 –0.3

Source: Bureau of Economic Analysis, U.S. Department of Commerce, 2008. Note: Components do not sum to totals, due to rounding. Official U.S. Budget

1952 1953 1954

Receipts

Outlays

Surplus/ Deficit (–)

Surplus/Deficit as a Percentage of the Gross Domestic Product

68.0 71.5 71.6

68.0 76.8 71.9

0.0 –5.3 –0.2

0.0 –1.4 –0.05

Source: U.S. Department of the Treasury and U.S. Office of Management and Budget, 2008. Note: Components do not always sum to totals, due to rounding.

President Truman instituted price and wage controls in January 1951. Controls were removed for many products during 1952, but wage controls were unchanged in 1952. Wage controls were removed early in 1953, and all prices were decontrolled in October 1953. The consumer price index (CPI) for urban and clerical workers increased by 5.8 and 6.0 percent in 1950 and 1951, which increases decelerated to 0.9 and 0.6 percent in 1952 and 1953, based on the twelve-month movements from December to December of each year. Defense spending surged in 1951 and reached full mobilization in 1952, more than doubling its share of the gross domestic product from 6.7 percent in 1950 to 14.7 percent in 1953. The defense share of the GDP in 1952 was maintained in 1953, though defense spending decreased in the third and fourth quarters of 1953. Federal income taxes were increased on individuals, and an excess profits tax was put on businesses in 1950 and 1951. Federal excise taxes on certain items were increased in 1951. The fiscal surplus/deficit fiscal position of the federal government in rela-

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tion to the overall economy was small. Federal spending and receipts rose considerably following the outbreak of the Korean War, thus stimulating demand and production. However, spending and receipts were in near balance, which resulted in a net neutral effect on prices and inflation. Interest rates rose by one percentage point from April 1952 to June 1953. In lowering reserve requirements on commercial banks in June 1953, the Federal Reserve stated that its previous tightening of bank credit had been too stringent. A major change in the Federal Reserve’s authority to conduct monetary policy occurred in March 1951, which was referred to as the Treasury– Federal Reserve Accord. This allowed the Federal Reserve to be free to influence interest rates upward or downward depending on the health of the economy. It reversed the policy that had been adopted early in 1942 to keep interest rates low in order to lessen the rising federal budget deficit costs of financing World War II. The economic expansion preceding the recession of 1953–54 was the first such period after World War II in which the Federal Reserve was free to use its influence in money markets to raise interest rates. The defense cutbacks that began in the third quarter of 1953 corresponded with the Korean War Armistice Agreement, which went into effect in July 1953. The defense cutbacks led to much larger percentage declines, and of longer duration, in defense spending than those in the GDP. In this recapitulation of the pace of economic activity among the several economic indicators in the nineteen months preceding the onset of the recession in July 1953, a picture emerges of economic growth occurring in various parts of the economy at modest rates, accompanied by short-term spurts and absolute declines. The problem of inflation following the outbreak of the Korean War was contained early in 1952. In the environment of this modest, noninflationary economic growth, the Federal Reserve maintained a restrictive monetary policy on bank credit that was accompanied by a rise in interest rates. This monetary restraint set in motion the weakness in the civilian market economy that triggered the 1953–54 recession. The lessening of reserve requirements in June 1953 was far too late to avoid the onset of the recession in July 1953. The cutback in defense spending aggravated the recession, but did not cause it. Notes 1. “Annual Economic Review of the Council of Economic Advisers,” Economic Report of the President, January 1951, pp. 34–39. 2. “Recent Monetary and Credit Developments,” Federal Reserve Bulletin, July 1951, p. 744.

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3. The American entry into World War II in December 1941 began when Japan attacked Pearl Harbor on December 7, and expanded one day later when Germany declared war against the United States. 4. President Truman’s concern was that allowing interest rates to freely rise or fall would put the holders of U.S. Treasury securities at risk to lose the value of their bonds and notes if interest rates rose. This occurs because rising interest rates reduce the principal value of the security. The president maintained that it was a bad faith with holders of U.S. securities who helped finance World War II and the Korean War to allow interest rates to rise. To accommodate the president’s concern, the accord provided that holders could exchange their existing two longest term 2½ percent bonds for a new issue of longerterm nonmarketable bonds with a higher coupon interest rate, with the privilege of converting the new longer-term bonds into shorter-term 1½ percent notes. The risk associated with rising interest rates occurs if holders of the Treasury securities or of commercial debt instruments want to sell them on the open market before their maturity dates. However, if they hold the debt instruments until their maturities, when they are redeemed at their par values, there is no risk from higher interest rates in the interim period. Of course, the obverse for holders of debt instruments occurs when interest rates decline, in which case the value of the debt instruments rises. 5. The LFPR used in the discussion is based on a revised definition of the labor force of workers sixteen years and older that was adopted in 1967, compared with the age definition of fourteen years and older used in the discussion. However, the revised definition does not affect the LFPR percentages for men and women workers in the discussion. 6. “Labor Market Developments,” Federal Reserve Bulletin, June 1953, p. 582. 7. “Recent Credit and Monetary Developments,” Federal Reserve Bulletin, July 1953, p. 695. 8. “The Business Situation Throughout 1953,” Survey of Current Business, February 1954, p. 4. 9. “Residential Real Estate Developments,” Federal Reserve Bulletin, August 1953, pp. 812–14. 10. “The Business Situation Throughout 1953,” p. 19. 11. “Recent Credit and Monetary Developments,” p. 689. In referring to the policy reversal associated with the June 1953 reduction in reserve requirements, the Federal Reserve stated the following: “At that time, there were indications that the Federal Reserve monetary measures were beginning to have a more restrictive effect than was appropriate for carrying out the general objectives of economic stability.” 12. The armistice was not signed by individual nations, such as the two Koreas or the United States. It was signed only by the U.S. general representing the United Nations forces of South Korea, the United States, and other nations on one side, and the North Korean general representing North Korea and China on the other side. This status has remained unchanged at the time of this writing in 2009. The United States had 28,500 troops in South Korea in 2009. 13. See Chapter 2, note 20, for the definitional differences between the gross national product and the gross domestic product. 14. David Glasner, ed., Business Cycles and Depressions: An Encyclopedia (New York: Garland Publishing, 1997), p. 567.

4 The Recession of 1957–58

The recession of 1957–58 began in August 1957 and ended in May 1958. The state of the economy at the beginning of 1957 reflected the 1955 recovery from the 1953–54 recession and the continued expansion during 1956. Table 4.1 shows selected economic indicators during 1954 (the 1953–54 recession), the 1955 recovery, and the 1956 expansion. The data reflect the price and wage movements during each calendar year of 1954, 1955, and 1956 by calculating the annual changes from the fourth quarter to the fourth quarter. The data are based on statistics available at the time of this writing in 2008, to best reflect the backdrop to the 1957–58 recession, as distinct from the monthly and quarterly real-time data during 1956 and 1957 discussed in the economic indicator sections below. Following the slowdown in the growth of the real gross domestic product (real GDP) in 1954 to 2.7 percent, which included part of the 1953–54 recession and part of the recovery, the sharp increase in economic growth of 6.5 percent in 1955 reflected the rebound from the low levels of activity from the 1953–54 recession in both consumer durables and housing. Economic growth in 1956 was much less—1.8 percent. Employment of nonfarm production workers in the 1954–56 period showed trends broadly similar, though diverging in direction in 1954, to those of real GDP. The number of jobs declined 0.7 percent in 1954, then increased by 5.0 percent in 1955, and slowed to an increase of 2.2 percent in 1956. Inflation and unemployment round out the backdrop to the 1957–58 recession. Inflation as measured by the consumer price index (CPI) was exceptionally low in 1954 and 1955; prices actually declined 0.4 percent in 1954 and increased only 0.4 percent in 1955. The CPI then accelerated to an increase of 2.8 percent in 1956. The unemployment rate dropped from 5.0 percent in December 1954 to 4.2 percent in both December 1955 and December 1956. The 4.2 percent rate at the end of 1955 and 1956 is a low peacetime rate for the period, surpassed only in the immediate post–World War II years. The Cold War with the Soviet Union was very much in evidence, though, by the late 1940s. This culminated 111

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Table 4.1 Selected Economic Indicators

December to December

Real Gross Domestic Product (annual percentage change)

Employment (annual percentage change)

1953 to 1954 1954 to 1955 1955 to 1956

2.7 6.5 1.8

–0.7 5.0 2.2

Consumer Price Index (annual percentage Unemployment change) Rate (percent) –0.4 0.4 2.8

5.0 (1954) 4.2 (1955) 4.2 (1956)

Sources: Real gross domestic product—Bureau of Economic Analysis, U.S. Department of Commerce, 2008. Employment, consumer price index, and unemployment rate—Bureau of Labor Statistics, U.S. Department of Labor, 2008. Note: The employment data are based on the establishment survey. The unemployment rate data are based on the household survey.

in the surrogate hot war of the Cold War with the outbreak of the Korean War in June 1950 until the armistice in July 1953. Overall, the economy during 1956 appeared strong, but not overheated. Economic Indicators in Real Time During 1956–57 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1957–58 recession in August 1957 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINMANUFACTURING s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of the chapter is an assessment of the economic policies preceding the 1957–58 recession.

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I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1957–58 recession is dated as beginning in August 1957. So September to December 1957 in the figures that follow were the first four months of the recession. To assess what was available to policy makers as 1956 and 1957 progressed, the figures chart the real-time data from January 1956 to December 1957. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in May 1957. Because economic data became available one month after the month to which they refer, the April 1957 data first appeared in May. Thus, the May 1957 starting point provides the most reliable data, including revisions up to that time, from January 1956 to April 1957. The data from May to December 1957 reflect the real-time data on a monthly and quarterly basis from June 1957 to January 1958, as they were produced. Revisions that occurred to the May-to-December data as of January 1958 changed the monthly and quarterly patterns at most slightly. I chose May 1957 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in May, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in August. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1956–57 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment.

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Figure 4.1

Jobs in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. The Federal Reserve seasonally adjusted the data. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly patterns of the May to December 1957 data are similar to the later data for those months that first became available in January 1958.

Figure 4.1 shows the monthly percentage change in jobs from January 1956 to December 1957 on a real-time basis. Employment during the period fluctuated between 51 million and 53 million jobs. On this basis, a 1 percent change in employment affected 510,000 to 530,000 jobs. During 1956, the monthly employment change ranged from –0.1 to 0.5 percent. Exceptions to this range appeared in the sharp movements of –1.2 percent in July and 1.4 percent in August, which were virtually offsetting, and may reflect a summer seasonal adjustment problem with the data. By contrast, monthly employment changes in 1957 up to the recession beginning in August were much smaller and less volatile, ranging from –0.1 to 0.2 percent. Then employment declines of 0.3 to 0.7 percent occurred from September to December. Employment generally increased during the twenty months preceding the onset of the 1957–58 recession, though the monthly movements were more

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volatile during 1956 than in 1957. Abstracting from the differences in volatility, employment gains over the twenty months were modest, and smaller in 1957 than in 1956. Unemployment The unemployment data used here represent the number of persons without jobs each month who were actively seeking work in the civilian sector of the economy. The data cover nonfarm and farm workers aged fourteen years and older. The unemployment data are not seasonally adjusted. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 4.2 shows the unemployment rate on a real-time basis from January 1956 to December 1957. Unemployment fluctuated in a range of 2.8 to 5.0 percent over the period. Actual unemployment ranged from 1.9 million to 3.4 Figure 4.2

Unemployment Rate in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. The data are not seasonally adjusted. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly data from May to December 1957 were unchanged when the later data for those months became available in January 1958.

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million workers. Thus, a one-percentage-point change in the unemployment rate affected 19,000 to 34,000 workers. The unemployment rate was volatile during the nineteen months preceding the onset of the 1956–57 recession. Unemployment declined from 4.4 percent in January and February 1956 to a low of 2.8 percent in October 1956. It then rose to 4.9 percent in January 1957, followed by a decline to 4 percent in April and May 1957. It rose again to 4.8 percent in June, then fell to 3.7 percent in September and October, followed by a rise to 5 percent in December 1957. The fluctuating 3-to-5-percent unemployment rate range suggested changing short periods of both tight and slack labor markets. An assessment by the Federal Reserve in the summer of 1957 referred to supply and demand for workers generally being well balanced, with pockets of labor surpluses and shortages.1 Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by employed urban wage workers in blue-collar and clerical occupations. For a discussion of inflation and deflation and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 4.3 shows the monthly percentage change in the CPI from January 1956 to December 1957 on a real-time basis. The monthly CPI movements were volatile during 1956. From the low monthly changes of –0.1 to 0.2 percent during January to April, the CPI change rose to peaks of 0.7 percent in June and July. After a sharp drop to –0.2 in August, subsequent upward and downward volatility ranged from increases of 0.1 to 0.5 percent from September to December 1956. During 1957, the CPI increases ranged from 0.2 percent in January and March to highs of 0.5 percent in June and July. Changes of zero in October and December were interrupted by a 0.4 percent increase in November. Table 4.2 shows inflation as measured by the CPI, in real time, over sixmonth periods from January to June and from July to December during 1955, 1956, and 1957. The data are calculated at annual rates to indicate what the six-month change would be in one year if that change continued at the same rate for the following six months. Annual rates are the usual way of assessing inflation. Viewed from the perspective of six-month periods, inflation accelerated in the 1956 and 1957 periods preceding the onset of the recession. During 1955, the CPI increased at an annual rate of 0.2 percent and 0.5 percent over

THE RECESSION OF 1957–58

Figure 4.3

117

Consumer Prices in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. The data are not seasonally adjusted. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data first became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly data from May to December 1957 were unchanged when the later data for those months became available in January 1958.

Table 4.2 Consumer Price Index in Real Time Annualized Percentage Change January–June 1955 July–December 1955 January–June 1956 July–December 1956 January–June 1957 July–December 1957

0.2 0.5 2.6 3.1 3.8 2.3

Source: Bureau of Labor Statistics, U.S. Department of Labor, 1955, 1956, 1957, 1958.

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the January–June and July–December periods, respectively. During 1956, the CPI increased at an annual rate of 2.6 percent and 3.1 percent over the January–June and July–December periods, respectively. During 1957, the CPI increased at an annual rate of 3.8 percent and 2.3 percent over the January– June and July–December periods, respectively. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing and minerals (mining) industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 4.4 shows the monthly percentage change in the IPI from January 1956 to December 1957 on a real-time basis. The IPI was far more volatile during 1956 than in 1957. In 1956, the monthly movements ranged from –1.4 to 1.4 percent, except for the larger changes of –3.5 percent in July and 5.1 percent in August. During the year, four months showed declines (below the zero line) and three months had zero change. In 1957, the monthly movements of the IPI were zero or showed declines (below the zero line). The declines were 0.7 percent in January, April, and May before the onset of the recession in July. Subsequent declines ranged from 0.7 percent in September to 2.2 percent in December. Five monthly movements of the IPI in 1956 showed some increases, and seven months had either declines or zero change. The monthly movements decelerated in 1957, with no months of increase, three months of decline, and three months of zero change before the onset of the recession in August. The declines were increasingly sharp after the recession began. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing start data, see Chapter 2 under Housing Starts. Figure 4.5 shows the monthly percentage change in housing starts on a real-time basis from January 1956 to December 1957. In 1956, the monthly movements of housing starts were mainly negative, with eight months of decline (below the zero line) and four months of increase. In 1957, following declines from January to March, housing starts increased in April and May, and then declined in June, before the onset of the recession in August. Housing starts then registered four months of increase and two months of decrease from July to December. In both 1956 and 1957, monthly housing starts were highly volatile, with changes of several percentage points.

THE RECESSION OF 1957–58

Figure 4.4

119

Industrial Production in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly patterns of the May to December 1957 data varied from the later data for those months that first became available in January 1958 for the May to August period, which fluctuated from 0.0 to 0.7, rather than a decrease of 0.7 in May and zero change from June through August.

The Federal Reserve attributed the weak performance of housing starts during 1956 and 1957 in part to the relatively low interest rates on federally insured mortgages by the Federal Housing Administration (FHA) and the Veterans Administration (VA) compared with those on conventional loans.2 The lower FHA/VA interest rates reflected the lower risk faced by lenders in case of defaults on loans because of the existence FHA/VA insurance. In the Federal Reserve’s assessment, the negative effect of the FHA/VA low interest rates took place because lenders financing mortgages found the higher rate of conventional mortgages more attractive than the FHA and VA loans, and builders in metropolitan areas, who depended mainly on FHA and VA financing, reduced their building because these loans were less readily available. By contrast, conventional financing was more important in nonmetropolitan rural areas, and there was little change in construction in those areas. In order to redress the conventional-FHA/VA interest rate differential, several statutory and administrative steps were taken from late 1955 into

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Figure 4.5

Housing Starts in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for privately owned nonfarm housing units. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly patterns of the May to December 1957 data are similar to the later data that first became available in January 1958, except that a decline in June and an increase in October were reversed by opposite movements in the later data.

1957. The Federal Home Loan Bank Board eased restrictions on borrowing by savings and loan associations, the Federal National Mortgage Association eased conditions under which it would purchase mortgages in the secondary market, and the FHA raised the interest rate on its insured loans and reduced the down-payment requirements on houses it insured. Housing starts during 1956 and 1957 were generally declining. In the sixmonth periods preceding the onset of the recession in July 1957—from June to December 1956 and from December 1956 to June 1957—the annual rates of decline in housing starts were 12.6 percent 9.6 percent, respectively. Earnings of Manufacturing Workers I cite money wages of production workers in private manufacturing industries as a measure of average weekly worker earnings. The earnings data are not

THE RECESSION OF 1957–58

Figure 4.6

121

Job Earnings in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on the U.S. Bureau of Labor Statistics data for all manufacturing industries. The data are not seasonally adjusted. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). Data from January 1956 to April 1957 represent data available as of May 1957. Data from May to December 1957 represent data when they first became available one month after each data month. The monthly patterns of the May to December 1957 are similar to those that became available in January 1958, except that the decrease in November was revised to an increase in the later data.

seasonally adjusted. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 4.6 shows the monthly percentage change in worker earnings in manufacturing industries on a real-time basis from January 1956 to December 1957. In 1956, the monthly movements of worker earnings appeared as eight increases, three declines (below the zero line), and one zero change. In 1957, following monthly increases from August to December 1956, worker earnings showed declines in January and March to May, with zero change in February. Worker earnings then increased in June before the onset of the recession in July. Increases followed from July to September, with declines in October and November, and zero change in December. Worker earnings generally increased during 1956 and declined during 1957. In the six-month periods preceding the onset of the recession in August 1957, worker earnings increased at an annual rate of 12.7 percent from

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June to December 1956 and declined at an annual rate of 3.4 percent from December 1956 to June 1957. The weak performance of worker earnings in 1957 preceding the onset of the recession indicated that labor costs would not lead businesses to raise prices in order to maintain profit margins. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three- to five-year U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.3 These loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open-market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 4.7a shows the monthly interest rates of three- to five-year U.S. securities from January 1957 to December 1958. Interest rates rose, with some monthly interruption, from 2.7 percent in January 1956 to 4 percent in October 1957, and then declined to 3 percent in December 1957. The climb was continuous from March to October 1957. Figure 4.7b (page 124) shows the monthly federal funds interest rate from January 1956 to December 1957. These interest rates rose from 2.5 percent during January–March 1956 to highs of 3.5 percent during August–October 1957, followed by a decline to 3 percent in November and December. The general upward movement included five months in which interest rates declined. The 1953–54 recession ended in May 1954. The Federal Reserve began restraining bank credit early in 1955.4 The discount rate, which is the cost that member banks might borrow funds from the regional Federal Reserve Banks, was raised four times during 1955, reaching 2.5 percent in November 1955, one percentage point above the rate at the end of 1954. In addition, monetary policy throughout 1955 was directed at restraining the reserves commercial banks had for lending, which required banks to borrow from the Federal Reserve at the increasingly higher discount rate. Federal Reserve restraint on bank credit continued in 1956.5 The discount

THE RECESSION OF 1957–58

123

Figure 4.7a Interest Rates on Three- to Five-Year U.S. Securities in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available became available one month after the data month (for example, February 1957 data became available in March 1957). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

rate at the end of 1956 was 3 percent, compared with 2.5 percent one year earlier. Federal Reserve restraint continued through the first three quarters of 1957.6 The restraint was relaxed in the fourth quarter of 1957, as the economy turned downward and inflation lessened. During the three years of restraint, commercial bank loans to borrowers increased, though at decreasing amounts from 1955 to 1956 and from 1956 to 1957. Because inflation was the primary factor driving Federal Reserve actions affecting interest rates, it is useful to recapitulate the trends in inflation from 1955 to 1957, as depicted in Table 4.2 in the above section on Inflation and Deflation. In its policy of raising interest rates and restraining the growth of commercial bank loans from 1955 through the first three quarters of 1957, the Federal Reserve cited inflation and inflationary expectations as primary problems facing the economy. Thus, the expectation that inflation will continue affects the behavior of households and businesses by leading them to “buy now” before prices rise even more, which of course only fuels the bidding up of prices and further inflation.

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Figure 4.7b Federal Funds Interest Rate in Expansion Preceding the 1957–58 Recession, Plus Five Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on the Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only August to December 1957 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1957 data became available in March 1957). The interest rate data are not normally revised. The exception occurs when and error is found, such as in a rounding calculation.

During 1955, the CPI increased at an annual rate of 0.2 percent and 0.5 percent over the January–June and July–December periods, respectively. During 1956, the CPI increased at an annual rate of 2.6 percent and 3.1 percent over the January–June and July–December periods, respectively. During 1957, the CPI increased at an annual rate of 3.8 percent and 2.3 percent over the January–June and July–December periods, respectively. The increase in interest rates and the restraint on the growth of bank loans had started early in 1955, less than one year after the 1953–54 recession ended in May 1954. It is noteworthy that William McChesney Martin, the Federal Reserve Board Chairman, considered an annual inflation rate of 2 percent to be too high, without specifying what inflation rate would be acceptable.7 Yet inflation was below 1 percent during 1955, when the Federal Reserve acted to restrain economic growth as a preemptive move to head off potential future inflation. And while the inflation rate fell to 2.3 percent during the recession period of July–December 1957, it still did not meet the criterion of less than 2 percent, but the Federal Reserve relaxed its restraint on credit in that period in order to revive economic growth.

THE RECESSION OF 1957–58

125

Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. Unlike most of the other economic indicators used in the book, the data are provided quarterly, not monthly. The consumer durable goods data are first reported monthly later, with the 1973–75 recession. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 4.8 shows the quarterly percentage change at an annual rate in consumer durable goods spending reported on a real-time basis from January– March 1956 to October–December 1957. Spending for durable goods declined during the first three quarters of 1956 (below the zero line), increased in the fourth quarter of 1956 and first quarter of 1957, declined in the second and fourth quarters of 1957, with zero change in the third quarter (the onset of the recession). In 1956, declining sales of cars drove the total spending for consumer durables downward. Spending for furniture and household appliances increased, but not as much as in 1955.8 In 1957, increasing car sales raised the total spending for consumer durables, while spending for furniture and household appliances was about the same as in 1956.9 Consumer installment credit lenders reported more difficulty with collections in the first ten months of 1957 than in 1956.10 This mainly reflected borrowers who were overextended in their debts rather than suffering declines in income. Repossessions increased, particularly of new cars. Consumer durable goods spending declined in four of the six quarters preceding the onset of the recession in August 1957. Most of the quarterly movements of total spending were driven by car sales. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are provided quarterly, not monthly like most of the other economic indicators used in the book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 4.9 (page 127) shows the quarterly percentage change at an annual rate in the GNP on a real-time basis from the first quarter of 1956 to the fourth quarter of 1957. During 1956, the annual rate of GNP increase accelerated from 1.5 percent in the first quarter, to 4.9 percent in the second quarter, to 5.5 percent in the third quarter, and to 10 percent in the fourth quarter. In 1957, the annual GNP increase fell to 3.2 percent in the first quarter

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Figure 4.8

Consumer Durable Goods Spending in Expansion Preceding the 1957–58 Recession, Plus Two Recession Quarters, in Real Time

s2ECESSIONQUARTER4HE*ULYn3EPTEMBERQUARTERINCLUDEDTWOMONTHSOFRECESSION (August and September) and the October–December 1957 quarter was a full recession. Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. The data are not deflated for price change. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only the third and fourth quarters of 1957 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, the first quarter of 1957 data became available in April 1957). Data from the first quarter of 1955 to the first quarter of 1957 represent data available as of April 1957. Data from second quarter to the fourth quarter of 1957 represent data when they first became available one month after each data quarter. The quarterly patterns of the second to the fourth quarter of 1958 are similar to the later data for those quarters that first became available in January 1958.

(from 10 percent in the 1956 fourth quarter), rose to 6.9 percent in the second quarter, slowed to 4.4 percent in the third quarter, and declined by -5.7 percent (below the zero line) in the fourth quarter. The full force of the recession appeared in the fourth quarter. GNP growth was strong during the six quarters preceding the onset of the recession in August 1957. The highest quarterly rate was an increase of 10 percent, the next highest was 6.9 percent, and the other quarters ranged from increases of 1.5 to 5.5 percent. This was a continually growing economy, but because the growth rates were not adjusted for the rising prices, they overstated the extent of the economic growth.

THE RECESSION OF 1957–58

Figure 4.9

127

Gross National Product in Expansion Preceding the 1957–58 Recession, Plus Two Recession Quarters, in Real Time

s2ECESSIONQUARTER4HE*ULYn3EPTEMBERQUARTERINCLUDEDTWOMONTHSOFRECESSION (August and September) and the October–December 1957 quarter was a full recession. Source: Based on U.S. Office of Business Economics data. The data are not deflated for price change. Note: The 1957–58 recession began in August 1957 and ended in May 1958, so only the third and fourth quarters of 1957 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, the first quarter of 1957 data became available in April 1957). Data from the first quarter of 1955 to the first quarter of 1957 represent data available as of April 1957. Data from the second quarter to the fourth quarter of 1957 represent data when they first became available one month after each data quarter. The quarterly patterns of the second to the fourth quarter of 1958 are similar to the later data for those quarters that first became available in January 1958.

Assessment of Economic Policies Preceding the 1957–58 Recession The pace of the economy in 1956 and 1957 in the run-up to the onset of the 1957–58 recession in August 1957 was one of uneven movements in employment, unemployment, industrial production, housing starts, worker earnings, consumer durable goods spending, and the gross national product. Inflation increased during 1956 from the exceptionally low rates in 1955, and accelerated further during the first half of 1957. During the 1955–57 period up to the onset of the recession in August 1957, the Federal Reserve acted to increase interest rates and restrain the growth of bank loans because of its intent to head off potential future inflation. This policy began in 1955, as preemptive moves, when inflation was exception-

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ally low, less than one year after the end of the recession of 1953–54. It is exemplified by the Federal Reserve Board chairman’s view that an annual inflation rate of 2 percent was too high, without specifying what inflation rate would be acceptable. I believe that the uneven growth and softness in many components of the economy did not warrant the long-term restrictive monetary policies of the Federal Reserve. I also believe that the consideration of an inflation rate of less than 2 percent as too high was unrealistic. At most, a restrictive monetary policy would have been justified beginning in the second half of 1956, which would have had a greater likelihood of tempering inflation without bringing on a recession. The cumulative effects of the long-term restrictive monetary policies beginning early in 1955 seem to be the primary force bringing on a recession only three years after the 1953–54 recession ended. Notes 1. “In most major labor market areas, supply and demand for workers appear to be well balanced currently. There are relatively few major areas with substantial labor surpluses—about the same number as a year ago—and these include mainly textile and coal-mining towns where the unemployment problem has prevailed over a long period. Shortages of professional, technical, and skilled workers persist despite some easing from the influx of recent graduates into the labor market and from curtailments in some activities.” “Labor Market Developments,” Federal Reserve Bulletin, September 1957, pp. 1005–6. 2. “Residential Real Estate Markets,” Federal Reserve Bulletin, April 1957, pp. 365–69. 3. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 4. “The Economy in Recovery and Expansion: A Review of 1955,” Survey of Current Business, February 1956, p. 19. 5. “Changing Patterns in Economic Expansion: A Review of 1956,” Survey of Current Business, February 1957, p. 18. 6. “Bank Credit and Money in 1957,” Federal Reserve Bulletin, February 1958, pp. 113–16. 7. Statement of William McChesney Martin, Jr., chairman, Board of Governors of the Federal Reserve System, before the Committee on Finance of the United States Senate, August 13, 1957, “Winning the Battle Against Inflation,” Federal Reserve Bulletin, August 1957, p. 872. 8. “Changing Patterns in Economic Expansion: A Review of 1956,” Survey of Current Business, February 1957, p. 9. 9. “Economic Progress and Adjustment: A Review of 1957,” Survey of Current Business, February 1958, p. 5. 10. “Consumer Installment Credit,” Federal Reserve Bulletin, December 1957, p. 1322.

5 The Recession of 1960–61

The recession of 1960–61 began in April 1960 and ended in February 1961. This was the fourth recession since World War II had ended in 1945. It began only two years after the end of the 1957–58 recession. This was next to the shortest expansion period between recessions of the postwar recessions, which also exacerbated the frequency of recessions. The shortest expansion between recessions was that between the 1980 and 1981–82 recessions, as discussed later. In addition to resulting in more recessions, short expansions limit achieving the full potential of a growing economy. Table 5.1 shows the duration of the four expansions preceding the onset of the 1948–49 recession through the onset of the 1960–61 recession. Beginning with the 1957–58 recession, expansion periods became shorter, and correspondingly, recessions became more frequent. The exception was the increase in duration from the 37 months preceding the 1948–49 recession to 45 months in the lead-up to the 1953–54 recession. The expansion periods then declined to 39 months preceding the 1957–58 recession and 24 months preceding the 1960–61 recession. On the eve of the 1960–61 recession, the American economy was affected by both the Cold War with the Soviet Union and economic developments during the 1950s. International tensions with the Soviet Union included spells of peaceful coexistence along with continuing Cold War surrogate confrontations with nations around the world. This kept the United States with a formidable defense establishment that included a military draft, though military spending was lowered after the Korean War armistice in 1953. Competition in the space race, in which the launching of Sputnik in 1957 showed the United States to be trailing the Soviet Union, was on the surface peaceful, but with military implications. Competition from European companies in the American car market began in the 1950s. This was highlighted by the introduction of imports of small cars, which stimulated U.S. car manufacturers to add small cars to their product lines. Construction of the 41,000-mile interstate highway system, which was a 129

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Table 5.1 Duration of Expansions Preceding the Onset of Recessions Recessions 1948–49 1953–54 1957–58 1960–61

Months 37 45 39 24

Source: National Bureau of Economic Research, Business Cycle Dating Committee. See Table 1.1 in this book.

major public works program, began in the 1950s. Only a small part was completed by 1960, and the bulk of the construction was done in the 1960s.1 Labor unions increasingly gained cost-of-living allowances and fringe benefit retirement and health care features in their contracts during the 1950s. A steel strike from July 1959 to January 1960 caused production cutbacks and worker layoffs in basic steel, metal fabricating, coal, iron ore, and freight transportation industries.2 The effect of the strike throughout the economy was ameliorated by a drawdown of steel product inventories and by steel imports from other countries.3 Economic Indicators in Real Time During 1959–60 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1960–61 recession in April 1960 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINMANUFACTURING s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of the chapter is an assessment of the economic policies preceding the 1960–61 recession.

THE RECESSION OF 1960–61

131

I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are of course complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1960–61 recession is dated as beginning in April 1960. So May to December 1960 in the figures that follow were the first eight months of the recession. To assess what was available to policy makers as 1959 and 1960 progressed, the figures chart the real-time data from January 1959 to December 1960. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in December 1959. Because economic data became available one month after the month to which they refer, the December 1959 data first appeared in January 1960. Thus, the January starting point provides the most reliable data, including revisions up to that time, from January 1959 to December 1959. The data from January 1960 to December 1960 reflect the real-time data on a monthly and quarterly basis from February 1960 to January 1961, as they were produced. Revisions that occurred to the January to December 1960 data as of January 1961 changed the monthly and quarterly patterns at most slightly. I chose January 1960 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in January, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in April. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1959–60 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment.

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Figure 5.1

Jobs in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on the U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). Data from January 1959 to December 1959 represent data available as of January 1960. Data from January to December 1960 are similar to the later data for those months that first became available in January 1961, except for June 1960, which was revised from a decrease of 0.1 percent to an increase of 0.1 percent.

Figure 5.1 shows the monthly percentage change in jobs from January 1959 to December 1960 on a real-time basis. Employment during the period fluctuated between 51 million and 53 million jobs. On this basis, a 1 percent change in employment affected 510,000 to 530,000 jobs. During 1959, the monthly employment change ranged from –0.3 to 0.8 percent. Exceptions to this range appeared in the sharp movement of –1.1 percent in August, which may reflect statistical problems with the summer seasonal adjustment or in accounting for the steel strike. During 1960, monthly employment changes ranged from –0.4 to 0.5 percent up to the recession beginning in April. Following increases of 0.3 percent in January and 0.1 percent in February, the decline of 0.4 percent in March and increase of 0.5 percent in April were largely offsetting. The remaining months of 1960 were dominated by decreases of 0.1 to 0.2 percent, except for zero change in July and a decrease of 0.9 percent in December. Employment generally increased during the sixteen months preceding the onset of the 1960–61 recession. The job increases typified a growing economy, but not one of exceptional economic growth.

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133

Unemployment The unemployment data used here represent the number of persons without jobs each month who were actively seeking work in the civilian sector of the economy. The data cover nonfarm and farm workers aged fourteen years and older. Because of new seasonal adjustment factors introduced in February 1960 for the 1959 unemployment data, the 1959 data represent those available in February 1960, contrary to the 1959 data for the other economic indicators, which represent those available in January 1960. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 5.2 shows the unemployment rate (UR) on a real-time basis from January 1959 to December 1960. The UR fluctuated in a range of 4.9 to 6.8 percent over the period. Actual unemployment ranged from 3.2 million to 4.7 million workers. Thus, a one-percentage-point change in the unemployment rate affected 32,000 to 47,000 workers. The unemployment rate was volatile during the sixteen months preceding Figure 5.2

Unemployment Rate in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). Data from January 1959 to December 1959 represent data available as of February 1960. Data from January to December 1960 represent data when they first became available one month after each data month. The monthly data from January to December 1960 were unchanged when the later data for those months became available in January 1961.

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the onset of the 1960–61 recession. Unemployment declined from 5.9 percent in January 1959 to 4.9 percent in April, rose to 6 percent in September, and fell to 4.8 percent in February 1960. The general thrust was upward from March to December 1960, though interrupted with monthly declines, reaching a high of 6.8 percent in December. The steel strike occurred from July 1959 to January 1960, but movements in the unemployment rate were neither congruent with a buildup of steel inventories preceding the strike, nor with the strike-generated layoffs during the strike. Thus, while the strike caused economic disruptions, it did not send the overall economy in one direction or another. The unemployment rate preceding the onset of the 1960–61 recession was higher than that preceding the onset of the earlier, 1948–49, 1953–54, and 1957–58 recessions. This probably reflects the increasing shortness of the expansions preceding the 1957–58 and 1960–61 recessions, noted at the beginning of the chapter, which consequently did not allow enough time for the economy to become more robust. Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by employed urban wage workers in blue-collar and clerical occupations. For a discussion of inflation and deflation and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 5.3 shows the monthly percentage change in the CPI from January 1959 to December 1960 on a real-time basis. The changes ranged from – 0.1 to 0.4 percent. The CPI changes in the following months, from October 1959 to March 1960, ranged from declines (below the zero line) of 0.1 percent to increases of 0.2 percent. The peak increase of 0.4 percent occurred in April 1960 (the beginning of the recession). The rest of 1960 showed monthly increases of 0.1 to 0.2 percent, except for zero change in August and 0.4 percent change in October. While the monthly movements of the CPI were volatile, the peak monthly changes of 0.3 and 0.4 percent before the onset of the recession occurred in June and July 1959. This was not an inflationary spiral that suggested an overheating economy. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing and minerals (mining) industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production.

THE RECESSION OF 1960–61

Figure 5.3

135

Consumer Prices in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. The data are not seasonally adjusted. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data first became available in March 1960). Data from January 1959 to December 1959 represent data available as of January 1960. Data from January to December 1960 represent data when they first became available one month after each data month. The monthly data from January to December 1960 were unchanged when the later data for those months became available in January.

Figure 5.4 shows the monthly percentage change in the IPI from January 1959 to December 1960 on a real-time basis. There were often increases of one or more percentage points, but there were also several months of zero change or declines (below the zero line). During 1959, the increase of 2.9 percent in April was followed by decelerating increases of 1.9 percent in May and 0.9 percent in June. There were then declines (below the zero line) in July, August, and October, with zero change in September. The next three months from November 1959 to January 1960 showed highly varying increases in the IPI of 1 percent, 5.8 percent, and 1.8 percent, respectively. The variations may have reflected an uneven rebounding from the immediate effects of the steel strike, though the strike only ended in January 1960. Then in the lead-up to the recession in April 1960, there were declines (below the zero line) of 0.9 percent in February and March and zero change in April. Other than an increase in May, declines appeared in the rest of 1960, except for zero change in two months.

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Figure 5.4

Industrial Production in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). Data from January 1959 to December 1959 represent data available as of January 1960. Data from January to December 1960 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1960 data are similar to the later data for those months that first became available in January 1961, except for October 1960, which was revised from zero change to a decrease of 0.9 percent, and November 1960, which was revised from a decrease of 1.9 percent to a decrease of 0.9 percent.

The monthly movements of the IPI leading up to the recession in April 1960 were erratic, with some months of robust increases and others with declines (below zero). Some of this volatility may have reflected monthly responses to talk of a possible steel strike and the shutdown during such a strike. But as noted in the above section on unemployment, the strike caused economic disruptions, though it did not send the overall economy in one direction or another. The overall pattern of the IPI in the lead-up to the recession was modest growth in the industrial sector of the economy. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts.

THE RECESSION OF 1960–61

Figure 5.5

137

Housing Starts in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). Data from January to December 1959 represent data available as of January 1960. Data from January to December 1960 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1960 data are similar to the later data that first became available in March 1961, except that the successive monthly revisions from April to July 1960 differed significantly from the March 1961 data, as well as from the ongoing revisions during 1960.

Figure 5.5 shows the monthly percentage change in housing starts on a real-time basis from January 1959 to December 1960. During 1959, housing starts increased in five months, declined (below the zero line) in six months, and had zero change in one month. The monthly movements showed large increases and declines in four of the five months from October 1959 to February 1960 of 8 to 11 percent. These included an increase of 8.3 percent in December 1959, and decreases of 10.8 percent in October 1959, 9 percent in January 1960, and 7.9 percent in February 1960. Housing starts from March to June 1960 showed two months of increases of 0.9 percent, one month of zero change, and one month of a decline of 0.1 percent. These were followed by large increases of 8 to 17 percent from July to October 1960, a 0.2 percent increase in November and a 19 percent decline in December. Housing starts were erratic in the sixteen months preceding the onset of the recession in April 1960, shifting from increases to declines. There was also a

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decline in the number of housing starts during the period, with levels rising above 1.4 million from January to April 1959, and falling to 1.1–1.2 million from October 1959 to April 1960. While housing starts rebounded from July to October 1960, those later levels were still below those from January to April 1959. Earnings of Manufacturing Workers I cite money wages of production workers in private manufacturing industries as a measure of average weekly worker earnings. The earnings data are not seasonally adjusted. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 5.6 shows the monthly percentage change in worker earnings in manufacturing industries on a real-time basis from January 1959 to December 1960. From January 1959 to June 1959, job earnings increased from 0.5 to 0.7 percent each month, except for a decline (below the zero line) of 0.7 percent in January and an increase of 1.4 percent in March. From July to November 1959, earnings declined in four months and increased in one month. Following an increase of 2.9 percent in December 1959 and a increase of 0.1 percent in January 1960, earnings declined by 1.2 percent in February and April 1960 and by 0.3 percent in March 1960. During the remaining months of 1960, earnings increased in three months and declined in five months. Job earnings declined in 8 of the 16 months preceding the recession in April 1960. Most of the declines occurred from July 1959 to April 1960. Part of the declines probably reflected the effects of the steel strike from July 1959 to January 1960. This pattern of declines indicated there were no overall labor cost pressures that would lead to inflation. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three- to five-year U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.4 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy.

THE RECESSION OF 1960–61

Figure 5.6

139

Job Earnings in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all manufacturing industries. The data are not seasonally adjusted. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). Data from January to December 1959 represent data available as of January 1960. Data from January to December 1960 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1960 data are similar to the later data that first became available in March 1961, except for September 1960, which was revised from a decline of 0.1 percent to an increase of 0.8 percent; for October 1960, which was revised from an increase of 0.7 percent to an increase of 0.3 percent; and for November 1960, which was revised from a decrease of 0.3 percent to a decrease of 0.7 percent.

Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 5.7a shows the monthly interest rates of three- to five-year U.S. securities from January 1959 to December 1960. Interest rates rose from 3.9 percent during January to March 1959 to a high of 4.95 percent in December 1959, with only one decline in October. Interest rates then fell to 3.5 percent in August and September 1960, with only one increase in May. This was followed by an increase to 3.7 percent in November, and then a decline back to 3.5 percent in December. Figure 5.7b (page 141) shows the monthly federal funds interest rate from January 1959 to December 1960. The rate rose from 2.5 percent in January and February 1959 to a high of 4 percent from October to December 1959. This was followed by a general decline in 1960, interrupted with increases in April, July, and December, leading to a low of 1.5 percent in November 1960.

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Figure 5.7a Interest Rates on Three- to Five-Year Securities in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

The decline was gradual from January to May, and then became sharper for the rest of 1960. The Federal Reserve began moving to a policy of monetary ease through its open market operations in March, and then lowering the discount rate in June at which member banks could borrow from the regional Federal Reserve Banks.5 The rise in interest rates during 1959 resulted in higher interest rates than at any time since the 1920s.6 The high interest rates resulted from two factors: s 4HERISINGDEMANDFORBANKLOANSFROMHOUSEHOLDSANDBUSINESSDURING the recovery from the 1957–58 recession required banks to increase their reserves in order to meet the borrowers’ requests for loans. During the 1957–58 recession, when the demand for loans by households and business was weak, banks had increased their investments in U.S. securities as a source of income. Then banks sold their holdings of U.S. securities in order to obtain the reserves to increase their loans to households and business. The sale of these investments increased their supply in the

THE RECESSION OF 1960–61

141

Figure 5.7b Federal Funds Interest Rate in Expansion Preceding the 1960–61 Recession, Plus Nine Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only April to December 1960 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, February 1960 data became available in March 1960). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

financial markets, which drove the prices of the securities down, and concomitantly drove interest rates up. s 4HE&EDERAL2ESERVEINSTITUTEDAPOLICYOFMONETARYRESTRAINTIN!UGUST and September 1958 through its open market operations and through raising the discount rate. The policy of monetary restraint reflected the concern that the economic expansion would lead to inflation, and that “inflationary expectations” were already appearing. This shift in Federal Reserve policy occurred four months after the 1957–58 recession ended in April 1958.7 The 1957–58 recession ended in April 1958, and the Federal Reserve reversed its policy from monetary ease during the recession to monetary restraint beginning in August 1958. In addition to restrictive open market operations, which drained commercial bank reserves from being available for loans to households and business, the Federal Reserve raised the discount

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rate on loans to commercial banks in September and November 1958, and in March, May, and September 1959. These increases raised the discount rate from the recession low of 1.75 percent to a peak of 4 percent. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent real quarterly movements in consumer durable goods spending. The data are provided only quarterly, not monthly, like most of the other economic indicators used in the book. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 5.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending reported on a real-time basis from the first quarter of 1959 to the fourth quarter of 1960. This is the first recession in which consumer durable goods spending was adjusted for price change (that is, real consumer durable goods spending) on a real-time basis. After rising 14.6 percent in the first quarter and 27.1 percent in second quarter of 1959, consumer durable goods spending declined 5.7 percent (below the zero line) in the third quarter and 6.7 percent in the fourth quarter of 1959. In 1960, consumer durables spending increased 9.3 percent in the first quarter and 1 percent in the second quarter, followed by a 15.3 percent decline in the third quarter and a 10 percent increase in the fourth quarter. This was a volatile pattern of consumer durables spending preceding the onset of the recession in April 1960. The sharp increase in consumer durable goods spending during the first half of 1959 was dominated by the surge in household purchases of cars. The stimulus for automotive increase was both the positive outlook among households after the end of the 1957–58 recession and the good reception of the 1959 model cars.8 The corresponding sharp falloff in the second half of 1959 in part reflected the cutbacks in the 1960 models due to the 1959 steel strike noted earlier. Purchases of furniture and household appliances such as refrigerators, ranges, water heaters, and waste disposals follow patterns of new housing construction, as well as replacements of outmoded or deteriorated existing equipment. New residential construction generally showed a declining rate of growth during 1959, as noted earlier under housing starts. There also was a demographic factor restraining consumer durable purchases during the late 1950s and the early 1960s. This was the low marriage rate resulting from the low birthrates during the Depression of the 1930s.9

THE RECESSION OF 1960–61

Figure 5.8

143

Real Consumer Durable Goods Spending in Expansion Preceding the 1960–61 Recession, Plus Three Recession Quarters, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. Note: The 1960–61 recession began in April 1960 and ended in February 1961, so only the second, third, and fourth quarters of 1960 are shown in the figure as recession quarters. Each quarter’s data became available on month after the data quarter (for example, the first quarter of 1959 data became available in April 1959). Data from the first quarter of 1959 to the fourth quarter of 1959 represent data available as of January 1960. Data from the first quarter to the fourth quarter of 1960 represent data when they first became available one month after each data quarter. The quarterly patterns of the first to fourth quarters of 1960 are similar to the later data for those quarters that first became available in January 1961.

Consumer durables purchases were spotty from the last half of 1959 through the first quarter of 1960, preceding the onset of the 1960–61 recession in April 1960. This resulted from the volatile automobile market, the weak pattern of housing starts, the low marriage rates in the late 1950s and early 1960s resulting from the low birthrates of the Depression of the 1930s, and the effects of the steel strike. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change and thus represent real quarterly movements in the GNP. Unlike most of the other economic indicators used in the book, the GNP data are provided quarterly, not monthly. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product.

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Figure 5.9

Real Gross National Product in Expansion Preceding the 1960–61 Recession, Plus Three Recession Quarters, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. Note: The 1960–61 recession began in April 1960 and ended in February, so only the second, third, and fourth quarters of 1960 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, the first quarter of 1959 data became available in April 1959). Data from the first quarter of 1959 represent data available as of January 1960. Data from the first quarter of 1960 represent data when they first became available one month after each data quarter. The quarterly patterns of the first to the fourth quarters of 1960 are similar to the later data for those quarters that first became available in January 1961.

Figure 5.9 shows the quarterly percentage change at an annual rate in the real GNP on a real-time basis from the first quarter of 1959 to the fourth quarter of 1960. This is the first recession in which the GNP was adjusted for price change (that is, real GNP), on a real-time basis. In 1959, the GNP increased by 10 percent in the first quarter and 11.3 percent in the second quarter, followed by a decline of 7 percent (below the zero line) in the third quarter and an increase of 1.6 percent in the fourth quarter. The decline in the third quarter and the small increase in the fourth quarter of 1959 reflected the effects of the 1959 steel strike. In 1960, the GNP increased by 12.2 percent in the first quarter (probably a strong rebound from the end of the strike), and 1.6 percent in the second quarter, and then declined by 3.7 percent in the third quarter and 0.9 percent in the fourth quarter. It is notable that following the end of the steel strike in January 1960 and the GNP increase of 12.2 percent in the first quarter of 1960, the 1960–61 recession

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145

began in April 1960. Given the shortness of the expansion following the end of the 1957–58 recession in April 1958, and the deferred spending resulting from the steel strike, the recession, even in retrospect, seems surprising. Assessment of Economic Policies Preceding the 1960–61 Recession The economy grew modestly from January 1959 to the onset of the recession in April 1960. For some indicators, the movements during the sixteen months were erratic, showing several months of decline. Part of the volatility resulted from the steel strike of July 1959 to January 1960. The effects of the strike appear in higher economic growth in the first half of 1959 than in the second half of the year. However, the strike did not change the overall upward direction of the economy. Price increases were relatively small and inflation was not a problem. This was not a description for an overheating economy that was leading to an inflationary spiral. The 1957–58 recession had ended in April 1958, but soon thereafter, in August 1958, the Federal Reserve began restraining the economy. The restraint reflected the Fed’s concern that ongoing “inflationary expectations” would lead to inflation. The Federal Reserve intensified its restraint through December 1959, and didn’t switch to a policy of monetary ease until March 1960, just one month before the onset of the recession. Notes 1. “The Business Situation,” Survey of Current Business, November 1960, p. 9. 2. “The Business Situation,” Survey of Current Business, September 1959, p. 2. 3. For a discussion of the drawdown of inventories, see “The Business Situation,” Survey of Current Business, February 1960, p. 10. I assume that steel producers and users had built up steel product inventories in the first half of 1959 in anticipation of a possible strike. For a discussion of the increase in steel imports, see “Steel: Critical Stage,” Time, September 14, 1959. 4. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 5. “Recent Money and Credit Developments,” Federal Reserve Bulletin, July 1960, p. 728. 6. “Money and Bank Credit in 1959,” Federal Reserve Bulletin, February 1960, p. 120; and “Highlights of Economic Expansion: A Review of 1959,” Survey of Current Business, February 1960, p. 5. 7. Statement of William McChesney Martin, chairman, Board of Governors of the Federal Reserve System, before the Joint Economic Committee of Congress, February 6, 1959, “A Year of Recession and Recovery,” Federal Reserve Bulletin, February 1959, p. 113. 8. “The Business Situation,” Survey of Current Business, February 1960, p. 9. 9. “Consumer Durable Goods in Recovery,” Federal Reserve Bulletin, January 1959, p. 5.

6 The Recession of 1969–70

The recession of 1969–70 began in December 1969 and ended in November 1970. The recession followed what now ranks as the second longest expansion since the end of World War II, from February 1961 to December 1969, lasting 106 months—close to nine years. During the economic expansion of the 1960s, social and political events occurred that changed the fabric of the nation. These included the Great Society initiatives of President Lyndon Johnson, which lessened poverty through expanded income support for the elderly and the needy; initiated major changes in civil rights and voting laws; greatly enlarged health care with Medicare and Medicaid; and expanded education and jobs programs. The 1960s were also affected by the Vietnam War, which was a surrogate hot war of the Cold War, analogous to the Korean War of the early 1950s. The hot war involving U.S. troops began in 1965 and ended in 1975, though U.S. involvement in Vietnam had gradually escalated beginning in the 1950s. And violence increased during the decade, with the assassinations of President John F. Kennedy, Martin Luther King, Jr., and Robert Kennedy, culminating in an outbreak of urban riots around the country. The economy in the run-up to the 1969–70 recession was influenced by these far-reaching developments, both directly and indirectly. With unemployment at or below 4 percent by the mid-1960s, the economy was considered at full employment, in accordance with the notion of full employment at the time, as discussed below. Following the end of the 1960–61 recession in February 1961, the unemployment rate declined from 5.5 percent in 1962 to 4.5 percent in 1965, and after falling to 3.8 percent in 1966, it declined further to 3.5 percent by 1969 (for selected months in 1969, unemployment declined to 3.3 and 3.4 percent). Based on the best available data on economic growth as of this writing in 2008, the gross domestic product increased at relatively high rates of 4.4 to 6.5 percent from 1962 to 1969. The exceptions were a slowdown to 2.5 percent growth in 1967, which reflected a decreased rate of growth from the second quarter of 1966 to the

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147

second quarter of 1967. Output then increased by 4.8 percent in 1968 and 3.1 percent in 1969. Inflation was mild through the mid-1960s, and then accelerated sharply. The increase in the consumer price index ranged from 1 to 2 percent during 1962–65, and then rose continuously to 6 percent in 1969. Fiscal Policy and the Vietnam War Along with the generally strong economy and the accelerating inflation as the 1960s progressed, the Vietnam War led to a sharp buildup of defense spending, based on nominal dollars. Because of rising prices, defense spending in real dollars declined in 1969.

1965 1966 1967 1968 1969

Billions of dollars 60.6 71.7 83.5 89.3 89.5

Because President Johnson was concerned that a tax increase would undermine congressional support for his Great Society initiatives, he did not propose a tax hike to finance the war until January 1967.1 In working its way through Congress, the proposal was revised to include higher tax rates and the inclusion of certain spending limits; the Revenue and Expenditure Control Act of 1968 was finally passed in June 1968. Tax increases in the act were retroactive to January 1 for corporations and to April 1 for individuals.2 A 10 percent surcharge was placed on the incomes of individuals and corporations. The act also established certain limitations on spending in fiscal year 1969, with exemptions for Vietnam operations, interest on the public debt, veterans’ benefits and services, and Social Security benefits. This was the first application of fiscal policy during the 1960s to moderate inflation by directly limiting private incomes and government spending. Until the passage of the act, monetary restraint pursued by the Federal Reserve was the sole economic policy instrument used to contain inflation, other than the voluntary price and wage guidelines instituted by President Kennedy in 1962. These may have been somewhat effective in containing inflation in the early 1960s, but they came to be viewed as declining in importance, and were no longer in effect by the fall of 1966.3

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Definition of Full Employment Three types of unemployment—frictional, cyclical, and structural—vary in magnitude over time. s 3OMEUNEMPLOYEDWORKERSDONOTIMMEDIATELYlNDWORKDUETOLAGS in matching job skills and aptitudes with available job openings at acceptable pay scales, or within commuting distance. This affects two categories of workers: (a) young workers who enter the labor force for the first time after finishing school, and (b) experienced workers who re-enter the labor force after having left to raise a family, or because of illness to themselves or a family member, or because of having served in the armed forces. These types of unemployment are typically temporary, though in some instances they may lead to workers having to accept lower pay rates than initially envisioned. This unemployment is referred to as “frictional unemployment.” s 3OMEWORKERSWHOHAVEBEENLAIDOFFBECAUSEOFADECLININGCYCLICAL demand for the products they produce expect to be called back to work when their employers’ order books revive from the cyclical downturn. This unemployment is referred to as “cyclical unemployment.” s 3OMELAID OFFWORKERSHAVEANEXTENDEDPROBLEMOFBECOMINGREEMployed, which results from a precipitous fall in the underlying demand for the products they have worked on over long periods. The problem results from the displacement of items produced in certain industries and communities, due to obsolescence caused by new products, or to competition in producing the same products in lower-cost areas in the United States or abroad. The workers’ skills, developed over long periods, have commanded increasing rates of pay. However, the skills are often not transferable to other fields, or in the general area where the workers live, at anywhere near the previous pay levels. This is referred to as “structural unemployment.” The continuing existence of some unemployment has brought about a definition of “full employment” that is cast in terms of the lowest level of unemployment that accommodates the above structural and frictional categories of unemployment. The definition requires that unemployment not be driven so low that it leads to a shortage of workers in several critical occupations or in a wide range of fields, since some of these outcomes would ignite inflation by causing a sharp bidding up of wages and salaries

THE RECESSION OF 1969–70

149

Estimates of Unemployment at Full Employment President Kennedy and his Council of Economic Advisers (CEA) in 1962 cited a 4 percent unemployment rate as an interim target for the economy, with a further goal of achieving an unspecified lower rate.4 In setting a background for this target in 1962, the CEA referred to the unemployment rate in the May 1955–August 1957 period that was in the neighborhood of 4 percent. This was a period of “peace” during the Cold War (after the Korean War ended in July 1953), and so was not impacted by a buildup in defense spending. The CEA also noted that the acceleration of inflation during the period was “sobering,” and that further experience would be needed to see if unemployment below 4 percent would be compatible with containing inflation. Looking ahead, the Full Employment and Balanced Growth Act of 1978 (Humphrey-Hawkins Act) then set goals for unemployment and inflation rates. This act was the first to legislate national numerical goals for these rates. It stipulated an unemployment rate of 4 percent and an inflation rate (based on the consumer price index) of 3 percent, these to be achieved by 1983, with a further reduction of the inflation rate to zero by 1988. The act also permitted a relaxation of the inflation goal if pursuing it would hinder achieving the unemployment goal. While the terminal dates in the act have passed, the act has not been repealed as of this writing in 2008. Economic Indicators in Real Time During 1968–69 The economic data on employment, production, prices, and other economic indicators that were available to policymakers preceding the onset of the 1969–70 recession in December 1969 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINMANUFACTURING s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT

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The last section of this chapter is an assessment of the economic policies preceding the 1969–70 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are, of course, complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1969–70 recession is dated as beginning in November 1969. So December 1969 in the figures that follow was the first month of the recession. To assess what was available to policy makers as 1968 and 1969 progressed, the figures chart the real-time data from January 1968 to December 1969. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in August 1969. Because economic data became available one month after the month to which they refer, the July 1969 data first appeared in August 1969. Thus, the August starting point provides the most reliable data, including revisions up to that time, from January 1968 to July 1969. The data from August 1969 to December 1969 reflect the real-time data on a monthly and quarterly basis from September 1969 to January 1970, as they were produced. Revisions that occurred to the August-to-December 1969 data as of January 1970 changed the monthly patterns at most slightly. I chose August 1969 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in August, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in December. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1968–69 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal,

THE RECESSION OF 1969–70

Figure 6.1

151

Jobs in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1968 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970, with these exceptions: July 1969 was revised from an increase of 0.3 percent to a decline of 0.1 percent, August was revised from an increase of 0.2 percent to an increase of 0.4 percent, and September was revised from zero change to a decline of 0.2 percent.

state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 6.1 shows the monthly percentage change in jobs from January 1968 to December 1969 on a real-time basis. In 1968, jobs typically increased monthly by 0.2 to 0.3 percent, which at annual rates were 2.4 to 3.7 percent. Lower and higher rates in January, February, May, and June were largely offsetting. In 1969, jobs typically increased by 0.3 to 0.4 percent per month from January to July, which at annual rates were 3.7 to 4.9 percent. Job growth slowed during the rest of 1969, with August and October showing increases of 0.2 and 0.3 percent, and zero growth occurring in September, November, and December. Job growth was strong during most of 1968 and 1969, but it weakened noticeably during the second half of 1969.

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Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged 16 years and older (this is the first recession in which the age cutoff of workers was raised from 14 years and older to 16 years and older). For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 6.2 shows the unemployment rate (UR) on a real-time basis from January 1968 to December 1969. Unemployment hovered around 3.5 to 3.7 percent from January to October 1968, and then fell to 3.3 percent from December 1968 to February 1969. The UR was 3.4–3.5 percent from March to August 1969, except for 3.6 percent in July. It jumped sharply to 4.0 percent in September, remained at 3.9 percent in October, but then dropped to 3.4 percent in November and December. Actual unemployment ranged from 2.6 million to 3.2 million workers. Thus, a 1 percent change in the unemployment rate affected 26,000 to 32,000 workers between January 1968 and December 1969. The fall in the UR in November and December 1969 was contrary to the slowdown in the last half of 1969 in employment growth noted in the previous section, and in industrial production and housing starts noted in the sections below. This may have reflected a tendency of employers to “hoard labor”— neither hiring nor laying off workers—because of an expectation that the slowdown would be temporary.5 Hoarding avoids the risk of losing skilled workers. It assumes that when the economy picks up, the employer would incur transaction costs in the rehiring. Unemployment was consistently well below 4 percent during 1968 and 1969, except for two months, one at 3.9 percent and one at 4 percent. The lowest levels of 3.3–3.4 percent appeared for selected months between November 1968 and December 1969. As of this writing in 2008, the economy from 1966 to 1969 and in 1999 and 2000 has shown the best performance of achieving “full employment” over the entire post–World War II period, as discussed in the earlier section of the chapter under Definition of Full Employment. The economy was also at full employment in 1947–48, but that was under the unique conditions of high levels of production being driven by the backlog of civilian needs from the Depression and World War II, as noted in Chapter 2. Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought

THE RECESSION OF 1969–70

Figure 6.2

153

Unemployment Rate in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1968 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970.

by employed urban wage workers in blue-collar and clerical occupations. For a discussion of inflation and deflation, and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 6.3 shows the monthly percentage change in the CPI from January 1968 to December 1969 on a real-time basis. The CPI showed varying monthly increases during 1968 and 1969. During 1968, the increases were mainly 0.3 percent, with two months at 0.4 and two at 0.5 percent. During 1969, the increases were mainly 0.4 to 0.6 percent. Table 6.1 shows the extent of the acceleration in the CPI in real time in six- and twelve-month periods during 1968 and 1969. The six-month periods are annualized to twelve months, which assumes that the percentage change that occurred during the six months would continue at the same rate for the following six months. After increases of 4.6 and 4.7 percent in the first and

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Figure 6.3

Consumer Prices in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. The data are not seasonally adjusted. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure) as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1968 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970.

Table 6.1 Consumer Price Index in Real Time Annualized Percentage Change Six-month periods: December 1967 to June 1968 June 1968 to December 1968 December 1968 to June 1969 June 1969 to December 1969

4.6 4.7 6.4 5.9

Twelve-month periods: December 1967 to December 1968 December 1968 to December 1969

4.7 6.1

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on data that are not seasonally adjusted.

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second halves of 1968, the CPI increased at an annual rate by 6.4 percent in the first half of 1969 and a lower, but still high rate of 5.9 percent in the second half. From one December to the next December, the CPI increased in 1968 by 4.7 percent and in 1969 by 6.1 percent. Price increases occurred in the various components of goods and services. This appears to be the case when the economy was operating at high rates, as indicated by the low unemployment rates noted above, and high capacity utilization rates in manufacturing were present (discussed below under Industrial Production), so the increased production costs in both purchased goods and services and in labor costs were not sufficiently offset by workplace productivity increases to avoid the higher costs from being passed into higher prices. Thus, because the economy was generally strong, businesses could increase prices without suffering a decline in sales, at least for this limited period. Productivity and Unit Labor Costs Two measures of workplace efficiency illustrate the role that increased business production costs in both purchased goods and services and labor costs played in the inflation occurring in 1968 and 1969. These are the economywide measures of productivity and unit labor costs, both of which are prepared by the Bureau of Labor Statistics in the U.S. Department of Labor. Productivity is business output per worker hour. Unit labor costs (ULC) is the relationship of worker payroll costs to productivity. ULC rise when payroll costs increase more (or decline less) than productivity, and ULC fall when payroll costs increase less (or decline more) than productivity. Productivity increased by 3.4 in 1968 and 0.5 percent 1969, while ULC increased by 4.5 percent in 1968 and 6.5 percent in 1969. These are only broad gauges that combine, rather than separate, long-term component changes in labor and other workplace efficiencies and costs. But they do highlight the fact that rising business costs of production were a main and immediate source of inflation, as workplace efficiency gains were not large enough to offset most of the production cost increases. The long-term component productivity measures, which are called Multifactor Productivity, are not included here because they reflect the effects of long-term changes in production efficiencies. Inflation accelerated to higher-than-normal levels during 1968 and 1969. The price increases were pervasive throughout the goods and services items. The monthly gyrations in the price increases were part of an upward trend from 1968 to 1969, as evidenced by the movements in the six- and twelvemonth periods in both years. Rising business costs of production were an

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undercurrent pushing up prices from the supply side of the economy, as workplace efficiency gains were not sufficiently large to offset most of the production cost increases. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 6.4 shows the monthly percentage change in the IPI from January 1968 to December 1969 on a real-time basis. In 1968, the index increased by 0.5 to 1.0 percent in seven months, and by 0.1 and 0.3 percent in two months. The IPI declined (below the zero line) in three months. In 1969, the IPI increased by 0.6 to 0.8 percent in five months and by 0.2 percent in two months. The IPI declined in all months from August to December 1969. Capacity Utilization Rate The capacity utilization rate (CUR), prepared by the Federal Reserve, is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capacity that bears on the rate of inflation. The CUR gives the percentage utilization of capital facilities (structures and equipment) used in producing output in the manufacturing, mining, and utilities industries. The CUR is calculated with the IPI (production) in the numerator and capacity (capital facilities) in the denominator: Manufacturing industrial production index CUR = ________________________________________ × 100 Manufacturing capacity (structures and equipment) I offer the following illustration as a broad guide for viewing the relevance of the CUR to the economy: When the economy is depressed, with high unemployment and low economic growth, and the CUR is in the neighborhood of 70 percent, there is considerable unused productive capacity available. Moreover, this available capacity can support a substantial increase in production using relatively new and efficient equipment, which keeps both production costs and inflation low. At the other extreme, when the economy is booming at “full employment” (see the earlier section on Unemployment), economic growth is high, and the CUR is approaching 90 percent, it would probably necessitate bringing into production older and less-efficient equipment that is also subject to more frequent breakdowns. This results in

THE RECESSION OF 1969–70

Figure 6.4

157

Industrial Production in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1969 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970.

higher production costs that lead to a greater need for higher prices in order to maintain profit margins. The CUR for manufacturing industries was first published during 1968. I have chosen to use the more-refined CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries from 1967 to 1969 was as follows: 1967 1968 1969

87.2% 87.1% 86.6%

The CUR in manufacturing hovered around 87 percent from 1967 to 1969, which is generally considered to be above maximum efficiency rates, because the high rate leads manufacturers to bring older, less productive, and less reliable equipment into production. This supports the notion that with the demand for manufactured products being so strong and manufacturing

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efficiency declining, production costs rose, which in turn led businesses to increase prices. The IPI showed generally strong growth from January 1968 to June 1969. This changed abruptly in July 1969, and declines appeared in the last six months of 1969. The relatively high rates of the CUR occurred during the strong growth in the IPI, and contributed to the acceleration of inflation noted in the previous section. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 6.5 shows the monthly housing starts changes on a real-time basis from January 1968 to December 1969. In 1968, housing starts fluctuated from monthly increases of 0.1 percent in one month, to 5 to 7 percent in three months, and to 10 to 17 percent in three months. Monthly declines (below the zero line) of 1 to 2 percent appeared in three months, and of 13–14 percent in two months. In 1969, monthly increases occurred in only two months, January and September. Housing starts declined in all the other months during the year. Housing starts weakened considerably from 1968 to 1969. Even during 1968, housing starts declined in four months. Earnings of Manufacturing Workers I cite money wages of production workers in private manufacturing industries as a measure of average weekly worker earnings. The earnings data are not seasonally adjusted. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 6.6 (page 160) shows the monthly percentage change in worker earnings in manufacturing industries on a real-time basis from January 1968 to December 1969. In 1968, the monthly movements changed sharply, often by more than several percentage points. The overall range spanned increases of 3.3 to 3.5 percent in two months, and declines (below the zero line) of 1.6 to 1.7 percent in two months. Increases of 0.7 to 1.5 percent occurred in four months, and declines of 0.1 and 0.2 percent appeared in two months. In 1969, the monthly movements were smaller, but nonetheless often showed changing upward and downward direction. The movements ranged from increases of 1.7 to 2.1 percent in two months, and declines of 1 to 1.4 percent in two months. Increases appeared in seven months and declines in five months.

THE RECESSION OF 1969–70

Figure 6.5

159

Housing Starts in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on the U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1968 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970, except for August 1969, which showed a decline of 1.6 percent in September 1969, and an increase of 0.9 percent in January 1970.

The monthly gyrations in worker earnings in 1968 and 1969 make it difficult to get an overall assessment of the magnitude of the earnings changes. Therefore, to get a better grasp of the extent of the earnings changes, I have grouped the changes over six-month and twelve-month periods. Table 6.2 shows the earnings changes in the following six-month and twelve-month periods. The six-month periods are annualized to twelve months, which assumes that the percentage change that occurred during the six months would continue at the same rate for the following six months. s3IXMONTHS s $ECEMBERTO*UNE s *UNETO$ECEMBER s $ECEMBERTO*UNE s *UNETO$ECEMBER

s4WELVEMONTHS s $ECEMBERTO$ECEMBER s $ECEMBERTO$ECEMBER

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Figure 6.6

Job Earnings in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all manufacturing industries. The data are not seasonally adjusted. Note: The 1969–79 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). Data from January 1968 to July 1969 represent data available as of August 1969. Data from August to December 1969 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1969 data are similar to the later data for those months that first became available in January 1970. Table 6.2 Job Earnings in Manufacturing in Real Time Annualized Percentage Change Six-month periods: December 1967 to June 1968 June 1968 to December 1968 December 1968 to June 1969 June 1969 to December 1969

6.3 7.5 2.9 7.1

Twelve-month periods: December 1967 to December 1968 December 1968 to December 1969

6.9 5.0

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on not-seasonally-adjusted data.

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In three of the four six-month periods, earnings increased at an annual rate of 6.3 to 7.5 percent. One six-month period showed an increase of 2.9 percent. Over the two twelve-month periods, the increases were 5.0 and 6.9 percent. Some of the large increases in earnings stem from the substantial rise in pay that unions gained in collective bargaining in 1968. This reflected the strong bargaining position unions were in because of two factors. One was that unemployment generally was low, and there was a strong demand for skilled and experienced workers.6 The other was that many of the new contracts replaced those that were made in 1965, which because of the rising inflation, resulted in small increases in real earnings that is the determinant of actual buying power. This led to most contracts being “front loaded,” that is, with a high proportion of the increases occurring in the first year of the contract, to compensate for the previous weak real earnings increases.7 Worker earnings increased sharply during 1968 and 1969, even though earnings declined in several months. However, due to the sharp increases in inflation noted in the Inflation and Deflation section, above, worker earnings adjusted for inflation—that is, the buying power of the earnings—increased much less than the dollar paychecks. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.8 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted, and interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

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Figure 6.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

Figure 6.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from January 1968 to December 1969. In 1968, interest rates fluctuated within a range of 5.5 to 6.2 percent. They rose from 5.5 percent in January to 6.1 percent in May, declined to 5.4 percent in September, and rose to 6.2 percent in December. In 1969, interest rates generally increased throughout the year, rising to 8.1 percent in December. Slight decreases occurred in April and October. Figure 6.7b shows the monthly federal funds interest rate from January 1968 to December 1969. In 1968, the rate rose from 4.6 percent in January to 6 percent from May to August. After a slight dip below 6 percent from September to November, it rose to 6.3 percent in December. In 1969, it rose to 8.9 percent in May and fluctuated between 8.0 and 8.8 percent for the rest of the year, except for a jump to 9.6 percent in September. The general rise in interest rates during 1968 and 1969 reflected three factors: s #ONTINUINGDEMANDFORCREDITINTHEEXPANDINGECONOMY INBOTHTHE household and business sectors

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163

Figure 6.7b Federal Funds Interest Rate in Expansion Preceding the 1969–70 Recession, Plus One Recession Month, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York Data. The data are not seasonally adjusted. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only December 1969 is shown in the figure as a recession month. Each month’s data became available one month after the data month (for example, April 1969 data became available in May 1969). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation).

s (IGHANDRISINGINmATION WHICHCAUSEDLENDERSTORAISEINTERESTRATES in order to maintain the purchasing power of the loans when they were repaid s &EDERAL2ESERVEPOLICYOFCOMBATINGINmATIONBYRESTRAININGTHEBANK reserves available for extending credit to borrowers, resulting in higher interest rates that made loans more costly to borrowers. As apparent in Figures 6.7a and 6.7b, the general rise in interest rates during 1968 and 1969 was interrupted for a short period during the summer of 1968. It reflected the Federal Reserve’s concern that the new federal tax increases that were made retroactive to January 1 for corporations and April 1 for individuals, by reducing private incomes available for spending, could be too strong a restraint on economic growth (see Fiscal Policy section noted above). Consequently, the Federal Reserve increased its purchases of securities in open market operations and lowered the discount rate in the summer of 1968, thus easing credit restraints by expanding bank reserves available for lending and lowering interest rates.9

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As the economy slowed during the last half of 1969 with the declines in employment, industrial production, and housing starts, the leveling of the federal funds interest rate during that time indicated that the Federal Reserve was neither lessening nor increasing its policy restraint (Figure 6.7b). However, the general credit markets still showed increasing interest rates throughout 1969 (Figure 6.7a). Bank Loans Though interest rates were rising in 1968 and 1969, commercial banks shifted their asset portfolios in both years in order to expand their reserves, which provided more credit to borrowers than would otherwise have been available. In 1968, this was accommodated by banks lessening their investments in securities and increasing their loans to household and business borrowers compared with 1967.10 In 1969, it was accommodated by banks selling some of their securities holdings.11 For part of the year, banks increased their Eurodollar borrowings as a way to raise more funds for lending, but this ended when the Federal Reserve subsequently imposed reserve requirements on Eurodollars in subsidiaries of U.S. banks abroad.12 Also, because of the greater stringency of bank loans in 1969, businesses increasingly raised outside funds by issuing commercial paper and borrowing in capital markets. The spiraling inflation was a major concern of the Federal Reserve in 1968 and 1969, which led it to restrain bank credit and raise interest rates in its conduct of monetary policy. Some of this restraint was offset by banks shifting their asset portfolios from investments to loans, by banks borrowing in Eurodollar markets, and by businesses raising greater amounts of outside funds by issuing more commercial paper and by increasing their borrowing in capital markets. With the civilian economy strong and the Vietnam War requiring more federal government spending, the Federal Reserve hoped to moderate the inflation by lessening spending increases without having the retrenchment so strong as to lead to a recession. In the Fed Speak of the time, the Federal Reserve Board chairman said: “What I have called the challenge of ‘disinflating without deflating’ can be met most effectively if lenders and borrowers will now exercise the utmost restraint in taking on new commitments.”13 I take “disinflating without deflating” to mean lessening inflation without creating a recession. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent

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real quarterly movements in consumer durable goods spending. The data are provided only quarterly, not monthly, like most of the other economic indicators used in the book. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 6.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending reported on a real-time basis from the first quarter of 1968 to the fourth quarter of 1969. In 1968, consumer durable goods spending increased strongly, by 22.2 and 18.8 percent in the first and third quarters, respectively, with a lesser increase of 9.6 percent in the second quarter, and a decline of 1.4 percent (below the zero line) in the fourth quarter. In 1969, consumer durable goods spending increased by 8 and 7.8 percent in the first and second quarters, respectively, and declined by 5.5 and 2.8 percent (below the zero line) in the third and fourth quarters, respectively. Overall, spending showed much less growth in 1969 than in 1968. In 1968, the sharp increase in durable goods spending in the first quarter reflected a burst of spending for automobiles. Spending for automobiles had been sluggish during the last part of 1967 due to an automobile strike, and when the strike ended, sales of automobiles rebounded. Sales of furniture and household appliances increased during 1968 as the construction of more new housing, which had begun in 1967, was completed and became available for occupancy in 1968. While the jump in sales during the first quarter dropped to a smaller increase in the second quarter, spending increased sharply in the third quarter, despite the higher rates of income tax withholdings on household incomes that began in the second quarter (see Fiscal Policy in the beginning of the chapter). The spurt in the third quarter appeared to reflect expectations of future increases in prices. However, consumer durable goods spending again turned soft in the fourth quarter.14 In 1969, the relatively large increases in the first half of the year were followed by declines in the second half of the year. This pattern was attributed to a growing uneasiness of households about the economy. The fall in housing starts during 1969 also may have dampened spending for furniture and household appliances.15 Consumer durable goods spending generally weakened from 1968 to 1969. It also showed considerable volatility from quarter to quarter, which is indicative of the fact that purchases of these items are typically deferrable, which makes them vulnerable to uncertainties in the economic outlook of households. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change and thus represent

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Figure 6.8

Real Consumer Durable Goods Spending in Expansion Preceding the 1969–70 Recession, Plus One Partial Recession Quarter, in Real Time

s2ECESSIONQUARTER4HE/CTOBERn$ECEMBERQUARTEROFINCLUDEDONERECESSION month (December 1969). Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only the fourth quarter of 1969 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, January–March 1969 data became available in April 1969). Data from January–March 1968 to April–June 1969 represent data available as of August 1969. Data for July–September and October– December 1969 represent data when they first became available once month after each data quarter. The quarterly patterns of the July–September and October–December 1969 data are similar to the later data for those quarters that first became available in January 1970.

real quarterly movements in the GNP. The data are provided only quarterly, not monthly like most of the other economic indicators used in this book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 6.9 shows the quarterly percentage change at an annual rate in the GNP on a real-time basis from the first quarter of 1968 to the fourth quarter of 1969. Following rates of 5.9 percent in the first quarter and 7.4 percent in the second, growth slowed to 4 percent in the third quarter. This was followed by a continual slowdown to a decline (below the zero line) of 0.1 percent in the fourth quarter of 1969. The GNP growth rate was strong in 1968. But economic growth weakened in 1969, and was relatively slow in the second and third quarters, followed by an absolute decline in output in the fourth quarter.

THE RECESSION OF 1969–70

Figure 6.9

167

Real Gross National Product in Expansion Preceding the 1969–70 Recession, Plus One Partial Recession Quarter, in Real Time

s 2ECESSION QUARTER 4HE /CTOBERn$ECEMBER  QUARTER INCLUDED ONE RECESSION month (December 1969). Source: Based on U.S. Office of Business Economics data as part of the national income and product accounts. Note: The 1969–70 recession began in December 1969 and ended in November 1970, so only the fourth quarter of 1969 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, January–March 1969 data became available in April 1969). Data from January–March 1968 to April–June 1969 represent data available as of August 1969. Data for July–September and October– December 1969 represent data when they first became available, one month after each data quarter. The quarterly patterns of the July–September and October–December 1969 data are similar to the later data for those quarters that first became available in January 1970.

Assessment of Economic Policies Preceding the 1969–70 Recession The U.S. economy in 1968–69 had been growing since the 1960–61 recession ended in February 1961, and the economic expansion was the longest up to that point. In the two years preceding the recession, the economy was “fully employed” in terms of low unemployment. Inflation was high, and generally accelerating. Rising business production costs, including both purchased goods and services and worker wages, contributed to the inflation, as workplace efficiency gains were not sufficiently large to offset the rising costs. And the Vietnam War absorbed greater amounts of resources—increasing numbers of armed forces personnel, increased production of military equipment, and a growing amount of the wide array of goods and services needed in such a conflict.

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But while the war led to rising defense spending, several commercial markets showed weaker demands in 1969. Industrial production peaked in July 1969, and declined for the rest of 1969. Housing starts declined in ten months during 1969. Consumer durable goods spending was strong during the first half of 1969, albeit below the rates in 1968, but declined sharply in the last half of 1969. The gross national product growth rate had been declining since the second half of 1968 and fell to low rates in the second and third quarters of 1969, followed by an absolute decline in the fourth quarter. Until mid-1968, the Federal Reserve exercised the only economic policy actions to contain inflation by limiting increases in bank credit and raising interest rates, except for the voluntary price and wage guidelines noted below. It was only in mid-1968 that a restrictive fiscal policy was adopted that raised household and corporate income taxes and limited federal government spending increases, which aimed at combating inflation. Mandatory price and wage controls were not used to contain inflation, and the voluntary price and wage guidelines that had been instituted in the early 1960s were no longer in effect by the fall of 1966. This posture of a “laissez-faire” federal government economic policy contrasted with the active fiscal policy restraint and the imposition of price and wage controls early in the Korean War, as noted in Chapter 2.16 I do not know whether an earlier introduction of fiscal policy restraints, say in 1967, would have lessened the burgeoning inflation. But given the “fully employed” economy both in labor and in capital facilities, and the rising business production costs, they might have given more heft to the monetary policy restraints in lessening the increases in spending. It also is possible that a willingness to apply price and wage controls during the wartime economy, for at least one or two years, would have helped partly in breaking the inflationary expectations on the part of businesses and workers, and both together when they functioned as households. In addition, it should be kept in mind that large military expenditures in a fully employed economy, such as occurred during the Vietnam War, are intrinsically inflationary. This reflects the fact that the military and ancillary goods needed for the war effort have, at best, limited use in the civilian economy. However, when military production is high, households and businesses face a market that has fewer civilian goods than if a greater proportion of civilian goods had been produced. Thus, there is a relative shortage of civilian goods in relation to the buying power of households and businesses, which may lead them to a bid-up of prices as prospective buyers. The expansion during the 1960s was the most impressive economic performance since the end of World War II up to that time, but the Vietnam War marred it. This raises a question as to whether the expansion would have

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been as long, or unemployment as low, without the large increases in defense spending for the war. Overall, I believe the late increase in federal income taxes to finance the war in 1968, and the absence of price and wage controls when inflation was accelerating in 1968 and 1969 in a “fully employed” economy, was poor economic policy by President Johnson, and turned out to be an important factor in bringing on the recession of 1969–70. It is likely that an earlier increase in federal income taxes, and the use of price and wage controls, would have lessened increases in inflation and in interest rates, and thus relaxed the Federal Reserve’s monetary restraint to contain inflation. Weakness in several markets during 1969 was a second important factor bringing on the recession. Notes 1. Steven A. Bank, Kirk J. Stark, and Joseph J. Thorndike, War and Taxes (Washington, DC: Urban Institute Press, 2008), pp. 126–37. 2. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1969, p. 38. 3. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, February 1970, p. 24. 4. “Economic Report of the President” and “Annual Report of the Council of Economic Advisers,” in Economic Report of the President, January 1962, pp. 8 and 44–49. 5. “The Economy in 1969,” Survey of Current Business, January 1970, p. 18. 6. “The U.S. Economy in 1968,” Survey of Current Business, January 1969, p. 24. 7. “Annual Report of the Council of Economic Advisers,” January 1969, pp. 46–47. 8. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 9. “The U.S. Economy in 1968,” p. 30. 10. “The U.S. Economy in 1968,” p. 31. 11. “The Economy in 1969,” pp. 20–21. 12. “Annual Report of the Council of Economic Advisers,” February 1970, p. 37. Eurodollars are dollar-denominated deposits in banks and other financial institutions outside the United States, both in Europe and in other parts of the world. 13. Statement by William McChesney Martin, chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking and Currency, U.S. Senate, March 25, 1969, Federal Reserve Bulletin, April 1969, p. 330. 14. “Consumption and Saving Patterns Since Mid-1968,” Federal Reserve Bulletin, June 1969, pp. 464–65. 15. “The Economy in 1969,” p. 13. 16. For the politics of the differing fiscal policy postures taken by Presidents Truman and Johnson in the Korean and Vietnam wars, see Bank, Stark, and Thorndike, War and Taxes, pp. 141–43.

7 The Recession of 1973–75

The recession of 1973–75 began in November 1973 and ended in March 1975. Two major policy changes preceded this recession: s %STABLISHMENTANDADMINISTRATIONOFMANDATORYPRICEANDWAGECONTROLS of August 15, 1971 s #ONVERTINGTHEFOREIGNEXCHANGEVALUEOFTHEDOLLARFROMlXEDTOmOATING rates in 1972 and 1973 The Arab oil embargo began in October 1973, only one month before the onset of the recession, resulting in much higher oil prices. While the embargo deepened and lengthened the recession, it did not precipitate it, which is the focus in this book. Economic Policy Changes of August 15, 1971 President Richard Nixon’s Council of Economic Advisers noted in January 1972 that, in the recovery from the 1969–70 recession during the first three quarters of 1971, unemployment remained high. While inflation had decelerated, there was a concern that the deceleration was temporary, which would be followed by a new outburst of inflation. The council characterized both conditions as “less than desirable.”1 Table 7.1 shows that this view of sluggish progress in the recovery was based on a steady unemployment rate of around 6 percent. And the general decline in inflation was interrupted by an acceleration in the second quarter of 1971, which raised fears that inflation could reignite. Price and Wage Controls On August 15, 1971, President Nixon announced a New Economic Policy, which froze all prices and wages for three months (Phase I).2 This was followed by the establishment of allowable increases of prices and wages that were 170

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Table 7.1 Unemployment and Inflation Before or Coincident with the August 1971 Controls Unemployment Rate (percent) 1969: IV 1970: IV 1971: I 1971: II 1971: III

3.6 5.8 5.9 6.0 6.0 Consumer Price Index (percentage change)

December 1968 to December 1969 December 1969 to December 1970 December 1970 to March 1971a March 1971 to June 1971a June 1971 to August 1971a

6.1 5.5 2.8 5.3 3.3

Source: “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1972, Table 5 and Table 6, pp. 38 and 43. a Annual rate.

determined by a Cost of Living Council, a Pay Board, and a Price Commission from November 14, 1971, to January 11, 1973 (Phase II). The program was designed and intended to be temporary.3 The program was mandatory, as distinct from voluntary. A mandatory program means that it is backed by legal penalties. Most price violations were handled administratively rather than through legal action, such as through requiring firms to refund or reduce prices. However, about 300 legal actions were taken in the first year of Phase II.4 Mandatory price and wage controls had been last instituted in the Korean War during 1951–53 (Chapter 3). The general pay standard allowed for wage increases of 5½ percent, with several exceptions to the standards on allowable price and wage increases. The general price standard was that prices could be increased above the August 1971 level proportionate to the increase in production costs over the same period, but if prices were increased, a firm’s profit margins in relation to sales could not exceed the average of the best two of the three fiscal years preceding August 1971. The further evolution of the price and wage controls occurred in Phase III from January 1973 to June 1973, in a second freeze from June 1973 to August 1973, and in Phase IV from August 1973 to April 1974. The controls ended in April 1974, except for continued controls on petroleum prices.

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Phase I (Freeze) Phase II Phase III Second Freeze Phase IV

Dates of Phase I to Phase IV of the Price and Wage Controls August 15, 1971–November 14, 1971 November 14, 1971–January 11, 1973 January 11, 1973–June 13, 1973 June 13, 1973–August 12, 1973 August 12, 1973–April 1974

Phase III and Phase IV became a progressive relaxation, allowing more exceptions for price and wage increases (though with a few tightened regulations), and a greater self-administration by companies in interpreting the increasingly complex rules of prospective price and wage increases. These lessened the delays and costs in Phase II of obtaining prior approval for increases from the Price Commission and Pay Board, and reporting requirements were lessened by limiting them to the largest companies.5 Prices and wages increased considerably in Phases III and IV of the program. Fiscal Policy Along with these constraints on price and wage increases, the New Economic Policy included proposed fiscal policy changes to be legislated by Congress in order to increase employment and economic growth.6 These included a job development tax credit for businesses; accelerating the timing of tax cuts previously legislated; repealing a 7 percent excise tax on automobiles; and a new Domestic International Sales Corporation that would encourage U.S. manufacturers, through a deferral of their income taxes, to produce goods domestically for export rather than in their plants abroad. In the other direction, fiscal policy included cutbacks in federal government employment and a deferral of six months in a scheduled federal employee pay increase. Congress generally adopted these proposed changes, though with some modifications. International Value of the Dollar After the end of World War II, dollar foreign exchange rates were essentially fixed. These rates were established in 1944 under international agreements, referred to as the Bretton Woods Agreements (based on an international conference in 1944 in Bretton Woods, New Hampshire). The agreements also provided for a new International Monetary Fund for the purpose of preventing the excesses of nationalistic currency manipulations that had occurred in

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the interwar period between World War I and World War II. The fixed dollar rate was set at $35 per ounce of gold, except that the rates were allowed to fluctuate within a band of plus or minus 1 percent. Under the agreements, foreign authorities were responsible for buying and selling their currencies in order to maintain their currency values in relation to the dollar within the 1 percent band. The United States only occasionally engaged in such market transactions to maintain the band because it was committed to buying and selling gold at $35 per ounce. The $35 figure was established in January 1934 by President Franklin Roosevelt through executive order under legislation that allowed the president to redefine the gold content of the dollar at not less than 50 percent of the previous gold content. Upon first taking office in March 1933, in the depth of the Depression, President Roosevelt had suspended U.S. adherence to the gold standard. The suspension prohibited both the redemption of dollars into gold and the export of gold, and all gold coin and gold certificates were called in from circulation.7 In January 1934, with the dollar established at $35 per ounce, the United States adopted a modified gold standard, in which international transactions in gold were confined to the purchase and sale of gold by the U.S. Department of the Treasury for the settlement of dollar transactions between nations. Congress extended the 1933 legislation that had given the president authority to redefine the gold content of the dollar through the mid-1940s. In 1946, the United States reported the par value of the U.S. dollar to the International Monetary Fund to be 0.888671 grams of fine gold, which was equivalent to $35 per ounce.8 Fine gold represents the proportion of pure gold in a gold alloy. In this case, fine gold was defined as 0.888671 grams of pure gold and 0.111329 grams of a different metal. Thus, fine gold contains 88.87 percent pure gold and 11.13 percent of a different metal. The fixed exchange rates under the Bretton Woods system appeared to work reasonably well for the international economy from the aftermath of World War II until the mid-1960s. As European nations and Japan recovered from the devastation of World War II, products made in foreign countries became increasingly competitive with U.S. products. The U.S. balance-of-payments surplus, in which exports exceeded imports over the postwar period, peaked in 1964. The surplus then lessened in the following years, and by 1971, the balance had shifted to a deficit, in which imports exceeded exports. The shift in the U.S. balance-of-payments position raised a question about the viability of maintaining the dollar value at $35 per ounce of gold. This was highlighted by a large outflow of dollars to other countries in the first half of 1971, which indicated that the individuals, firms, and governments operating in foreign currency markets felt that the dollar was overvalued.

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Following these currency outflows, as part of the New Economic Policy, the U.S. government concluded that the dollar was overvalued. The first step toward changing the foreign exchange value of the dollar was taken on August 15, 1971, which suspended the convertibility of dollars or other international reserve assets held by foreign monetary institutions into gold. In December 1971, an international conference composed of selected European nations, Japan, and Canada (the Group of Ten) agreed to the devaluation of the dollar from $35 per ounce to $38 per ounce, with an increase in the fluctuating band to 2¼ percent (this was called the Smithsonian Agreement because the conference met in the Smithsonian Institution). However, because of the continued deterioration in the U.S. balance-of-payments deficit, this turned out to be merely an interim stage in establishing the value of the dollar based on floating the dollar, which policy was adopted in 1973.9 Floating exchange rates are based on the principle that the value of a nation’s currency fluctuates with changing market conditions.10 Under floating rates, the dollar can change in value in each trading day as it relates to other national currencies, including the euro, depending on the money flow in foreign currency markets. Under a “free float,” the nation’s monetary authorities intervene only slightly, if at all, in the currency markets. In a “managed float” (also referred to as a “dirty float”), which the United States follows, the monetary authorities of a nation intervene significantly from time to time in the currency markets in fulfilling their responsibility for enhancing economic growth and containing inflation, as well as in fostering stable exchange rates and liquidity in underpinning world trade. In the managed U.S. float, the Federal Reserve and the U.S. Department of the Treasury carry out the intervention in currency markets jointly and equally.11 The U.S. float has no specific upper or lower limits. In 1978, floating exchange rates were codified in an amendment to the International Monetary Fund’s Articles of Agreement. The devaluation resulting from the floating exchange rate led to an associated rise in import prices, which increased inflation. Import Tax Surcharge In addition to the change in determining the foreign exchange value of the dollar, a temporary tax (surcharge) of up to 10 percent on various products was put on dutiable imports on August 15, 1971. The surcharge was limited to products on which duties had previously been reduced by reciprocal trade agreements. In some cases the surcharge was less than the 10 percent maximum, because the surcharge did not raise duties on a particular product above the statutory rate for any product. All imports subject to mandatory quantitative quotas were exempt from the surcharge. The surcharge affected about one-half of all imports. It was lifted at the beginning of 1972.

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Economic Indicators in Real Time During 1972–73 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1973–75 recession in November 1973 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of this chapter is an assessment of the economic policies preceding the 1973–75 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are, of course, complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1973–75 recession is dated as beginning in November 1973. So November and December 1973 in the figures that follow were the first two months of the recession. To assess what was available to policy makers as 1972 and 1973 progressed, the figures chart the real-time data from January 1972 to December 1973. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in July 1973. Because economic data became available one month after the month to which they refer, the June 1973 data first appeared in July 1973. Thus, the July starting point provides the most reliable data, including revisions up to that time, from January 1972 to June 1973. The data from July 1973 to December 1973 reflect the real-time data on a monthly and quarterly basis from August 1973 to January 1974, as they were produced. Revisions that occurred to the

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July-to-December 1973 data as of January 1974 changed the monthly and quarterly patterns at most slightly. I chose July 1973 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in July, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in November. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1972–73 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 7.1 shows the monthly percentage change in jobs from January 1972 to December 1973 on a real-time basis. In 1972, jobs typically increased by 0.3 to 0.4 percent each month, with two months at 0.2 percent and one month of zero change. In 1973, jobs increased most frequently by 0.3 percent, with one month at 0.6 percent, two months at 0.4 percent, one month each at 0.2 and 0.1 percent, and one month of zero change (the second recession month of December). The job increase of 3.8 percent from December 1971 to December 1972 was the largest increase since the Vietnam War–related buildup in 1966.12 Increases in 1972 were led by durable goods manufacturing and by services. The Public Employment Program in 1971 and 1972 that aimed at placing unemployed workers in jobs augmented state and local government employment. The job increase from December 1972 to December 1973 was 3.6 percent, close to the 3.8 percent of the previous 12 months. This continued the rebound in employment that first appeared in the last four months of 1971, after a sluggish recovery from the low levels of the 1969–70 recession. The job market was strong both in 1972 and 1973. Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of

THE RECESSION OF 1973–75

Figure 7.1

177

Jobs in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the January to December 1973 data are similar to the later data for those months that first became available in January 1974, except for July 1974, which declined by 0.1 percent (below the zero line), in place of the 0.1 percent increase.

the economy. The data cover nonfarm and farm workers age sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 7.2 shows the unemployment rate on a real-time basis from January 1972 to December 1973. In 1972, unemployment from January to May was in the 5.8–5.9 percent range, close to the high levels of 1971 discussed early in the chapter (also see Table 7.1 above). Then from June to December, unemployment declined, with short interruptions, to 5.1 percent in December. In 1973, unemployment declined further to a low of 4.5 percent in October, and then rose to 4.9 percent in December. The decline in 1972 was slightly sharper than that in 1973 up to the 1973 low point in October, and much of the decline in 1973 evaporated with the onset of the recession months of November and December.

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Figure 7.2

Unemployment Rate in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on the U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the July to December 1973 data are similar to the later data for those months that first became available in January 1974.

Actual unemployment ranged from 4.1 million to 5.1 million workers between January 1972 and December 1973. Thus, a one-percentage-point change in the unemployment rate affected 41,000 to 51,000 workers. The decline in unemployment, which began in mid-1972 and continued into most of 1973, occurred in all age, gender, racial, industry, and occupational categories, though at different rates. The most prominent declines occurred in manufacturing and blue-collar occupations.13 The decline in unemployment during 1972 and 1973 reflected a growing economy. The low point in the unemployment rate of 4.5 percent in October 1973 approached the “full employment” unemployment rate of 4 percent, as discussed in Chapter 6 under Definition of Full Employment. But unemployment turned up during the first two months of the recession, reaching 4.9 percent in December.

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Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by employed urban wage workers in blue-collar and clerical occupations. For a discussion of inflation and deflation and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 7.3 shows the monthly percentage change in the CPI from January 1972 to December 1973 on a real-time basis. In 1972, the CPI increased at a monthly rate of 0.2 to 0.4 percent, except for increases of 0.1 and 0.5 percent in January and February. In 1973, inflation accelerated, and also fluctuated, considerably. After increasing by 0.3 percent in January, the CPI increased by 0.6 to 0.9 percent from February to June. There was a huge 1.8 percent increase in August, bounded by increases of 0.2 and 0.3 percent in July and September. The Arab oil embargo in October led to increases of 0.8 percent in October and of 0.7 percent both in November and December, but the embargo occurred at the end of the expansion, so it did not affect the rising inflation during the expansion. On an annual basis during 1972, the CPI increased by 3.4 percent from December 1971 to December 1972. And during 1973, the CPI increased by 8.8 percent from December 1972 to December 1973. The spike of 1.8 percent increase in August 1973 came at the end of a sixty-day freeze on food prices that had been imposed as part of the price control program in mid-June, at which time food processors and distributors were allowed a dollar-for-dollar pass-through of the higher farm prices. Overall, the acceleration in inflation from 3.4 percent in 1972 to 8.8 percent in 1973 reflects the following:14 s )NCREASEDECONOMICGROWTHSTIMULATINGDEMANDANDHIGHERLABORAND other production costs s (IGHERALLOWABLEPRICESANDDIMINISHEDENFORCEMENTOFTHEPRICECONTROLS noted in the early part of the chapter s 2ISINGIMPORTPRICESASSOCIATEDWITHTHEDECLINETHATRESULTEDFROMTHE shift to floating foreign exchange rates noted in the early part of the chapter s )NCREASEINFOODPRICESSTEMMINGFROMGREATEREXPORTSOFFOODANDFEED grains, due to sharp drops in farm output abroad that began in 1972, particularly in the Soviet Union, but also occurring in other countries due to adverse weather conditions; shortages of many basic materials that are used in further production appeared in 1973.

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Figure 7.3

Consumer Prices in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics. The data are not seasonally adjusted. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the July to December 1973 data are similar to the later data for those months that first became available in January 1974.

The sharp acceleration of inflation in 1973 arose from a variety of factors. Because it was a complex interaction of the factors that led to the acceleration, it is difficult to assign a relative importance to any particular one. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 7.4 shows the monthly percentage change in the IPI from January 1972 to December 1973 on a real-time basis. In 1972, the IPI increased at rates of 0.6 to 1.2 percent in eight months, 1.4 percent in one month, and 0.2 to 0.4 percent in three months. In 1973, the IPI increased by 0.6 and 0.7 percent in seven months, 0.9 percent in one month, 0.2 and 0.3 percent in two months, and declined (below the zero line) by 0.2 percent in August and 0.5 percent in December (the second recession month).

THE RECESSION OF 1973–75

Figure 7.4

181

Industrial Production Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the July to December 1973 data are similar to the later data for those months that first became available in January 1974, except that the increases of 0.7 and 0.6 percent in September and October were revised to 0.3 and 0.2 percent.

Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capacity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries from 1971 to 1973 was as follows: 1971 1972 1973

77.9% 83.3% 87.6%

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The CUR in manufacturing rose from 77.9 percent in 1971 to 83.3 percent in 1972 to 87.6 percent in 1973. The 87.6 percent rate in 1973 is generally considered to be above maximum efficiency rates, which leads manufacturers to bring older, less productive, and less reliable equipment into production. This supports the notion that with the demand for manufactured products being so strong and manufacturing efficiency declining, production costs rose, which in turn led businesses to increase prices. The IPI increased strongly in both 1972 and in 1973, though at lower rates in 1973. The relatively high rate of the CUR in 1973 reflected the strong growth in the IPI. The rising production costs stemming from the high CUR in 1973 contributed to the acceleration in inflation in 1973 noted in the previous section. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 7.5 shows the monthly percentage change in housing starts on a real-time basis from January 1972 to December 1973. In 1972, housing starts increased in six months, one month by 8 percent, two months by 4 and 5 percent, two months by 1 and 2 percent, and one month by 0.1 percent. Housing starts declined (below the zero line) in six months, one month by 9 percent, one month by 5 percent, three months by 1 to 3 percent, and one month by 0.1 percent. In 1973, housing starts increased in five months, one month by 14 percent, one month by 8 percent, and three months by 4 to 5 percent. Housing starts declined in seven months, two months by 12 and 15 percent, three months by 6 to 8 percent, one month by 2 percent, and in December (a second recession month) by 20 percent. Housing starts would have been higher in 1972 and 1973 but for the decline in federal government support (rent supplements and mortgage interest subsidies) for new private housing construction in both years.15 In 1972, federally subsidized housing accounted for 340,000 housing starts, compared with 430,000 units in 1971. This resulted in subsidized units accounting for 14 percent of total private housing starts in 1972, compared with about 25 percent in 1970 and 1971. In January 1973, new commitments in federal subsidy programs were suspended indefinitely, leading to a further drop in subsidized housing to 190,000 units in 1973. There were also new state and local government restrictions on housing construction in 1973, such as sewer

THE RECESSION OF 1973–75

Figure 7.5

183

Housing Starts in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the July to December 1973 data are similar to the later data for those months that first became available in January 1974.

moratoria, environmental impact statement requirements, and “no-growth” policies in some localities. Housing starts totaled 2.4 million units for the full year of 1972, up from the previous record of 2.1 million in 1971. Housing starts in 1973 totaled 2.0 million units, down from both 1972 and 1971. Housing starts were volatile in 1972 and 1973, with large shifts between monthly increases and decreases. There were an equal number of increases and declines in 1972, and more declines than increases in 1973, even allowing for the one-month decline in the recession month of December. Housing starts in both years also were probably lessened because of the decline in federal government construction subsidies and rising state and local government restrictions on new housing construction.

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Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. This is the first recession for which earnings data cover the total of all nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 7.6 shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from January 1972 to December 1973. In 1972, worker earnings increased in one month by 1.4 percent, in two months by 1.1 percent, in three months by 0.6 to 0.8 percent, and in three months by 0.3 percent; in one month, earnings were unchanged, and in two months earnings declined (below the zero line) 0.8 and 0.3 percent. In 1973, worker earnings increased in four months by 1.0 to 1.1 percent, in three months by 0.5 percent, in three months by 0.2 to 0.3 percent; in two months they saw zero change. While the demand for workers was strong in 1973 and many union contracts had expired or were subject to reopening, there were no major strikes, and working time lost in work stoppages appeared to be less than in 1972, though 1972 had fewer contracts subject to new bargaining.16 Wage increases in the labor-management union contracts negotiated in 1973 were smaller than those in the preceding three years. At the same time, worker earnings in 1973 were bolstered by an increasing number of workers under labor-management wage contracts covered by costof-living allowances (COLAs), which compensated wage dollar earnings that were depreciated by rising inflation. The COLAs reflected price increases in the consumer price index, which increased sharply in 1973, as noted in the earlier section on Inflation and Deflation. The number of workers covered by these COLAs rose from 2 million in the mid-1960s to 2.8 million in 1970 and to more than 4 million in 1973. Also, some wage contracts liberalized the COLA formulas for calculating inflation. All of these led to larger earnings increases in 1973 than in 1972. Worker earnings were less volatile in 1973 than in 1972. There were no months of decline in worker earnings in 1973, in contrast to two months of decline in 1972. While the wage increases in union contracts negotiated in 1973 were smaller than those in the preceding three years, worker earnings in 1973 were lifted by the increasing number of workers covered by COLAs and by the rising inflation in 1973. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free

THE RECESSION OF 1973–75

Figure 7.6

185

Job Earnings in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all private nonfarm industries. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). Data from January 1972 to June 1973 represent data available as of July 1973. Data from July to December 1973 represent data when they first became available one month after each data month. The monthly patterns of the July to December 1973 data are similar to the later data for those months that first became available in January 1974.

outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.17 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 7.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from January 1972 to December 1973. In 1972, interest rates rose from 5.1 percent in January to 6.0 percent in December. There were

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Figure 7.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

two monthly downward interruptions, one in May and one in November. In 1973, interest rates accelerated the rise from 1972, peaking at 7.9 percent in August. They fell to 6.8 percent in October, and after rising to 7.0 percent in November, ended at the October rate of 6.8 percent in December. Figure 7.7b shows the monthly federal funds interest rate from January 1972 to December 1973. In 1972, federal funds rose from 3.4 percent in January to 5.3 percent December. In 1973, federal funds accelerated the rise from 1972, peaking at 10.8 percent in September, and fell to 9.5 percent in December. The general rise in interest rates during 1972 and 1973 reflected the same three factors as noted in Chapter 6 preceding the 1969–70 recession: s #ONTINUINGDEMANDFORCREDITINTHEEXPANDINGECONOMY BOTHINTHE household and business sectors s (IGHANDRISINGINmATION WHICHCAUSEDLENDERSTORAISEINTERESTRATES in order to maintain the purchasing power of the loans when they were repaid s &EDERAL2ESERVEPOLICYOFCOMBATINGINmATIONBYRESTRAININGBANKREserves for extending credit to borrowers, resulting in higher interest rates that made the loans more costly to borrowers

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Figure 7.7b Federal Funds Interest Rate in Expansion Preceding the 1973–75 Recession, Plus Two Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only November and December 1973 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, April 1973 data became available in May 1973). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

Bank Loans There was a sharp drop in the increase of business loans extended by banks in the fourth quarter of 1973.18 The increase in bank loans to other broad categories of borrowers, real estate and consumers, also declined, but not nearly so sharply. Much of the sharp drop in business loans arose from two changes in the method of corporate financing, both of which appeared to reflect a search for lower interest rates. These were shifts to greater reliance on capital markets and commercial paper in place of bank loans for the fourthquarter financing because of the sharp decline in short-term interest rates in September and October. The backdrop for the monetary policy in 1972 was the context of the price and wage controls instituted on August 15, 1971, which as noted early in the chapter, were in response to the high rates of inflation and unemployment during the recovery from the 1969–70 recession. By 1972, as the previous Inflation and Deflation, and Unemployment, sections showed, the inflation rate had come down, but unemployment was still high at 5.8–5.9 percent from January to May 1972. But then unemployment began falling, and the Federal Reserve began its policy of monetary restraint.

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The Federal Reserve began 1972 by making credit more available for loans at commercial banks in order to stimulate economic growth. This policy continued into the spring of 1972. The policy changed late in the third quarter of 1972 as the economy had strengthened and unemployment fallen, at which time monetary policy aimed at tightening the increase in bank credit. The policy of increasing monetary restraint continued into 1973 because of concern that greater monetary accommodation would lead to increased inflation.19 This period is known for allegations that President Nixon interfered with the independence of the Federal Reserve by pressuring Arthur Burns, chairman of the Board of Governors of the Federal Reserve System, to stimulate the economy in 1971 and 1972 because of the upcoming presidential election in November 1972. Nixon and Burns knew each other from the 1950s, when Burns headed the Council of Economic Advisers under President Dwight Eisenhower and Nixon was vice president. When Nixon became president, he nominated Burns to head the Federal Reserve in 1969, and Burns took office in February 1970. The most direct evidence of the pressure is from recordings of the Nixon tapes, which include both telephone and White House conversations between Nixon and Burns.20 Though monetary policy was expansive in 1972, this could have reflected Burns’s intent independent of Nixon’s urgings. However, at one point the tapes suggest that Burns thought the economy would right itself without the stimulation. Whatever the effect of the pressure on monetary policy in 1971 and 1972, the lesson for today at the time of this writing in 2008 is that Congress in its oversight of the Federal Reserve should make every effort to prevent the politicization of the Federal Reserve by the president. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent real quarterly movements in consumer durable goods spending. The data are provided only quarterly, not monthly, like most of the other economic indicators used in the book. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 7.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending reported on a real-time basis from the first quarter of 1972 to the fourth quarter of 1973. Consumer durable goods spending was strong through 1972, with the rates of increase ranging from 11 to 15 percent in the four quarters, followed by a spending surge in the first quarter of 1973 to a 32 percent increase.

THE RECESSION OF 1973–75

Figure 7.8

189

Real Consumer Durable Goods Spending Preceding the 1973–75 Recession, Plus One Recession Quarter, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only the fourth quarter of 1973 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, January–March 1973 data became available in April 1973). Data from January–March 1972 to April–June 1973 represent data available as of August 1973. Data for July–September and October– December 1973 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September and October–December 1973 data are similar to the later data for those quarters that first became available in January 1974.

But spending weakened considerably in the last three quarters of 1973, declining (below the zero line) at 3 and 4 percent rates in the second and third quarters, and then at a 41 percent rate in the fourth quarter (the first recession quarter). Personal Income and Individual Income and Social Security Taxes Some of these spending patterns were affected by changes in fiscal policy under the New Economic Policy announced on August 15, 1971, that were noted in the early part of the chapter under Fiscal Policy. I repeat them here: job development tax credit for businesses; accelerating the timing of tax cuts that had been previously legislated; repeal of a 7 percent excise tax on automobiles; and a new Domestic International Sales Corporation that would encourage U.S. manufacturers, through a deferral of their income taxes, to

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produce goods for export at home rather than abroad. In the other direction, fiscal policy included cutbacks in federal government employment and a deferral of six months for a scheduled federal employee pay increase. In addition, subsequent tax changes reduced individual income taxes through increases in personal exemptions and the standard deduction, both of which raised personal incomes available for spending.21 Other legislated changes increased Social Security benefit payments and Social Security taxes, which though moving in opposite directions, led to a net increase in personal incomes.22 The overall effect of these changes in individual income taxes and Social Security taxes and benefit payments reduced total federal budget revenues, though the reduction was partially offset by rising tax payments arising from increased economic growth and incomes. To complete the story on personal incomes, a timing wrinkle occurred affecting the collection of individual income taxes in 1972 that necessitated tax rebates in 1973. Because an earlier problem in the withholding tax table in 1971 caused withheld taxes to be less than the tax liabilities in that year, the new withholding tax tables for 1972 corrected this deficiency. However, under the new schedules, taxpayers had to claim additional exemptions if they were to avoid over-withholding, which for the most part they did not do. Therefore, individual income taxes were over-withheld in 1972, resulting in less personal income available for spending in that year. Despite the over-withholding of individual income taxes in 1972, consumer durables spending increased much more in 1972 than in 1973, as seen in Figure 7.8. Thus, increased spending by households in 1972 could have stemmed both from a lower saving rate as well as from the increase in personal income.23 Spending for furniture and household appliances increased much more in 1972 than in 1971, which could be related to the large annual increase in housing starts (see previous section on housing starts) and replacements of home appliances. Sales of new domestic cars totaled 9.3 million units in 1972, up from 8.7 million units in 1971. Sales of foreign cars totaled 1.5 million units in 1972, about the same as in 1971. In 1973, taxpayers received rebates to compensate for the over-withholding in 1972, and the legislated rise in Social Security benefits began to be paid late in 1972, thus boosting personal incomes available for spending in 1973.24 Increases in consumer durables peaked in the first quarter and then were at much lower levels in the remaining quarters. This pattern has been attributed to the introduction of Phase III of the price and wage control program in January 1973 (noted early in the chapter), which relaxed the control standards on allowable price increases and decreases as well as their enforcement. In turn, households perceived that prices would rise in the future, which gave them

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the incentive to concentrate more of their planned purchases for the year in the first quarter, instead of buying them later in the year when prices would be higher. Other developments in 1973 also probably contributed to the slowdown in consumer durables spending in the last three quarters of the year. One was the introduction of new mandatory pollution and safety features in the 1974 model cars, which households seemed to believe would make them more expensive, thus leading to a surge in buying the 1973 models. Another was the outbreak of the Arab oil embargo in October 1973, which brought with it higher gasoline prices and long lines at gas stations in the first recession quarter. The weakening in consumer durable goods spending in the last three quarters of 1973 stemmed from several factors: s !NTICIPATEDPRICEINCREASESFOLLOWINGTHEINTRODUCTIONOFTHE0HASE))) price and wage controls in January 1973, which probably shifted some spending from the last three quarters to the first quarter s %XPECTATIONTHATTHENEWMANDATORYPOLLUTIONANDSAFETYFEATURESONTHE 1974 car models would raise the prices of the 1974 cars; this expectation also accelerated spending to the first quarter s !RABOILEMBARGOTHATBEGANIN/CTOBERAFFECTEDSPENDINGINTHE fourth quarter (the first quarter of the recession) At the same time, consumer durables spending was strengthened in the last three quarters of 1973 by increases in household incomes. Personal income was bolstered by the tax rebates that compensated for the over-withholding of 1972 individual income taxes, and by the new larger Social Security benefit payments. But the Phase III controls, the new pollution and safety features on cars, and the Arab oil embargo apparently overrode these props to personal income. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change, and thus represent real quarterly movements in the GNP. The data are provided quarterly, not monthly like most of the other economic indicators used in the book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 7.9 shows the quarterly percentage change at an annual rate in the real GNP on a real-time basis from the first quarter of 1972 to the fourth quarter of 1973. The growth rate rose from an increase of 4.8 percent in the

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Figure 7.9

Real Gross National Product in Expansion Preceding the 1973–75 Recession, Plus One Recession Quarter, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1973–75 recession began in November 1973 and ended in March 1975, so only the fourth quarter of 1973 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, January–March 1973 became available in April 1973). Data from January–March 1972 to April–June 1973 represent data available as of August 1973. Data for July–September and October–December 1973 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September and October–December 1973 data are similar to the later data for those quarters that first became available in January 1974.

first quarter of 1972, to an exceptional 9.5 percent in the second quarter, followed by increases ranging from 5.8 percent to 8.6 percent in the next three quarters. Following the 8.6 percent increase in the first quarter of 1973, GNP growth fell sharply to increases of 2.4 and 3.5 percent in the second and third quarters of 1973, and fell further to a 1.2 percent increase in the fourth quarter, reflecting the Arab oil embargo (the first quarter of the recession). GNP growth weakened in the last three quarters of 1973, falling much below the strong growth of 1972 and the first quarter of 1973. Part of the sharp deceleration in GNP growth in the last three quarters of 1973 stemmed from the exceptionally high growth rates of 1972 to the first quarter of 1973, which were not sustainable over an extended period; temporary shortages of certain basic materials that were used in further production; and the disruption caused by the Arab oil embargo beginning in October 1973 that intensified the fourth-quarter fall (the first quarter of the recession). But these were greatly exacerbated by

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the softening of both housing starts and consumer durables spending, which I believe were the underlying forces driving the deceleration. Assessment of Economic Policies Preceding the 1973–75 Recession The recession of 1973–75 began toward the last stages of the price and wage controls that had been instituted on August 15, 1971, and that ended in April 1974, excluding the continuation of controls on petroleum prices. The controls had been progressively relaxed both in the standards for allowable price and wage increases and in their enforcement. The controls were imposed in the context of the sluggish recovery from the 1969–70 recession that ended in November 1970. While unemployment remained high, and inflation had come down, there was a concern that inflation would reignite, as inflation had accelerated in the second quarter of 1971. The Vietnam War was ongoing, though the number of U.S. armed forces in Vietnam had declined from the peak levels of 536,000 in 1968 to 157,000 in 1971.25 In addition, the first step in the transition to floating foreign exchange rates in determining the value of the dollar occurred on August 15, 1971. This was the suspension of the convertibility of dollars or other international reserve assets held by foreign monetary institutions into gold. Floating dollar rates ultimately replaced the fixed foreign exchange dollar rates based on the gold content of the dollar in 1973. The fixed gold-based dollar rates, which had been formalized toward the end of World War II, were considered to be outdated, because of the economic recovery of European nations and Japan from the devastation of World War II in both international trade and capital markets. The price and wage controls were intended to be temporary. My understanding of the basis for the controls was that the inflation was not thought to be caused by excessive demand in the economy. Shortages emanating from the Vietnam War were not apparent. Had they existed, they could have driven up inflation. If excessive demand had existed, it could have led households and businesses to bid up prices for products that were in short supply. But demand was slack, as evidenced by the high unemployment. I conclude that the premise of the controls was to break the psychology of inflationary expectations, which was the mindset of businesses and workers, because the recent past showed no letup in inflation. This reflected the expectation that the price/wage spiral would continue indefinitely, with higher prices leading to higher wages so workers could catch up with the loss in purchasing power of their earnings, and with the higher wages leading to higher prices so businesses could offset the increase in labor production costs.

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The controls were intended to hold down inflation while the Federal Reserve stimulated economic growth and employment through an expansionary monetary policy. Such stimulation would continue until economic growth brought unemployment down to levels that were considered to be noninflationary, in light of the acceleration of inflation in the second quarter of 1971. Four main weak areas of the economy emerged in 1973: s !CCELERATINGINmATION FROMPERCENTINTOPERCENTIN s &ALLINGHOUSINGSTARTS FROMMILLIONUNITSINTOMILLIONUNITS in 1973 s .EGATIVEGROWTHINCONSUMERDURABLEGOODSSPENDING nANDnPERCENT in the second and third quarters, and –41 percent in the fourth quarter (the first quarter of the recession) s 3HARPDECELERATIONIN'.0GROWTHINTHELASTTHREEQUARTERSOF OF which the driving forces were the softening of housing start construction and consumer durable goods spending The price and wage controls worked fairly well in 1972 in containing inflation, while the economy grew strongly and unemployment fell. However, President Nixon was wrong to move from the Phase II controls of 1972 to the Phase III controls of 1973, because Phase III relaxed the standards of allowable price and wages and weakened the enforcement of the standards, which undermined the anti-inflation effort. In turn, with inflation rising sharply in 1973, the Federal Reserve continued tightening the availability of bank loans, which it had begun late in the third quarter of 1972. Thus, because inflation had erupted again, the idea that the containment of inflation would allow the Federal Reserve to stimulate the economy was irrelevant. The result was that the Federal Reserve resorted to containing inflation by restraining economic growth through its restrictive monetary policies. This led to higher unemployment and the 1973–75 recession. Notes 1. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1972, p. 65. 2. Curiously, the term New Economic Policy, used by President Nixon, is the same term that Nikolai Lenin used in instituting a temporary return to capitalism in the Soviet Union early in the 1920s. I believe President Nixon should have used a different term. 3. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1973, pp. 54–55. 4. Ibid., p. 153.

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5. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1974, pp. 88–91. 6. “Annual Report of the Council of Economic Advisers,” January 1972, pp. 69–71. 7. Arthur I. Bloomfield, “Gold Standard,” Encyclopedia of Economics, Douglas Greenwald, editor in chief (New York: McGraw-Hill, 1982), p. 454. 8. “Annual Report of the Council of Economic Advisers,” January 1972, p. 161. 9. Bernard S. Katz, “Smithsonian Agreement,” Encyclopedia of Economics, pp. 863–65. 10. Walter E. Hoadley, “International Economics, an Overview,” Encyclopedia of Economics, p. 550. 11. Board of Governors of the Federal Reserve System, The Federal Reserve System: Purposes and Functions, 9th ed. (Washington, DC: June 2005), p. 53. 12. “The U.S. Economy in 1972,” Survey of Current Business, January 1973, p. 14. 13. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, February 1974, pp. 58–60. 14. Ibid., pp. 65–70; and “The U.S. Economy in 1973,” Federal Reserve Bulletin, January 1974, pp. 12–13. 15. “The U.S. Economy in 1972,” January 1973, p. 19; and “The U.S. Economy in 1973,” January 1974, p. 23. 16. “The U.S. Economy in 1973,” January 1974, p. 13. 17. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 18. “Financial Developments in the Fourth Quarter of 1973,” Federal Reserve Bulletin, February 1974, pp. 73–74. 19. “The U.S. Economy in 1972,” January 1973, p. 28; “The U.S. Economy in 1973,” January 1974, p. 16; “Annual Report of the Council of Economic Advisers,” January 1973, pp. 45–46; and “Annual Report of the Council of Economic Advisers,” February 1974, pp. 83–85. 20. Burton A. Abrams, “How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes,” Journal of Economic Perspectives (Fall 2006), pp. 177–188. 21. “Annual Report of the Council of Economic Advisers,” January 1973, pp. 42–44. 22. “Annual Report of the Council of Economic Advisers,” January 1974, p. 53. 23. “The U.S. Economy in 1972, January 1973, pp. 17–18. 24. “The U.S. Economy in 1973,” January 1974, p. 20. 25. The American War Library (http://americanwarlibrary.com/Vietnam/vwatl.htm).

8 The Recession of 1980

The recession of 1980 began in January 1980 and ended in July 1980. Three major developments affected the economic environment in 1978 and 1979, the years just prior to the recession: s -ARKEDSLOWDOWNINPRODUCTIVITYINCREASESDURINGTHES s 4HE)RANIAN2EVOLUTIONOF WHICHRESULTEDINMUCHHIGHERGASOLINE and other oil prices s $ECLINEINTHEVALUEOFTHEDOLLAR WHICHRAISEDTHEPRICESOFIMPORTS All three developments not only exacerbated the problem of inflation in the lead-up to the 1980 recession, but hampered attempts to stimulate economic growth and employment. The economy, plagued by inflation, had not yet come close to full employment since the end of the last recession in 1973–75 (Chapter 7). Productivity Slowdown Productivity represents the efficiency of producing the nation’s goods and services. It reflects the quantity of goods and services produced in relation to the quantity of resources used in their production. Productivity increases from one period to the next, say quarter-to-quarter or year-to-year, if the quantity of goods and services produced increases more (or declines less) than the corresponding movements of resources used in their production. Analogously, productivity falls from one period to the next if the quantity of goods and services produced decreases more (or increases less) than the corresponding movements of resources used in their production. Algebraically, this appears as: Productivity =

196

Output = _________ Input

Goods and services produced ______________________________ Resources used in their production

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The resources used in production are the quantity and skills of workers; quantity and technological level of capital equipment; quality of raw materials, semi-finished products, component parts, and services that are processed into end-use goods and services; managerial know-how and executive direction; public infrastructure including roads, airports, and sewers; and many other factors. Labor productivity in the business sector of the economy increased on average by 3.3 percent per year from 1948 to 1973. The annual increase then fell 1.3 percent from 1973 to 1979, the years relevant to the 1980 recession. Partial explanations for the sharp drop in labor productivity increases in the 1970s include: lower technological advances due to lower research and development spending, higher energy costs that led businesses to substitute labor for high-energy-consuming machinery, and more hours paid for than hours worked because of increases in paid vacations and sick leave. However, statistical estimates of these and other possible reasons for the slowdown account for only about 20 percent of the fall.1 Coincidently, or not so coincidently, productivity slowdowns occurred in virtually all industrial countries in the 1970s, but the causes of the slowdown are not well understood. Inflation is linked to the productivity slowdown by the much greater increase in wage and salary costs than in productivity during the 1970s. Higher-than-usual production costs ensued, which in part led businesses to increase the prices of their goods and services in an effort to maintain their profit margins. Iranian Revolution The Iranian Revolution of 1979 led to a second escalation in the price of petroleum products during the 1970s, the first being the Arab oil embargo in 1973. Control over a significant share of world oil production by the Organization of Petroleum Exporting Countries (OPEC), led to the use of the cartel’s powers to raise crude oil prices, which resulted in a sharp jump in gasoline prices. For example, the nationwide price of unleaded regular gasoline was 66.3 cents per gallon in June 1978, 90.1 cents per gallon in June 1979, and $1.269/10 in June 1980. While oil products are most visible in their direct use in transportation and heating, they are also used in electric power generation, as well as in components of petrochemical and other products. Thus, the policies emanating from the Iranian Revolution gave a second jolt to inflation in the 1970s in the lead-up to the 1980 recession.

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Decline in the Foreign Exchange Value of the Dollar Between the implementation of the floating foreign exchange value of the dollar in 1973 (Chapter 7) and the spring of 1976, the dollar had several phases of appreciation.2 These fluctuations ended from the spring of 1976 to the fall of 1977, during which time the dollar stabilized. Then a marked deterioration in the value of the dollar began that led to a decline in the dollar of 21 percent from September 1977 to October 1978. The Federal Reserve and the U.S. Department of the Treasury considered this decline to be excessive, in light of the differential growth rates of the United States and major foreign economies and the rising U.S. inflation. The two agencies then acted to reverse the decline by raising interest rates in the United States and intervening in international currency markets, and by February 1979, the dollar had appreciated by 7 percent from the October 1978 low. The decline in the value of the dollar is estimated to have raised the level of consumer prices in the United States by 1 percent by the end of 1978.3 The study that made that estimate also stated that if the depreciation were sustained, the eventual full impact could raise prices by 2 to 3 percent above what they otherwise would have been. The decline in the dollar intensified inflation because it increased the prices of goods imported into the United States. Of course, the counterpart of the dollar’s fall was that it increased exports of U.S. goods, as U.S. goods became more competitive abroad because of their lower price in foreign countries. But the economic policy emphasis at the time was on containing inflation, not in stimulating exports. Two other general aspects that are of interest in this period appear below. Private and Government Forecasts of a Recession in 1979 or 1980 In the periods preceding the recessions covered in the earlier chapters, neither private nor government forecasts foresaw a pending recession. I base this conclusion on my review of reports in BusinessWeek, and in the Federal Reserve Bulletin and of testimony that Federal Reserve governors gave to the Congress, by the president in the annual Economic Report of the President, and in the Annual Report of the Council of Economic Advisers. There may have been occasional private forecasts of a recession, but the overriding thrust of the forecasts was of continuing economic expansion. This changed in the period before the 1980 recession. Private forecasts of recession occurring in 1979 and 1980 were common.4 And President Jimmy Carter’s Council of Economic Advisers published a forecast a recession for

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1980.5 This was the first time in the post–World War II period that a presidential agency made public a forecast of a recession. Voluntary Price and Wage Standards In order to contain and reverse the accelerating inflation over the following twelve months, President Jimmy Carter, on October 24, 1978, announced the establishment of voluntary price and wage standards for allowable price and wage increases.6 The Council on Wage and Price Stability (CWPS) administered the overall program. The general perception of a voluntary program is that it is not backed by legal penalties, though for companies selling directly to households, adverse publicity could be more damaging than a substantial fine.7 Also, though the program was voluntary, the federal government could avoid purchasing from noncompliant firms where feasible. The price and pay standards covered the entire economy, except for its limited application to food, energy, and housing prices. The nature of those parts of the economy makes it difficult to apply price limitations on them. In the first year of the program, the price standard offered companies a choice of following either a price deceleration standard or a profit margin standard, which allowed prices to increase based on profit margins of the average of the best two of three previous fiscal years. The pay standard allowed for wage increases that assumed an inflation rate of 6 percent in calculating cost-of-living adjustments. In the second year of the program, beginning on November 1, 1979, recommendations to the CWPS for changes to the price and wage standards and their interpretations were provided by a newly created Price Advisory Committee and a Pay Advisory Committee. The Price Committee was composed of six public members appointed by the president. The Pay Committee was composed of eighteen members—six from labor, six from management, and six from the public. Companies were expected to limit their price increases according to various formulas based on price increases or profit margin for the years 1976 and 1977. The allowable price and wage increases, as well as the company reporting requirements to the CWPS, were considerably relaxed in 1979, the second and last year of the program. The CWPS estimated that from 1978 (fourth quarter) to 1980 (third quarter), the standards program had the immediate direct effect of lowering wage inflation by 1.2 percentage points and of lowering price inflation by 1.5 percentage points.8 The smaller reduction in wage inflation is said to result from the difference between the immediate direct effect and the full effect of

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the deceleration. In the immediate effect, businesses quickly passed through the reduced wage inflation to less price inflation in the goods and services they produced, while in the full effect, the impact of the reduced price inflation on wage increases was spread out over a longer period. Economic Indicators in Real Time During 1978–79 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1980 recession in January 1980 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of the chapter is an assessment of the economic policies preceding the 1980 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are of course complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for consumer durable goods spending and the gross national product, which are available only quarterly. Monthly data on personal consumption expenditures were first published in 1979, but I used the quarterly data for consumer durable goods spending because real-time monthly data for personal consumer spending were not readily available. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1980 recession is dated as beginning in January 1980. So January to June 1980 in the figures that follow were the first six months of the recession. To assess what was available to policy makers as 1978 and 1979 progressed, the figures chart the real-time data from July 1978 to June 1980.

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The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in September 1979. Because economic data became available one month after the month to which they refer, the August 1979 data first appeared in September 1979. Thus, the August starting point provides the most reliable data, including revisions up to that time, from July 1978 to August 1979. The data from September 1979 to June 1980 reflect the real-time data on a monthly and quarterly basis from October 1979 to June 1980, as they were produced. Revisions that occurred to the September 1979–June 1980 data as of July 1980 changed the monthly and quarterly patterns at most slightly. I chose August 1979 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in September, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in January 1980. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1978–79, in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 8.1 shows the monthly percentage change in jobs from July 1978 to June 1980 on a real-time basis. From July 1978 to August 1979, employment increased by 0.3 percent and 0.5 percent monthly in eight months and by 0.1 percent in two months, with zero change in four months. From September 1979 to February 1980, employment increased monthly by 0.2 percent and 0.3 percent, with one month increasing by 0.4 percent. And from March to June 1980, employment declined (below the zero line) by 0.2 to 0.6 percent per month. During the July 1978–August 1979 period, most months showed relatively high rates of employment increase, while several months showed small increases and zero change in employment. Overall, July 1978–August 1979 showed continual relatively high increases, along with marked interruptions of weak and zero growth. Also, the size of the increases during July 1978–August 1979 was typically greater than those during September 1979–February 1980.

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Figure 8.1

Jobs in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first became available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980, with the following exceptions: December 1979, which increased by 0.1 percent, in place of the 0.4 percent increase; March 1980, which showed zero change, in place of a 0.2 percent decline (below the zero line); April 1960, a decline of 0.2 percent in place of a 0.5 percent decline; and May 1960, a decline of 0.4 percent in place of a 0.2 percent decline.

Sharp declines in employment occurred in the recession months of March– June 1980. Job growth was relatively strong in the eighteen months preceding the 1980 recession, though with periods of low and zero growth. The rate of increase in job growth declined as the economic expansion came closer to what turned out to be the recession. Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment.

THE RECESSION OF 1980

Figure 8.2

203

Unemployment Rate in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first became available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980.

Figure 8.2 shows the unemployment rate on a real-time basis from July 1978 to June 1980. Unemployment declined from 6.1 percent in July 1978 to 5.9 percent in August and September, and fluctuated within 5.7 to 5.8 percent from October 1978 to July 1979. Unemployment was slightly higher from August 1979 to March 1980, ranging from 5.8 to 6.2 percent. It then jumped to 7 percent in April 1980 and 7.7 and 7.8 percent in May and June. Actual unemployment ranged from 5.8 million to 8 million workers between July 1978 and June 1980. Thus, a one-percentage-point change in the unemployment rate affected 58,000 to 80,000 workers. While employment growth was strong from July 1978 to February 1980 (see Figure 8.1 above), unemployment remained slightly below 6 percent during the period. Thus, unemployment did not drop toward the “full employment” level of 4 percent, which would have been expected from the counterpart employment growth. For a discussion of full employment, see Chapter 6 under Definition of Full Employment. Much of the relative stability in the unemployment rate resulted from the

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rising number of women entering the labor force in search of employment. This was part of the major cultural shift in which women in all age categories increasingly sought paid employment. One aspect of this was a broadening number of occupations that previously had not been open to women.9 In addition, teens entered the labor force in larger numbers during this period. Because women during this period had higher unemployment rates than men, and teens always have higher unemployment rates than adults, these demographic shifts of increasing numbers of women and teens in the labor force contributed to the relative stability of the unemployment rate. Also, the unemployment rate among experienced workers was higher in 1978–79 than in previous periods of tight labor markets. For example, unemployment rates for experienced workers in 1978–79 were 0.5 to 1.5 percentage points above those that prevailed in previous tight labor markets, such as in 1965, 1969, and 1973. These differences suggest less scarcity of experienced workers in 1978–79 than in 1972–73, as indicated by labor turnover measures in quit rates and new hires in the two periods. Both quit rates and new hires ordinarily rise in periods of strong job growth, indicative of the willingness of workers to change jobs as employers raise wages in their attempt to attract experienced workers away from their present jobs. The unemployment rate was relatively constant in 1978–79. This differed from previous periods of strong employment growth and tight labor markets, in which unemployment declined noticeably. Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by all urban households, including workers in all urban occupations, the unemployed, and retired persons. For a discussion of inflation and deflation and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 8.3 shows the monthly percentage change in the CPI from July 1978 to June 1980 on a real-time basis. The CPI increased monthly by 0.6 to 0.9 percent from July 1978 to January 1979. After increasing by 1.2 percent in February 1979, the CPI increased by 1.0–1.1 percent monthly from March 1979 to November 1979, and then by 1.2 percent in December. A further acceleration to 1.4 percent occurred during January–March 1980, followed by lower increases of 0.9 to 1.0 percent during April–June 1980. This was an extraordinarily high rate of inflation. Table 8.1 summarizes the inflation rate in six-month periods at annual rates over the eighteen months preceding the onset of the recession in January 1980, plus the six months of

THE RECESSION OF 1980

Figure 8.3

205

Consumer Prices in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. Note: The 1980 recession began in January 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first became available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980. Table 8.1 Consumer Price Index in Real Time Six-Month Periods

Annualized Percentage Change

June 1978 to December 1978 December 1978 to June 1979 June 1979 to December 1979 December 1979 to June 1980

7.9 14.7 12.7 16.0

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on not-seasonally-adjusted data.

recession during January–June 1980. The lowest annualized increase in the CPI over the six-month periods was 7.9 percent, from June 1978 to December 1978. The CPI increased at annual rates of 12.7 percent to 16.0 percent in the subsequent six-month periods. 7HATCAUSEDTHISOUTSIZEDINCREASEININmATION&IRST ITDOESNOTAPPEAR that overall demand in the economy exceeded the capability of the economy

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to supply the goods and services demanded. There were no broad-based shortages of goods and services that would have led households to bid up prices because of excessive demand. The exception to this was the sharp increase in meat prices due to shortages of beef products, which was caused by the low production of beef products. At the most aggregate level, the absence of overall shortages in the economy stemming from excessive demand is evident in the relatively high unemployment rates noted in the above Unemployment section. Therefore, I believe that the inflation had its root causes in the three developments noted in the beginning of the chapter: s Marked slowdown in productivity increases during the 1970s. This precluded productivity from serving its usual role of lessening increased labor costs to businesses. The greater costs included increased wages and fringe benefits in worker compensation, increased Social Security payroll taxes and Unemployment Insurance payments by employers, and higher federally mandated minimum wages. These greater production costs led businesses to raise their prices in order to maintain profit margins. s Iranian Revolution in 1979, which resulted in much higher prices of gasoline and other oil products. The oil product price increases spread to transportation, home heating, and production of certain goods that use oil as a component of materials and energy consumed in these activities, much beyond their direct impact. This resulted in the initial higher oil prices becoming increasingly embedded in the prices of a wide array of products: agricultural and manufactured goods, passenger and freight transportation costs, heating of houses, and energy production that depends on oil as fuel in generating electric power. s Decline in the value of the dollar that raised prices of imports. The higher prices of imported goods into the United States increased inflation to American households. Inflationary expectations converted these root causes of inflation to a continuing upward spiral in prices. The expectations of households, businesses, and workers that prices would continue rising rapidly became a self-fulfilling prophecy in propelling inflation, as the three agents acted to protect themselves against future price increases eroding their real incomes. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production.

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207

Figure 8.4 shows the monthly percentage change in the IPI from July 1978 to June 1980 on a real-time basis. From July to December 1978, the IPI increased by 0.6 to 0.7 percent monthly, except for one month at 0.8 percent and one month at 0.4 percent. From January 1989 to November 1979, the IPI showed an increase of 1.1 percent in one month, increases of 0.7 percent and 0.5 percent in two months, an increase of 0.3 percent in one month, increases of 0.1 percent in two months, zero change in one month, and declines (below the zero line) in four months. The IPI increased by 0.2 to 0.3 percent per month between December 1979 and February 1980, and declined (below the zero line) by 0.8 to 2.4 percent from March to June 1980. After high monthly growth from July to December 1978, the monthly IPI movements were both volatile and weaker. From January to November 1979, the monthly pace of production slowed, with small increases (including one month of zero change) and declines predominating. There were high increases in only three of the eleven months during this period. After stabilizing at the lower increases between December 1979 and February 1980, sharp declines in production were evident during the recession months of March to June 1980. The cyclical industries that comprise the IPI showed a diminished rate of growth, including monthly declines, in the twelve months preceding the onset of the recession in January 1980. Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing a shortage or an excess of industrial capacity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries from 1977 to 1979 was as follows: 1977 1978 1979

82.4% 84.3% 84.2%

The rise in the CUR from 82.4 percent in 1977 to 84.2–84.3 percent in 1978–79 indicated that the economy was approaching a full utilization of manufacturing capacity. This rate did not necessitate bringing older, less efficient equipment into production. The CUR was at efficient operating rates that did not increase production costs, and therefore did not contribute to inflation.

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Figure 8.4

Industrial Production Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first became available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980, except for the recession months of January–June 1980, in which the later data available in July 1980 showed a sharper decline that the real-time data.

Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 8.5 shows the monthly percentage change in housing starts on a real-time basis from July 1978 to June 1980. From July to November 1978, housing starts increased monthly by 1.0 to 2.6 percent in three months, by 0.5 percent in one month, and declined (below the zero line) by 4.8 percent in one month. From December 1978 to April 1979, housing starts declined by 17.7 and 19.0 percent in two months and by 1.6 and 2.3 percent in two months, while increasing by 29.3 percent in one month. From May to December 1979, housing starts increased by 4.2 to 5.2 percent in three months and by 0.3 percent in one month, while declining by 13.8 percent in one month, by 6.9 and 7.9 percent in two months, and by 0.4 percent in one month. From

THE RECESSION OF 1980

Figure 8.5

209

Housing Starts in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first became available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980.

January to June 1980, housing starts declined by 21.8 percent in one month, by 11.5 percent in one month, by 6.3–6.4 percent in two months, and by 2.1 percent in one month. Housing starts increased by 30.4 percent in one month during this period. In the eighteen months preceding the onset of the recession in January 1980, housing starts increased and decreased equally in nine months each. The size of the decreases was also often substantial. Thus, there was no sustained growth in housing starts during the period. The sharp decline in housing starts in five of the six months of the January–June 1980 recession period was a clear weakness in new housing construction in the period preceding the onset of the recession. For annual totals of housing starts preceding the onset of the 1980 recession, I have chosen to use the latest housing data that were available at the time of this writing in 2008. Total privately owned housing starts from 1977 to 1979 were:

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1977 1978 1979

Total (000) 1,987.1 2,020.3 1,745.1

Annual change (000) — + 33.2 –275.2

After a slight increase of 33,000 from 1977 to 1978, housing starts fell by 275,000 from 1978 to 1979. 7HATCAUSEDTHESHARPDECLINEINHOUSINGSTARTSIN Severe weather led to the large drop in housing starts during January– February 1979.10 But beyond this short-term weather effect, the weak performance of housing starts in 1979 stemmed from rising interest rates and a general tightening of credit markets that affected (a) the construction of new housing, and (b) the ability of prospective home owners to afford new housing. Lenders charged builders higher rates for land development and construction credit, and were also more selective in financing particular projects. Potential builders and homeowners faced more stringent terms on mortgage loans, and in some localities, shortages of mortgage credit occurred because interest rates exceeded state usury ceilings. In addition, a run-up in single-family housing prices for a few years going into 1978 made it difficult for some first-time buyers to accumulate enough money to meet down payment requirements.11 This limited the infusion of prospective homebuyers into the housing market. And from the vantage of prospective homeowners, it prevented them from becoming homeowners. Housing starts moved from being a weak prop to the economy, to having a negative effect on the economy, in the eighteen months preceding the onset of the 1980 recession. Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 8.6 shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from July 1978 to December 1980. During the eighteen months preceding the onset of the 1980 recession, the patterns of monthly increases were: s ANDPERCENTˆMONTHS s nPERCENTˆMONTHS s nPERCENTˆMONTHS s ANDPERCENTˆMONTHS s -ONTHLYDECLINESBELOWTHEZEROLINE s ANDPERCENTˆMONTHS

THE RECESSION OF 1980

Figure 8.6

211

Job Earnings in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all private nonfarm industries. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). Data from July 1978 to August 1979 represent data available as of September 1979. Data from September 1979 to June 1980 represent data when they first become available one month after each data month. The monthly patterns of the September 1979 to June 1980 data are similar to the later data for those months that first became available in July 1980, except for September and October 1979, in which the real-time data and the July 1980 data differed between the individual months (0.9 and –0.1 percent real time and 0.4 and 0.3 percent in July), but the combined total for the two months showed little difference.

Worker earnings increased at high rates during the eighteen-month period, but because of sharply rising inflation, the purchasing power of worker earnings declined. This is apparent in the following comparison of dollar earnings both before and after adjustment for inflation. Based on the latest earnings data that were available at the time of this writing in 2008, annual percentage changes in worker earnings from 1977 to 1979 were:

1977 1978 1979

Current Dollars 6.9% 7.8 7.2

Inflation Adjusted Dollars 0.4% 0.0 –0.7

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The purchasing power of worker earnings was unchanged in 1978, and fell by 0.7 percent in 1979. Thus, to the extent that worker earnings included cost-of-living adjustments (COLAs), the COLAs just offset the rising inflation in 1978, but were insufficient in compensating for the rising inflation in 1979. Of course, workers whose wages did not include COLAs fared worse because of the inflation. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.12 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 8.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from July 1978 to June 1980. From July–October 1978 to January 1979, interest rates rose from 8.5 percent 9.5 percent. After slightly lower interest rates reaching 9 percent during June–August 1979, interest rose to a peak of 14 percent in March 1980, and then fell to 8.9 percent in June 1980. Figure 8.7b (page 214) shows the monthly federal funds interest rate from July 1978 to June 1980. Federal funds rose from 7.8 percent in July 1978 to hover around 10 percent between December 1978 and July 1979. Federal funds then rose to 14.1 percent in February 1980, jumped to peaks of 17.2 to 17.6 percent in March–April 1980, followed by drops to 11 percent in May and 9.5 percent in June 1980. On October 6, 1979, the Federal Reserve announced three actions that aimed at making monetary policy more restrictive as a way of combating inflation by slowing economic growth.13 These were:

THE RECESSION OF 1980

213

Figure 8.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

s 2AISINGTHEDISCOUNTRATEAT&EDERAL2ESERVE2EGIONAL"ANKSTOPERCENT on the request of the directors of the individual Banks. The discount rate is the interest rate charged to commercial banks when they borrow from their regional Federal Reserve Banks. s %STABLISHMENTOFAMARGINALRESERVEREQUIREMENTTHATREQUIRESCOMMERCIAL banks to put up an additional 8 percent reserve against their deposits to the extent that the banks extend such liabilities above a base amount. s !SHIFTINCONDUCTING&EDERAL2ESERVEDAY TO DAYOPENMARKETOPERATIONS by lessening the emphasis on short-term fluctuations on the federal funds rate, and giving more emphasis to supplying commercial bank reserves. The sharp rise in interest rates reached extraordinarily high levels in the eighteen months preceding the onset of the 1980 recession, and continued upward into the January–March/April 1980 recession months. The strong role of the Federal Reserve in driving the high interest rates is apparent in the federal funds rate being three percentage points higher than the U.S. Treasury three-year constant maturities rate in the early months of 1980.

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Figure 8.7b Federal Funds Interest Rate in Expansion Preceding the 1980 Recession, Plus Six Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1980 recession began in January 1980 and ended in July 1980, so only January to June 1980 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1978 data became available in October 1978). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

Bank Loans Beginning in June 1978, commercial banks became less accommodating in providing business and most other types of loans.14 This included tightening credit standards to qualify for a given interest rate spread above the prime rate. The more restrictive policy also included firmer compensating balance requirements on bank loans. A compensating balance is the money that a borrower must keep on deposit with a bank when taking out a loan, and which the borrower forfeits upon failure to repay the loan either in full or in part. The restrictive policy reversed the previous policy of a willingness to lend. Thus, because of a low demand for bank loans after the 1973–75 recession, banks had increased their liquidity in 1976, which also reduced their dependence on borrowed funds. In this environment, banks were more willing to extend loans, which, after all, is the way they make money. With the subsequent rising demand for loans, bank liquidity diminished, which also increased bank reliance on borrowed funds. It was this condition that brought on the new restrictive policy in June 1978.

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215

While banks became more selective in making loans under the restrictive policy, business loan demand into the third quarter of 1979 was strong for the short-term financing needs of the largest companies, notwithstanding the higher interest rates.15 Consumer installment credit expanded in the third quarter of 1979, though at lower rates than in 1978 and in the first half of 1979. This probably reflected the less accommodative lending policy of banks as well as a greater hesitancy to take on further debt in the economic uncertainty of the times. And in March 1980, three months into the recession, the Federal Reserve announced new credit restraints on households and on commercial banks.16 These were: s "ANKSWEREASKEDTOLIMITTHEINCREASEINLOANSTOBETWEENANDPERCENT in 1980. s #ONSUMERCREDITORS ISSUERSOFCREDITCARDSANDBANKS WEREREQUIREDTO deposit 15 percent of their increase in certain consumer loans into noninterest-bearing accounts held by Federal Reserve Banks and certain other federal financial agencies. Loans excluded from this restraint were automobile credit, purchase of household goods such as furniture and appliances, home improvement loans, and mortgage credit. s !THREE PERCENTAGE POINTSURCHARGEWASADDEDTOTHEDISCOUNTRATEFOR large banks that borrowed repeatedly at the discount window, and the marginal reserve requirement on managed liabilities (deposits that banks solicit from other banks or brokers to maintain adequate levels of liquidity) was raised from 8 to 10 percent. s 2ESTRAINTSWEREPLACEDONTHEAMOUNTOFCREDITRAISEDBYNONMEMBER banks of the Federal Reserve, and steps were taken to curb the expansion of assets of money market mutual funds. The Federal Reserve pursued a strong, active monetary restraint in the eighteen months preceding the onset of the recession and into the recession itself in its goal of lessening inflation by curbing economic growth. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent real quarterly movements in consumer durable goods spending. Unlike most of the other economic indicators used in the book, the data are provided only quarterly, not monthly. For more detail on the attributes of

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the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 8.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending reported on a real-time basis from the third quarter of 1978 to the second quarter of 1980. From the third quarter of 1978 to the second quarter of 1979, real consumer durable goods spending declined (below the zero line) in three of the four quarters. The increase occurred in the fourth quarter of 1978. In the two quarters of 1979 immediately preceding the onset of the recession in the first quarter of 1980, real consumer durables spending increased in the third quarter and declined in the fourth quarter. During the recession in 1980, real consumer durable goods spending declined in both the first and second quarters of 1980. A possible cause of the weakness in consumer durable goods spending was the record indebtedness and debt repayment burdens that led households to become more cautious in spending on durable goods.17 This was exacerbated by the sharp inflation in fuel, food, and other necessities, causing a squeeze on household budgets. Unlike these necessities, consumer durables last for several years, so in periods of financial strain, purchases of consumer durables are deferrable. Consumer durable goods spending is a highly cyclical component of the economy because cars, furniture, household appliances, and other durables are typically deferrable to a later time. Weakness of consumer durables spending and several declines in the six quarters preceding the onset of the 1980 recession reflected the hesitation that households had about taking on new financial commitments. This hesitation was intensified by the previously noted weakness in housing starts, which lessened the market for furniture and household appliances. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change and thus represent real quarterly movements in the GNP. The data are provided quarterly, not monthly like most of the other economic indicators used in the book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 8.9 (page 218) shows the quarterly percentage change at an annual rate in the real GNP on a real-time basis from the third quarter of 1978 to the second quarter of 1980. In the third and fourth quarters of 1978, the GNP increased by 3.5 and 5.6 percent. GNP growth slowed to an increase of 1.1 percent in the first quarter and a decline (below the zero line) of 2.3 percent in

THE RECESSION OF 1980

Figure 8.8

217

Real Consumer Durable Goods Spending in Expansion Preceding the 1980 Recession, Plus Two Recession Quarters, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis as part of the national income and product accounts. Note: The 1980 recession began in January 1980 and ended in July 1980, so only the first and second quarters of 1980 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, January–March 1979 data became available in April 1979). Data from July–September 1978 to April–June 1979 represent data available as of September 1979. Data from July–September 1979 to April–June 1980 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September 1979 to the January–March 1980 data are similar to the later data for those quarters that first became available in July 1980, except for October–December 1979 and January–March 1980, in which the real-time data and the July 1980 data differed between the two quarters (–2.3 and –1.0 percent real time and –0.6 and –3.5 percent in July), as the rate of decline in the two quarters decreased in real time and increased according to the later July 1980 data.

the second quarter of 1979. This was followed by an increase of 2.4 percent in the third quarter of 1979 and increases of 1.1–1.4 percent in the fourth quarter of 1979 and first quarter of 1980. A sharp decline of 9.1 percent occurred in the second quarter of 1980, which was the second quarter of the recession. After registering a strong third and fourth quarter of 1978, economic growth slowed considerably during 1979 in the run-up to the recession beginning in the first quarter of 1980. Assessment of Economic Policies Preceding the 1980 Recession Following the end of the 1973–75 recession in March 1975, the subsequent economic expansion included relatively high levels of unemployment. But

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Figure 8.9

Real Gross National Product in Expansion Preceding the 1980 Recession, Plus Two Recession Quarters, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Notes: The 1980 recession began in January 1980 and ended in July 1980, so only the first and second quarters of 1980 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, January–March 1979 data became available in April 1979). Data from July–September 1979 to April–June 1979 represent data available as of September 1979. Data from July–September 1979 to April–June 1980 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September 1979 to the January–March 1980 data are similar to the later data for those quarters that first became available in July 1980, except for July–September and October–December 1979, in which the real-time data and the July 1980 data differed between the two quarters (2.4 and 1.4 percent real time and 3.1 and 2.0 percent in July), as the rate of increase in the two quarters increased with the later July 1980 data.

while the expansion was not especially vigorous, inflation became an everincreasing problem. The rising inflation was not driven by high levels of demand that were causing labor and industrial production shortages, which would have raised business production costs. Rather, the inflation stemmed from three problems: s -ARKEDSLOWDOWNINPRODUCTIVITYINCREASESDURINGTHES The productivity slowdown, the causes of which are still not understood at the time of this writing in 2008, diminished an underlying structural strength of the economy in containing inflation. s )RANIAN 2EVOLUTION IN  WHICH RESULTED IN MUCH HIGHER PRICES OF gasoline and other oil products:

THE RECESSION OF 1980

219

In addition to the direct impact on prices of oil-related products, the sharp increase in oil prices resulting from the Iranian Revolution spread to other products and industries that require oil products for their activities. s $ECLINEINTHEVALUEOFTHEDOLLARTHATRAISEDPRICESOFIMPORTS By raising U.S. prices of imported goods, the fall in the foreign exchange value of the dollar increased inflation in a variety of products. President Jimmy Carter tried to address these nondemand sources of inflation by initiating voluntary price and wage standards in October 1978. This program was assessed to have lessened price inflation by 1.5 percentage points and wage inflation by 1.2 percentage points in the first year of its operation. The standards and their enforcement were relaxed considerably in the second year of its operations, lessening their effect compared with the previous year. As the rate of inflation accelerated to double-digit levels in the late 1970s, the Federal Reserve took an aggressive role in containing inflation by restraining economic growth through its monetary policies. In the twelve to eighteen months preceding the onset of the recession in January 1980, there were increasing signs of weakness in industrial production, housing starts, consumer durables spending, and the gross national product. There was also a general perception at the time of weakness in the economy, as many private forecasters expected a recession in 1979 or 1980. This contrasted with the previous six recessions covered in the book, before which private forecasts of recession were rare. President Carter’s Council of Economic Advisers (CEA) published a forecast of a recession for 1980 late in 1979. Such a published forecast of a recession by a presidential agency was unprecedented in the postwar period. But it was too late for policy actions to be taken to prop up the economy to prevent or limit the impact of the recession. While there was strong evidence that the inflation was not driven by excessive demand, and there were many forecasts of a recession for 1979 or 1980, the Federal Reserve pursued a vigorous monetary policy to reduce demand and economic growth as a means of lessening inflation. In fact, this monetary restraint was continued into March 1980, three months into the recession. I believe there were two economic policy failures that led to the 1980 recession. One was that the Federal Reserve acted to reduce inflation by lessening demand, which was the wrong diagnosis of the cause of inflation and seemed destined to cause a recession and higher unemployment. The other was the unraveling of President Carter’s wage and price standards program. Had he maintained and vigorously supported the standards, they could have been

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instrumental in breaking the psychology of inflationary expectations on the part of businesses and workers, which had become a fundamental roadblock in the fight to curb inflation. The problem in that environment was that both workers and businesses expected the wage/price spiral to continue indefinitely, with higher prices calling forth higher wages so workers could catch up with the loss in purchasing power of their earnings, and higher wages calling forth higher prices so businesses could offset the increase in their production costs, and so on in subsequent rounds. Notes 1. Jerome A. Mark, William H. Waldorf, et al., Trends in Multifactor Productivity, Bulletin 2178, Bureau of Labor Statistics, U.S. Department of Labor, September 1983, chs. III and IV. See also, Edward F. Denison, Trends in Economic Growth, 1929–82 (Washington, DC: Brookings Institution, 1985). The productivity slowdown in the text indicates that average annual productivity increased by 3.3 percent from 1948 to 1973, and fell to 1.3 percent from 1973 to 1979. These estimates are based on industry data derived from the Standard Industrial Classification System (SICS), which was used in the above-cited studies. Data based on the new North American Industry Classification System (NAICS) show that average annual productivity increased by 3.2 percent from 1948 to 1973, and fell to 1.3 percent from 1973 to 1979. The only difference between the estimates in the two systems occurred from 1948 to 1973, in which the SICS showed a 3.3 percent increase and the NAICS showed a 3.2 percent increase, a 0.1 percentage point difference. This marginal difference did not change the extent of the slowdown. 2. Board of Governors of the Federal Reserve, “Monetary Policy Report to Congress,” Federal Reserve Bulletin, March 1979, pp. 191–92. Report submitted to the Congress on February 20, 1979. Statement of Paul A. Volcker, chairman, Board of Governors of the Federal Reserve System, before the Committee on the Budget, U.S. House of Representatives, September 5, 1979, Federal Reserve Bulletin, September 1979, pp. 738–43. 3. Peter Hooper and Barbara R. Lowery, “Impact of the Dollar Depreciation on the U.S. Price Level: An Analytical Survey of Empirical Estimates,” Federal Reserve Bulletin, April 1979, pp. 305–6. 4. BusinessWeek, July 16, 1979, p. 29; November 12, 1979, pp. 33–34; November 19, 1979, p. 37; November 26, 1979, p. 19; and December 31, 1979, p. 27. Federal Reserve Bank of Philadelphia, Survey of Professional Forecasters, median forecasts of the U.S. economy by professional economists. The forecasts for the 1979–80 period are from a joint project of the American Statistical Association and the National Bureau of Economic Research (ASA/NBER) called the Economic Outlook Survey. The Philadelphia Bank took over the ASA/NBER Economic Outlook Survey in 1990 and published the earlier years of that survey online. The Philadelphia Bank has conducted its own survey of professional forecasters since 1990, which it publishes online on a current basis. See Dean Croushore, “Introducing: The Survey of Professional Forecasters,” Business Review, Federal Reserve Bank Philadelphia, November/December 1993.

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5. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1980, pp. 66–67. In that same economic report, President Carter noted that his Budget of the United States Government assumed the occurrence of a recession. 6. Ibid., pp. 7–8; and “Annual Report of the Council of Economic Advisers,” Economic Report of the President, January 1980, pp. 32–35 and 79–82. These voluntary standards differed from the mandatory price and wage controls introduced by President Richard Nixon in August 1973 (Chapter 7). 7. Council on Wage and Price Stability, Executive Office of the President, Evaluation of the Pay and Price Standards Program, January 16, 1981, p. 3. Sally Katzen and R. Robert Russell were the principal authors of this report. It provides a detailed record and assessment of the workings of the program. 8. Evaluation of the Pay and Price Standards Program, January 16, 1981, p. 21. 9. Robert S. Gay and A. Michael Berman, “Recent Labor Market Developments,” Federal Reserve Bulletin, June 1979, pp. 450–52. 10. “Monetary Policy Report to Congress,” Federal Reserve Bulletin, August 1979, p. 593. Report submitted to the Congress on July 17, 1979. 11. David F. Seiders, “Recent Developments in Mortgage and Housing Markets,” Federal Reserve Bulletin, March 1979, p. 177. 12. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 13. “Monetary Policy Actions,” Federal Reserve Bulletin, November 1979, pp. 830–32. 14. Thomas F. Brady, “Changes in Bank Lending Practices, 1977–79,” Federal Reserve Bulletin, October 1979, pp. 802–3. 15. “Domestic Financial Developments in the Third Quarter of 1979,” Federal Reserve Bulletin, November 1979, pp. 882–86. 16. “The Administration’s Anti-Inflation Program of March 1980,” Survey of Current Business, March 1980, p. 2. While this citation is called the “administration’s” program, it refers to the Federal Reserve’s program that the administration endorsed. 17. “Monetary Policy Report to Congress,” August 1979, pp. 592–93.

9 The Recession of 1981–82

The recession of 1981–82 began in July 1981 and ended in November 1982, and it followed a pre-recession period that was extraordinary: s 4HEnRECESSIONFOLLOWEDTHEEXPANSIONPERIODFROMTHEENDOF the 1980 recession by just twelve months. The twelve-month expansion (July 1980–July 1981) that preceded the 1981–82 recession was by far the shortest of the post–World War II era. s "ECAUSE OF THE BACK TO BACK CLOSENESS OF THE  AND THE n recessions, the 1981–82 recession was affected by economic policy actions taken during the 1980 recession, as well as by actions taken during the recovery following the 1980 recession. s )N-ARCH three months into the 1980 recession, the Federal Reserve tightened its monetary restraint on household credit, raised the discount rate at which banks borrow from the Federal Reserve, raised reserve requirements on commercial banks, and raised restraints on the amount of credit extended by large nonmember banks of the Federal Reserve.1 Also in March 1980, President Jimmy Carter proposed reductions in federal loans and loan guarantees. s 4HE&EDERAL2ESERVEPURSUEDANAGGRESSIVEANTI INmATIONPROGRAMBY restraining economic growth from October 1979 through 1982. Effect of the 1980 Recession on Subsequent Inflation Table 9.1 shows the six-month annualized rates of change from June 1979 to June 1981 in the consumer price index (CPI) for all items and for all items less energy, based on data available as of 2008. The two measures highlight the direct effect on inflation of the 1979 Iranian Revolution on petroleum prices. For all items, the inflation rate accelerated from 12.5 percent from June to December 1979 to 16.3 percent from December 1979 to June 1980. Part of the 16.3 percent jump reflected the higher gasoline prices following the Iranian 222

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Table 9.1 Consumer Price Index, for All Items and for All Items Less Energy (annualized percentage change) Six-Month Periods June 1979 to December 1979 December 1979 to June 1980 June 1980 to December 1980 December 1980 to June 1981

All Items

All Items Less Energy

12.5 16.3 8.9 10.2

11.3 13.4 10.0 8.5

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on not-seasonally-adjusted data as of 2008.

Revolution, which, for example, led to an increase in the price of unleaded regular from 71.6 cents in January 1979 to $1.065 per gallon in December 1979. The inflation rate dropped to 8.9 percent from June to December 1980, and then rose to 10.2 percent from December 1980 to June 1981. For all items less energy, which exclude all petroleum inflation, the CPI accelerated from 11.3 percent from June 1979 to December 1979 to 13.4 percent from December 1979 to June 1980. The inflation rate dropped to 10.0 percent from June to December 1980, and to 8.5 percent from December 1980 to June 1981. The 1980 recession began in January 1980 and ended in July 1980. Both CPI measures indicate that one year after the end of the 1980 recession, despite some decline in inflation, the inflation rates were still very high: 10.2 percent for all CPI items and 8.5 percent for all CPI items less energy. In addition to the petroleum price increases stemming from the Iranian Revolution, the ending of the phased deregulation of prices for domestic crude petroleum in January 1981 exacerbated the energy-induced inflation during January–June 1981.2 Economic Recovery Tax Act of 1981 and the 1981–82 Recession The Economic Recovery Tax Act of 1981 (ERTA), which was signed into law in August 1981, contained major federal income tax cuts for individuals and businesses:3 s !PERCENTREDUCTIONININDIVIDUALINCOMETAXRATESOVERMONTHS s &ASTERDEPRECIATIONWRITE OFFSFORBUSINESSEQUIPMENTANDPROPERTY s )NCENTIVESFORPERSONSWHOPUTSAVINGSINTOSPECIlEDSAVINGSACCOUNTS s 2EPEALOFTHEEXCLUSIONFROMGROSSINCOMEOFINTERESTANDDIVIDENDS s 2EDUCTIONINESTATEANDGIFTTAXES s )NCREASEINTHEWINDFALLPROlTSTAXCREDITFORQUALIlEDROYALTYRECIPIENTS

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The main effects of the reduced tax payments under ERTA began in the fourth quarter of 1981, and accelerated into 1982. But the 1981–82 recession began in July 1981. So for this fiscal policy stimulus to help in staving off the recession, households and businesses would have needed a tremendous anticipatory effect while the tax cuts were being legislated in Congress, as well as a large spending effect. These clearly did not happen. Economic Indicators in Real Time During 1980–81 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1981–82 recession in July 1981 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of this chapter is an assessment of the economic policies preceding the 1981–82 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are of course complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for the gross national product, which is available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1981–82 recession is dated as beginning in July 1981 and ending in November 1982. So July to September 1981 in the figures that follow were the first three months of the recession. To assess what was available to policy makers as 1980 and 1981 progressed, the figures chart the real-time data from August 1980 to September 1981.

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The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in September 1980. Because economic data became available one month after the month to which they refer, the August 1980 data first appeared in September 1980. Thus, the August starting point provides the most reliable data, including revisions from that time up to April 1981, of the August 1980–March 1981 period. The data from April 1981 to September 1981 reflect the real-time data on a monthly and quarterly basis up to September 1981 as they were produced. Revisions that occurred to the April–September 1981 data as of November 1981 changed the monthly and quarterly patterns at most slightly. I chose April 1981 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in April, it would have been too short a lead-time for changes to occur in the market economy to prevent the recession from beginning in July 1981. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1980–81 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 9.1 shows the monthly percentage change in jobs from August 1980 to September 1981 on a real-time basis. From August 1980 to January 1981, employment increased from 0.2 to 0.4 percent per month. From February to May 1981, employment showed zero change in three months and a decline (below the zero line) of 0.2 percent in March. Following a 0.4 percent increase in June, employment dropped 0.1 percent in July, 0.1 percent in August, and 0.2 percent September (July to September were recession months). Employment growth during the recovery from the 1980 recession was relatively strong from August 1980 to January 1981. Employment growth was nonexistent, including a decline in one month, from February to June 1981, except for an increase in June. Overall, employment growth was tepid in the short recovery/expansion preceding the onset of the 1981–82 recession.

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Figure 9.1

Jobs in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 9.2 shows the unemployment rate on a real-time basis from August 1980 to September 1981. In the start of the recovery from the 1980 recession, unemployment rose from 7.4 percent in August 1980 to 7.6 percent in September. Unemployment then declined to 7.3 percent during January–March and May 1981, which was interrupted by an increase to 7.6 percent in April. After falling to a low of 7.0 percent in June, unemployment rose in the recession months to 8.0 percent in September.

THE RECESSION OF 1981–82

Figure 9.2

227

Unemployment Rate in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 are similar to the later data for those months that first became available in November 1981.

Actual unemployment ranged from 7.5 million to 8.2 million workers. Thus, a one-percentage-point change in the unemployment rate between August 1980 and September 1981 affected 75,000 to 82,000 workers. Unemployment remained high in the short recovery/expansion from the 1980 recession preceding the onset of the 1981–82 recession. Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by all urban households, including workers in all urban occupations, the unemployed, and retired persons. For a discussion of inflation and deflation, and of price indexes in general, as well as more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation.

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Figure 9.3

Consumer Prices in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

Figure 9.3 shows the monthly percentage change in the CPI from August 1980 to September 1981 on a real-time basis. From August 1980 to January 1981, the CPI increased by 0.8 to 1.0 percent per month. After slowing to 0.6 percent in March 1981, the CPI increase rose to 1.1 percent in June. Following increases of 0.8 and 1.0 percent in July and August, the CPI increase slowed to 0.1 percent in September, the third month of the 1981–82 recession. Inflation continued at exceptionally high rates in the months preceding the onset of the 1981–82 recession, and in the first two months of the recession. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For

THE RECESSION OF 1981–82

Figure 9.4

229

Industrial Production Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 9.4 shows the monthly percentage change in the IPI from August 1980 to September 1981 on a real-time basis. In the immediate recovery months after the 1980 recession, the IPI increased from 1.6 percent in August to 1.9 percent in September, with a slowing of the increase to 0.5 percent in December. Following a decline (below the zero line) of 0.4 percent in January 1981, the IPI increased by 0.3 to 0.4 percent from February to June, except for a 0.1 percent decline in May. The IPI declines in the recession months accelerated from 0.4 percent in July to 1.5 percent in September. The IPI increased robustly in the first four recovery months following the end of the 1980 recession, from August to November 1980. The IPI monthly increases lessened considerably from December 1980 up to the onset of the 1981–82 recession in July, including two months of decline. This entire prerecession period was thus one of modest growth.

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Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capacity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries from 1979 to 1981 was as follows: 1979 1980 1981

84.2% 78.7% 77.0%

The CUR at 84.2 percent in 1979 indicated a full utilization of manufacturing capacity. The sharp drop in the CUR to 78.7 percent in 1980 and 77.0 percent in 1981 indicated unused capacity in those years. These low operating rates permitted the use of the most efficient capital facilities without necessitating the use of older and less reliable equipment. While the annual rates for both 1980 and 1981 spanned expansion and recession years, the drop from the 1979 rate was so substantial that it indicates the existence of a fair amount of unused capacity within those years. The low CUR levels for 1980 and 1981 indicate that the availability of unused manufacturing capacity kept capital production costs from increasing significantly, and therefore did not contribute to inflation. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 9.5 shows the monthly percentage change in housing starts on a real-time basis from August 1980 to September 1981. After housing starts increased by 10.5 percent in August and 5 percent in September, the monthly movements were volatile from October 1980 to June 1981. Preceding the onset of the 1981–82 recession in July 1981, housing starts increased by 10.5 percent in August 1980 and slowed to increases of 5 percent in September, 2.5 percent in October, and 2 percent in November. Housing starts were volatile from December 1980 to June 1981, declining (below the zero line) by 1 percent in

THE RECESSION OF 1981–82

Figure 9.5

231

Housing Starts in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on the U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

December 1980, increasing by 8.1 percent in January 1981, declining by 26.9 percent in February, increasing by 5.8 and 4.6 percent in March and April, and declining by 14 and 11 percent in May and June. In the first months of the 1981–82 recession, housing starts increased by 3.3 percent in July 1981 and declined by 10.7 and 1.7 percent in August and September. Table 9.2 shows the percentage change in housing starts in the six-month periods from June 1979 to June 1981 based on seasonally adjusted data as of 2008. Housing starts dropped by 21.7 percent during the six months preceding the onset of the 1980 recession (June–December 1979), and by 20.2 percent during the 1980 recession (January–June 1980). Housing starts increased by 23.9 percent during the six months following the end of the 1980 recession (June–December 1980), and fell by 29.5 percent during the six months preceding the onset of the 1981–82 recession (December 1980–June 1981). High mortgage interest rates were an important factor limiting strength in housing starts from the winter of 1980 through the first half of 1981 in the

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Table 9.2 Housing Starts Six-Month Periods

Percentage Change

June 1979 to December 1979 December 1979 to June 1980 June 1980 to December 1980 December 1980 to June 1981

–21.7 –20.2 23.9 –29.5

Source: Bureau of the Census, U.S. Department of Commerce. Note: Based on seasonally adjusted data as of 2008.

run-up to the 1981–82 recession. Following a sharp decline in fixed-rate, long-term home mortgages to about 12.5 percent in mid-1980, average home mortgage rates rose to over 16 percent in May 1961.4 Housing starts were clearly a weak element from the periods preceding the both the 1980 and 1981–82 recessions. Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 9.6 shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from August 1980 to September 1981. From August 1980 to January 1981, worker earnings increased by 1.2 to 1.5 percent per month, except for a 0.6 percent increase in December. After dropping to a decline (below the zero line) of 0.1 percent in February 1981, followed by an increase to 1 percent in March, worker earnings increased by 0.3 to 0.4 percent from April to July. In the first three months of the recession of 1981–82, worker earnings increased by 0.4 percent in July and 1.3 percent in August, and declined by 0.9 percent in September. Table 9.3 (page 234) shows the six-month movements of worker earnings from June 1979 to June 1981 in current dollars and in 1982 dollars, based on data as of 2008. In the current dollar measure, worker earnings increases accelerated from 3.7 and 2.3 percent between the June–December 1979 and the December 1979–June 1980 periods, to 5.4 and 3.8 percent between the June–December 1980 and the December 1980–June 1981 periods. In the 1982 dollar measure, which is adjusted for inflation, worker earnings decreased in three of the four periods, at 2.6, 4.7, and 0.7 percent, and earnings increased in one period at 0.6 percent.

THE RECESSION OF 1981–82

Figure 9.6

233

Job Earnings in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all private nonfarm industries. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

Worker earnings increased at accelerated rates in current dollars, the actual money wages received by workers, in the six-month periods from June 1979 to June 1981. In contrast, worker earnings adjusted for inflation fell in three of the four six-month periods, which resulted in workers falling behind in the spending power of their incomes, and consequently in their living conditions. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations.

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Table 9.3 Worker Earnings

Six-Month Periods June 1979 to December 1979 December 1979 to June 1980 June 1980 to December 1980 December 1980 to June 1981

Percentage Change in Current Dollars

Percentage Change in 1982 Dollars

3.7 2.3 5.4 3.8

–2.6 –4.7 0.6 –0.7

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on seasonally adjusted data as of 2008.

The other interest rate covers federal funds, which is the interest rate charged for loans between banks.5 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 9.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from August 1980 to September 1981. Interest rates rose steadily from 10.6 percent in August 1980 to 16.2 percent in September 1981, except for declines of less than one percentage point in January, March, and June 1981. Figure 9.7b (page 236) shows the monthly federal funds interest rate from August 1980 to September 1981. The federal funds rate rose from 9.6 percent in August 1980 to 20.1 percent in January 1981, declined to 14.9 percent in April 1981, fluctuated from 18.3 to 18.9 percent between May and August 1981, and fell to 16.9 percent in September. Interest rates were exceptionally high during the run-up to the 1981–82 recession, even exceeding the high rates during the run-up to the 1980 recession (Chapter 8). The federal funds rate also exceeded the interest rate of U.S. Treasury three-year constant maturities, as in the period preceding the onset of the 1980 recession, indicating a continued strong Federal Reserve policy of containing inflation by slowing economic growth.

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Figure 9.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

Bank Loans Table 9.4 (page 237) shows business loans at commercial banks from the first quarter of 1979 to the second quarter of 1981. The quarterly data are calculated at seasonally adjusted annual rates. The quarterly patterns of business loans fluctuated between 1979 and 1980, but with no apparent upward or downward trend. Business loan increases in the first two quarters of 1981, preceding the onset of the 1981–82 recession in July 1981, were decidedly lower than the quarterly increases during 1979 and 1980. Following the Federal Reserve announcement in October 1979 of its intention to restrain the growth of money and credit in order to combat inflation (Chapter 8), there was a tendency for the banks to apply stricter lending standards to would-be business borrowers, including larger compensating-balance requirements and stricter review of credit applications from new customers.6 This posture continued through the second quarter of 1980, which may have

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Figure 9.7b Federal Funds Interest Rate in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). The interest rate data are not normally revised.

reflected in part the bankers’ desire to adhere to the Federal Reserve policy of monetary restraint. Businesses also may have increased their borrowing in the first quarter of 1980 in anticipation of future credit reductions. Though the 1980 recession was in progress, the concern over combating inflation was overriding, as noted in Chapter 8. Rising economic growth during the last two quarters of 1980 and the first quarter of 1981 in the recovery/expansion from the 1980 recession led to increased corporate profits during that period, reducing business needs for external financing.7 But as the economy slowed in the second quarter of 1981, businesses increased their dependence on loans. Business loans by commercial banks in the short one-year recovery/expansion from the 1980 recession before the onset of the 1981–82 recession reflected two economic conditions. One was the tightening of loan standards by the banks as they sought to conform to the restrictive monetary policy adopted by Federal Reserve in the fourth quarter of 1979. The other was the shifts in economic growth and the concomitant business profits in the recovery from the

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Table 9.4 Business Loans at Commercial Banks Quarterly Percentage Change at Annual Rate 1979 I II II IV 1980 I II III IV 1981 I II

21.0 18.1 19.5 8.6 18.6 –10.7 14.3 24.2 5.8 9.0

Source: Warren T. Trepeta, “Changes in Bank Lending Practices, 1979–81,” Federal Reserve Bulletin, September 1981, Table 1, p. 671. Note: The data are seasonally adjusted.

1980 recession, which first led to a decreased need for external financing by business in the first quarter of 1981, and then to an increased need for loans in the second quarter, as economic growth and profits turned down. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent real movements in consumer durable goods spending. This is the first recession for which monthly data for consumer durable goods spending are available (in previous recessions, only quarterly data were available). For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 9.8 shows the monthly percentage change at an annual rate in real consumer durable goods spending reported on a real-time basis from August 1980 to September 1981. Consumer durable goods spending declined (below the zero line) in August and September 1980, increased by 7.6 percent in October, had a 0.1 percent decline and a 0.1 percent increase in November and December, and increased by 4.9 and 0.5 percent in January and February 1981. This was followed by four monthly declines from March to June 1981.

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Figure 9.8

Real Consumer Durable Goods Spending in Expansion Preceding the 1981–82 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only July to September 1981 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1981 data became available in October 1981). Data from August 1980 to March 1981 represent data available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available as of April 1981. Data from April 1981 to September 1981 represent data when they first became available one month after each data month. The monthly patterns of the April 1981 to September 1981 data are similar to the later data for those months that first became available in November 1981.

In the first three months of the 1981–82 recession, spending increased in July and August 1981, and declined in September. The bulk of the 4.9 percent jump in durable goods spending in January 1981 reflected a sharp increase in purchases of motor vehicles.8 Based on data for the first and second quarters of 1981, new motor vehicle purchases increased by 51.4 percent in the first quarter and fell by 47.1 percent in the second quarter. Furniture and household equipment purchases increased by 9.3 percent in the first quarter and fell by 5.3 percent in the second quarter. Purchases of other durable goods increased by 6.5 and 6.1 percent in both quarters. This pattern corresponded with sharp increases in automobile installment credit during the first quarter of 1981 that was likely attributable to the auto rebate programs in February and March.9 Consumer durable goods spending was weak between August 1980 and June 1981, preceding the onset of the 1981–82 recession in July.

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Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change and thus represent real quarterly movements in the GNP. The data are provided quarterly, not monthly like most of the other economic indicators used in this book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 9.9 shows the quarterly percentage change at an annual rate in the real GNP on a real-time basis from the third quarter of 1980 to the third quarter of 1981. Following the end of the 1980 recession in July 1980, GNP growth accelerated from 2.4 percent in the third quarter of 1980 to a high of 6.5 percent in the first quarter of 1981. The GNP declined (below the zero line) by 1.9 percent in the second quarter of 1981, preceding the onset of the 1981–82 recession in July 1981. And the GNP declined by 0.6 percent in the third quarter of 1981, the first quarter of the 1981–82 recession. The GNP decline in the second quarter of 1981 occurred among a broad spectrum of the component items that are included in the GNP: consumer durable goods spending, nonresidential and residential investment, exports, and federal government and state and local government purchases of goods and services.10 The general weakness in the recovery from the 1980 recession was highlighted by the decline in several GNP components and the overall GNP in the second quarter of 1981. Assessment of Economic Policies Preceding the 1981–82 Recession The short economic recovery/expansion of twelve months between the end of the 1980 recession and the beginning of the 1981–82 recession resulted in the two recessions being connected in ways that were not present in the previous recessions covered in this book. This was the carryover from the 1980 recession into the twelve months preceding the onset of the 1981–82 recession. By contrast, the next shortest expansion of twenty-four months between the end of the 1953–54 recession and the beginning of the 1957–58 recession showed a distinct break between the two recessions. The twelve-month upturn appeared more like a respite from the declines in production and employment during the 1980 recession than like a fullfledged economic expansion. While there was strong growth in employment, industrial production, and housing starts during the first six months following the end of the 1980 recession, these slowed considerably in the next six

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Figure 9.9

Real Gross National Product in Expansion Preceding the 1981–82 Recession, Plus One Recession Quarter, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1981–82 recession began in July 1981 and ended in November 1982, so only the third quarter of 1981 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, October–December 1980 data became available in January 1981). Data from July–September 1980 to January– March 1981 represent data available as of April 1981. Data from April–June 1981to July– September 1981 represent data when they first became available one month after each data quarter. The quarterly patterns of the April–June 1981 to the July–September 1981 data are similar to the later data for those quarters that first became available in November 1981, except for the change in the July–September 1981 quarter from –0.6 percent in the October 1981 data to 0.6 percent in the November data.

months—that is, those immediately preceding the onset of the 1981–82 recession. Unemployment remained high during the upturn, declining only from 7.4 percent in August 1980 after the end of the 1980 recession to 7.0 percent in June 1981 on the eve of the 1981–82 recession. Consumer durable goods spending was weak during the twelve months of the upturn, which included several months of decline. Overall economic growth, as reflected in the gross national product, accelerated during the first three quarters following the 1980 recession, but then GNP declined in the second quarter of 1981 preceding the onset of the 1981–82 recession, with widespread declines occurring among the GNP components. It also was evident that while inflation decreased somewhat after the end of the recession of 1980, inflation was still very high during the six

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months preceding the onset of the 1981–82 recession. From December 1980 to June 1981, prices increased at annual rates of 10.2 percent for all items in the consumer price index and 8.5 percent for all CPI items excluding energy. This spotlights the problem with the Federal Reserve policy of restraining economic growth in order to combat inflation when unemployment was high and the economy showed only halting strength in breaking into a solid expansion. In my opinion, the Federal Reserve, in its relentless desire to curb inflation by restraining economic growth three months into the recession of 1980, and again during the run-up to the recession of 1981–82 from August 1980 to June 1981, viewed the inflation in one of two ways. One was that the economy was at full employment or over-full employment, which would have brought on excessive demand. Or, it believed that the economy was not at full employment, but that the psychology of inflationary expectations was such an overriding problem that it justified restraining demand, with the accompanying risk of causing a recession and higher unemployment. For a discussion of full employment, see Chapter 6 under Definition of Full Employment. I believe the causes of the inflation were the inflationary expectations of businesses and workers, not excessive demand in the economy. As noted in Chapter 8, inflationary expectations reflect an environmental psychology in which both workers and businesses expect the wage/price spiral to continue indefinitely, with higher prices calling forth higher wages so that workers can catch up with the loss in purchasing power of their earnings, and higher wages calling forth higher prices so businesses can offset the increase in their production costs in order to maintain their profit margins, and so on, in subsequent rounds. In order to curb the inflation, the Federal Reserve pursued an active policy of monetary restraint aimed at slowing economic growth during the expansion, despite the high rate of unemployment and the low rate of industrial capacity utilization. This is a blunt tool for curbing inflationary expectations. I believe the Federal Reserve’s monetary restraint brought on the 1981–82 recession. The direct way to combat the inflationary expectations would have been to institute price and wage controls (mandatory) or price and wage standards (voluntary), Effective enforcement of the controls or standards would have lessened the degree of the Federal Reserve’s monetary restraint, and so probably would have avoided bringing on the 1981–82 recession. But President Ronald Reagan would not have considered this because of his philosophic opposition to such government action.

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Notes 1. “The Administration’s Anti-Inflation Program of March 1980,” Survey of Current Business, March 1980, p. 2. 2. James E. Glassman and Ronald A. Sege, “The Recent Inflation Experience,” Federal Reserve Bulletin, May 1981, p. 395. 3. “The Business Situation,” Survey of Current Business, August 1981, pp. 5–7. 4. David F. Seiders, “Changing Patterns of Housing Finance,” Federal Reserve Bulletin, June 1981, p. 462. 5. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 6. Warren T. Trepeta, “Changes in Bank Lending Practices, 1979–81,” Federal Reserve Bulletin, September 1981, pp. 672–75. 7. Board of Governors of the Federal Reserve System, “Monetary Policy Report to Congress,” Federal Reserve Bulletin, March 1982, p. 127. 8. “The Business Situation,” Survey of Current Business, October 1981, Table 7, p. 6. 9. “The Business Situation,” May 1981, p. 4. 10. “The Business Situation,” July 1981, Tables 6, 7, 9, and 10, pp. 5 and 9.

10 The Recession of 1990–91

The recession of 1990–91 began in July 1990 and ended in March 1991. It followed an expansion of ninety-two months, or approaching eight years, from November 1982 to July 1990, which ranks as the third longest expansion since the end of World War II. The longest expansion was 120 months, or ten years, from March 1991 to March 2001. The second longest expansion was 106 months, or close to nine years, from February 1961 to December 1969. The 1982–90 expansion came after the two back-to-back recessions of 1980 and 1981–82 (Chapters 8 and 9). This background discussion of the 1980s preceding the onset of the 1990–91 recession is in two parts. The first part contains narratives of international political and economic events, the savings and loan associations failures, the stock market crash of 1987, the deregulatory program of the 1980s, and the natural disasters of Hurricane Hugo and the San Francisco Bay Area earthquake. These events have not been quantified for their impact on the overall economy because of the difficulty of developing credible estimates. However, I give qualitative judgments of their stimulative or restraining effects on the economy at the end of the chapter under “Assessment of Economic Policies Preceding the 1990–91 Recession.” The second part describes the fiscal-policy-driven federal government budget deficits preceding the onset of the 1990–91 recession. International Events Breakup of the Soviet Union The economic expansion witnessed the political and economic upheavals brought about by the breakup of the Soviet Union and the accompanying freeing of the Eastern European nations from the Soviet orbit. The demise of the Soviet Union relieved the concerns from the threats of a long-time Cold War enemy.

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Value of the Dollar In addition to these international political events, the U.S. economy was affected by large shifts in the value of the dollar in relation to the currencies of other countries. There was a sharp rise in the value of the dollar from 1981 to 1985, and then an even sharper fall from 1986 to 1988. Such changes in the value of the dollar have complex origins and effects. Examples are the relative rates of inflation in the United States and other countries, the trade surplus or deficit that the United States has with other nations, the desirability of the U.S. as a place for foreigners to invest their capital, and actions taken by the U.S. and other governments to buy or sell dollars. A well-known illustration of the effects of changes in the value of the dollar is that a rise in the value of the dollar makes U.S. exports more expensive and imports less expensive for Americans to buy, and therefore is a deterrent to exports and also spurs imports, while a dollar rise, by making imports cheaper, also lessens inflation. The opposite occurs in the case of a decline in the value of the dollar. In addition, a strong dollar is an incentive for foreigners to invest in the United States, and vice versa for a weak dollar. These, however, are only first-order effects, as international companies may change the prices of the goods and services they produce for foreign markets to offset or partially offset the changes in the value of the dollar. Also, the effects of these changes in the value of the dollar on the U.S. economy are further complicated by the varying effects between exports and imports on the one hand, and on foreign investment in the United States on the other. Federal Government Regulations Federal government regulations spell out the details of how laws passed by Congress are defined and carried out by the president. Regulations are an action roadmap for the executive departments to follow in carrying out the laws. Federal laws enacted by Congress enunciate categories of subjects, some of which are relatively specific in their meaning and others that provide for a wider range of interpretation. In both cases, the president crafts the regulations to implement the laws. Those laws that are less specific in their meaning provide the president with greater latitude in detailing the definitions and enforcement mechanisms that are written into the regulations. The writing of regulations requires public comment for at least one set of regulations, a preliminary set. The second set, for the adoption of final regulations, may be sent for another round of public comment. A regulation is sometimes challenged in court on the premise that it does not conform to the intent of the underlying law. Should the court overturn

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the regulation, the president must begin anew the process of adopting a regulation. The issue in writing regulations for a particular law is to follow the intent of the law as closely as possible. However, because some laws lack specificity, the interpretation given by the president in writing the regulations also reflects the president’s political philosophy. For instance, President Ronald Reagan espoused the philosophy that government regulations stultified businesses in increasing their sales and in raising workers’ productivity, which stifled the incentive for businesses to expand their investments. He referred to this as the rationale for “getting the government off the backs of the people.” Deregulatory Program President Reagan’s philosophy resulted in a general “deregulatory program” during the 1980s that lowered federal standards for food, drugs, and other products; workers’ health, safety, and pensions; environmental air and water protection; and other government programs. Additionally, during the 1980s antitrust enforcement was relaxed against monopolistic practices, and took a benign view of the surge in business mergers and acquisitions brought about by junk bond financing. This antitrust policy also came under the rubric of deregulation. The expectation of the deregulatory program was that it would increase economic growth and business productivity. Table 10.1 shows the average annual growth rates of the real gross domestic product (GDP) and of labor productivity in the business sector for the long expansions of the 1960s, the 1980s, and the 1990s–2000. The growth rates are based on the initial and terminal years from expansion to expansion, in order that low years of interim cyclical recessions do not distort the long-term trends.1 The initial and terminal years of the expansions are: s SAND s SAND s SnAND Table 10.1 shows that real GDP increased at an annual rate of 4.4 percent during the 1960s. This dropped two decades later to 3.0 percent in the 1980s, and remained at the same level at 3.1 percent in the 1990s–2000 expansion. Labor productivity increased at an annual rate of 3.1 percent during the 1960s. It dropped two decades later to 1.5 percent in the 1980s, and rose to 3.4 percent during the 1990s–2000.

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Table 10.1 Real Gross Domestic Product and Labor Productivity (annualized rates)

Expansion period 1959–69 1979–89* 1989–2000

Real GDPa

Labor Productivityb (Business Sector)

4.4 3.0 3.1

3.1 1.5 3.4

Sources: a Bureau of Economic Analysis, U.S. Department of Commerce; b Bureau of Labor Statistics, U.S. Department of Labor. * The years 1979–89 rather than the years 1981–89 are used because the 1980 and the 1981–82 recessions were only one year apart, and, too, the 1981–82 recession began in mid-1981. Both of these outcomes would have had a cyclical effect of depressing economic indicators for the year 1981, which would have distorted the subsequent growth rates during the expansion of the 1980s. See Chapter 10, note 1.

Natural Disasters Two natural disasters occurred in the United States in 1989. In September 1989, Hurricane Hugo struck mainly the coast of South Carolina and to a smaller extent that of North Carolina, with inland impacts in both states. Hurricane Hugo killed 82 people, left an estimated 56,000 homeless, and caused an estimated $16 billion in property damage. In October 1989, an earthquake struck the San Francisco Bay Area (the Loma Prieta earthquake). The earthquake killed 63 people, left an estimated 8,000 to 12,000 people homeless, and caused $6 billion to $13 billion in property damage. The human and economic effects of these disasters to the areas affected were devastating. The economic losses probably spread to other areas, though this geographic transmission of the economic effects undoubtedly became less intense the further away communities were from the actual disasters. However, I have seen no estimates of the economic impacts of the hurricane and earthquake on the national economy, though the disasters undoubtedly lessened national economic growth in 1989 and 1990 preceding the 1990–91 recession, albeit by small amounts. I am not aware of successful attempts to quantify the geographic transmission of economic developments between metropolitan areas, states, and nations. For example, while this is being written during 2008, the recessions and international financial weaknesses in various countries during this time are undoubtedly related, yet I know of no statistical measures of these global transmissions and interactions.

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Savings and Loan Associations Failures The Savings and Loan Association (S&L) failures of the 1980s and into the 1990s resulted in many such institutions going out of business, being bought out by other institutions, or being resuscitated. The cost of the failures is estimated at $160 billion, of which $125 billion was paid by the federal government. The underlying problem started with the S&Ls longstanding concentration on lending for home mortgages at fixed long-term interest rates. They also were limited until the late 1970s to a cap on interest rates they could pay to depositors. With inflation heating up in the 1970s, S&Ls would have had to sell those mortgages in order to get out of the relatively low-interest-rate long-term mortgage loans. But the value of those loans plummeted because of the rise in the inflation-driven higher interest rates. The result was that in selling those mortgages as a way of raising funds to extend new mortgages at higher interest rates, the S&Ls would have taken a large capital loss. Thus, the institutions were faced with increasingly unprofitable operations either by selling the mortgages or by holding onto them. Then, in a series of banking reforms during the 1980s, S&Ls were allowed to go into various other lines of business, such as making commercial loans, issuing credit cards, and taking an ownership position in real estate and other projects in which they made loans, all of which departed from their original mission of using savings to provide mortgages. They also were permitted to pay higher interest rates for deposits, which allowed them to attract more funds for lending. However, in this new environment, they engaged in risky and speculative ventures on which they lost much money. The S&L industry was entirely restructured in the 1980s, and came under new federal government oversight and reorganization functions. Loss of the S&Ls as a major source of funding for home mortgages in the 1980s lessened the availability of funds for mortgages, leading to high interest rates for homebuyers. However, the effect of this on the overall economy is not known. Stock Market Crash of 1987 The stock market crash of 1987 occurred during five business days in October. Declines began on October 14–16 (Wednesday to Friday), the greatest drop occurred on October 19 (Monday), and the last drop was on October 20 (Tuesday). The fall in the stock market indexes on October 19 was 18 percent for the Wilshire 5000, 20 percent for the S&P 500, and 23 percent for the Dow Jones Industrial Average.

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The crash has been attributed to several causes.2 The initial spark stemmed from two reports on Wednesday, October 14, that were suggestive of a decline in the stock market. One report from news organizations was of possible legislation that would end tax benefits associated with financing mergers, leading investors to feel that there was less of a chance for certain companies to be take-over targets. The other was that the foreign trade deficit for August was above expectations, which led to a decline in the value of the dollar and to the view that the Federal Reserve would act to raise interest rates in order to shore up the dollar, thus leading to a decline in stock prices. On Thursday the decline continued, reflecting anxiety among pension funds, among individual investors leading them to shift funds from stocks to bonds, and from program trading related to portfolio insurance.3 On Friday, stocks fell further, which increasingly included various forms of trading associated with the end of money options that occurred in the previous two days. These lessened the availability of funds for new contracts to be used for hedging, and also led investors to move into futures markets and index arbitrage trading. At the end of Friday, October 16, the S&P 500 had fallen 9 percent for the week. On Monday, October 19, stocks opened much lower, with considerable price declines throughout the day, fed by program trading models. There were also rumors that the New York Stock Exchange would close, causing further sales, as traders feared that a closing market would lock them into existing positions. The downward spiral was also intensified by margin calls, in which stocks bought partially on borrowed funds result in the investor having to provide additional cash or selected financial instruments such as U.S. Treasury securities if the stock price fell below the equity value of the initial purchase of the stock. On Tuesday, October 20, the Federal Reserve announced before the opening of the stock market that it would serve as a source of liquidity to support the economic and financial system. Nevertheless, the hemorrhaging continued for most of the day. Later in the afternoon, the market firmed and rose as corporations announced buyback programs to support their stocks. The buyback programs had begun being announced on Monday afternoon, but they influenced the market only when a critical mass of such buybacks had developed. Federal Reserve Actions In addition to the October 20 announcement by the Federal Reserve that it would provide liquidity to the economic and financial system, the Fed engaged in open market operations that drove the federal funds rate down from over 7.5 percent on Monday to around 7 percent on Tuesday. For the next several

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weeks, the Fed injected more reserves into the financial system in shoring up liquidity. The Fed also encouraged banks and securities firms to support the liquidity and funding needs of brokers and dealers. And it engaged in a variety of supervisory actions to bolster the soundness of the financial system, including placing examiners in major banks to identify potential runs and to assess the banking industry’s credit exposure to securities firms. And beyond the banking industry, the Fed increased daily monitoring of government securities markets and of the health of primary dealers and brokers. Effect of the Crash on the Economy While the crash probably tamped down economic growth in late 1987 and part of 1988, it was not followed by a recession. There was also little in the way of forecasting of recessions following the crash. In a joint project by the American Statistical Association and the National Bureau of Economic Research of economic forecasters, the median forecast of this group did not expect a recession. And of a list of thirty-six forecasters compiled by the Wall Street Journal, only two predicted a recession. Fiscal Policy On taking office in 1981, President Reagan initiated a program of sharp cuts in federal income taxes and sharp increases in defense spending. These shifts required passage of legislation by Congress, and first impacted federal expenditures and receipts to a major extent in 1982. In addition, because of the 1981–82 recession (Chapter 9), large federal deficits occurred in 1981 and 1982 independent of the above-noted fiscal policy changes. As described below, the taxation and spending actions led to sharp increases in the federal deficit from 1983 to the onset of the 1990–91 recession, because economic growth during the decade was not strong enough to generate sufficient increases in income tax receipts to offset (a) the reduction in tax rates and, (b) the defense increases. Tax Cuts and Partial Offsets The Economic Recovery Tax Act of 1981 (ERTA) lowered the individual income tax rates over three years from the top marginal rate of 70 percent to 50 percent, with the bottom rate dropping from 14 percent to 11 percent. The act also lowered taxes on businesses associated with expensing depreciable property. The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) repealed increases in accelerated depreciation deductions, instituted a 10 percent with-

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holding tax on dividends and interest paid to individuals, and increased the wage base and tax rate of the Federal Unemployment Tax Act. The Deficit Reduction Tax Act of 1984 (DEFRA) tightened income averaging requirements, eliminated corporate tax deductibility of Golden Parachute payments to executives and subjected them to a 20 percent excise tax, delayed to 1987 the scheduled decrease in estate and gift taxes, and lengthened real estate depreciation from 15 to 18 years. The Tax Reform Act of 1986 (TRA) lowered the marginal tax on the highest-income individuals from 50 percent to 28 percent, and lowered taxes to a lesser extent on individual incomes below the highest rates. The tax base was broadened, with fewer individuals and businesses allowed to escape taxation. The investment tax credit on business purchases of depreciable assets was repealed. Both short-term depreciation and accelerated depreciation of business property as expenses on income tax returns were eliminated. Table 10.2 shows the effects of these four new tax laws on the revenue of the federal government from one to four years after the laws were enacted. The estimates are based on the revenue losses (negative) and revenue gains (positive) as a percentage of the gross domestic product. The revenue losses from ERTA increased from 1.21 percent of the GDP in the first year to 4.15 percent in the fourth year. The revenue gains from TEFRA increased from 0.53 percent in the first year to 1.23 percent in the fourth year. The revenue gains from DEFRA increased from 0.24 percent in the first year to 0.49 percent in the fourth year. Revenue effects of TRA were mixed, slowing from revenue gains of 0.41 percent in the first year to 0.02 percent in the second year, and then becoming revenue losses of 0.23 percent in the third year and 0.16 percent in the fourth year. Overall, less than one-half of the revenue losses of ERTA were offset by the revenue gains of TEFRA and DEFRA. The mixed revenue gains and losses of TRA were not only much smaller than those of the other tax laws, but over the four years were neutral, as the gains in the first two years were offset by the losses in the last two years. This is consistent with the crafting of the TRA, which aimed at restructuring the tax system to be more equitable among different economic groups, while making it revenue neutral. Federal individual income taxes were increased under President George H.W. Bush in November 1990 under the Omnibus Budget Reconciliation Act of 1990, but those tax increases occurred after the onset of the 1990–91 recession and therefore are not a focus of this chapter. Defense Spending and the Gross Domestic Product Defense spending increased more sharply than the GDP for most of the 1980s, so that defense spending rose as a percentage of the GDP during most of the

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Table 10.2 U.S. Government Revenue Effects of Selected Federal Tax Laws (percentage of the GDP) 1 Year After Enactment Economic Recovery Tax Act of 1981 Tax Equity and Fiscal Responsibility Act of 1982 Deficit Reduction Act of 1984 Tax Reform Act of 1986

2 Years After 3 Years After 4 Years After Enactment Enactment Enactment

–1.21

–2.60

–3.58

–4.15

0.53

1.07

1.08

1.23

0.24 0.41

0.37 0.02

0.47 –0.23

0.49 –0.16

Source: Office of Tax Analysis, U.S. Department of the Treasury, “Revenue Effects of Major Tax Bills,” Working Paper 81, Table 2, September 2006.

decade. This contrasts with the 1970s, when defense spending declined as a share of the GDP. Table 10.3 shows the annual percentage change in real GDP and real defense spending from 1980 to 1987. Abstracting from 1980 and 1982, when real GDP declined because of recessions during those years, defense spending initially increased by three to four percentage points more than GDP, except for 1984, when the opposite occurred. Smaller differences occurred in 1986 and 1987. Large Jump in Federal Government Deficits Federal government budget surpluses and deficits represent the difference between government receipts (mainly taxes) and government expenditures (outlays for goods and services and income support programs). I use the estimates of these federal economic transactions that are developed from the national income and product accounts (NIPAs), rather than from the official federal budget data in the budget laws passed each year. The levels and yearly movements of the two data series are similar, though they differ because of variations in the coverage of certain items, in the timing of when items are recorded, and in accounting definitions. I use estimates from the NIPAs of federal expenditures and receipts because they are fully integrated with the measures of economic growth as summarized by the gross domestic product, and thus are more relevant for assessing their economic impacts.

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Table 10.3 Real Gross Domestic Product and Real Defense Spending (annual percentage change)

1980 1981 1982 1983 1984 1985 1986 1987

Real GDP

Real Defense Spending

–0.2 2.5 –1.9 4.5 7.2 4.1 3.5 3.4

4.4 6.3 7.6 7.2 4.9 8.5 6.4 4.7

Source: Bureau of Economic Analysis, U.S. Department of Commerce.

The terminology of the difference between expenditures and receipts in the NIPAs is “net federal government saving,” which is positive if receipts exceed expenditures, and negative if expenditures exceed receipts. This differs from the “surplus” and “deficit” terminology of the official budget data in recording the difference between receipts and expenditures noted above. Terminology aside, “net federal saving” in the NIPAs is akin to the official budget nomenclature of “surplus” and “deficit”; but because the NIPAs federal economic transactions are not a legislated budget, use of a more neutral economic term of “net federal government saving” avoids confusing it with the official budget. Table 10.4 shows federal receipts minus expenditures from 1980 to 1987. They are all negative because expenditures exceeded receipts in all years. The deficit rose sharply from $53 billion in 1982 and 1983, to $132 billion in 1984, fluctuated between $168 and $191 billion during 1983–86, and declined to $145 billion in 1987. The deficits were much higher during 1982–87 than during 1980–81. This quantum jump stems from the above-noted tax cuts and the increased defense spending, which were not offset by reductions in nondefense spending. Economic Indicators in Real Time During 1989–90 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 1990–91 recession in July 1990 are referred to as real-time data, as discussed under the analogous section in Chapter 2. The economic indicators discussed here are:

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Table 10.4 Federal Government Receipts Minus Expenditures Billions of Dollars 1980 1981 1982 1983 1984 1985 1986 1987

–53.6 –53.3 –131.9 –173.0 –168.1 –175.0 –190.8 –145.0

Source: Bureau of Economic Analysis, U.S. Department of Commerce. Note: Based on the national income and product accounts.

s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSNATIONALPRODUCT The last section of the chapter is an assessment of the economic policies preceding the 1990–91 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are, of course, complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except for the gross national product, which is available only quarterly. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 1990–91 recession is dated as beginning in July 1990 and ending in March 1991. So July to September 1990 in the figures that follow were the first three months of the recession. To assess what was available to policy makers as 1989 and 1990 progressed, the figures chart the real-time data from January 1989 to September 1990.

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The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in January 1989. Because economic data became available one month after the month to which they refer, the January 1989 data first appeared in February 1989. Thus, the January starting point provides the most reliable data, including revisions from that time up to February 1990, of the January 1989–March 1990 period. The data from March 1990 to September 1990 reflect the real-time data on a monthly and quarterly basis up to September 1990 as they were produced. Revisions that occurred to the March 1989–September 1990 data as of November 1990 changed the monthly and quarterly patterns at most slightly. I chose March 1990 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in March, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in July 1990. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see during 1989–90 in what TURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 10.1 shows the monthly percentage change in jobs from January 1989 to September 1990 on a real-time basis. Employment increased at monthly rates of 0.2 to 0.3 percent between January and June 1989. Job growth became more volatile between July 1989 and March 1990, with increases of 0.1 percent in four months, of 0.4 percent in three months, one month of 0.2 percent, and one month of zero change. These averaged out to slower growth compared with that in the January–June 1989 period. A further decline in employment growth occurred from April to June 1990, with increases of 0.2 percent in two months, and zero change in two months. Employment declined (below the zero line) in the three recession months of July to September. Job growth was modest during January–June 1989, and became progressively weaker from July 1989 to June 1990, the last month of the expansion. This weakening turned into job losses during the first three months of the 1990–91 recession.

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Figure 10.1 Jobs in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 10.2 shows the unemployment rate on a real-time basis from January 1989 to September 1990. Unemployment was typically 5.3 percent from January 1989 to June 1990, the last month before the onset of the 1990–91 recession. During this period, unemployment was 5.4 percent in two months, 5.2 percent in four months, and 5.0 percent in one month. Unemployment climbed progressively in the three recession months of July to September, reaching 5.7 percent in September.

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Figure 10.2 Unemployment Rate in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

Actual unemployment ranged from 6.2 million to 7.1 million workers between January 1989 and September 1990. Thus, a one-percentage-point change in the unemployment rate affected 62,000 to 71,000 workers. Unemployment during the eighteen months preceding the onset of the 1990–91 recession was well above the full employment level of 4 percent. This indicated that the economy had a fair amount of unused resources during the expansion. For a discussion of full employment, see Chapter 6 under Definition of Full Employment. Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically

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bought by all urban households, including workers in all urban occupations, the unemployed, and retired persons. For a discussion of inflation and deflation and of price indexes in general, and for more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 10.3 shows the monthly percentage change in the CPI from January 1989 to September 1990 on a real-time basis. From January 1989 to June 1990, the CPI typically increased at a monthly rate of 0.2 to 0.5 percent. The exceptions were March to May 1989, which had increases of 0.6 to 0.7 percent, and January 1990, which had an increase of 1.0 percent. In the three recession months, the CPI increased by 0.4 percent in July, 0.9 percent in August, and 0.8 percent in September. The large increases in August and September reflected the Iraqi invasion of Kuwait in August 1990. Food and Energy Contributions to Inflation Table 10.5 (page 259) shows the percentage change in the CPI, with and without the volatile food and energy components, in six-month intervals at annual rates, from December 1988 to June 1990. For the CPI all items index, price increases of 5.7 to 5.8 percent during the first six months of 1989 and of 1990 were sandwiched around a lower increase of 3.6 percent during the last six months of 1989. For the CPI excluding food and energy, price increases of 4.4 to 4.5 percent during the two six-month periods of 1989 accelerated to 5.4 percent in the first six months of 1990. This appears as an increasing rate of underlying (core) inflation, because it abstracts from the great volatility of energy prices. The sharp increase of 17 percent in energy prices during the first half of 1989, due to the actions of Organization of Petroleum Exporting Countries (OPEC), reflected OPEC’s power to limit crude oil production.4 Added to these upward price pressures were temporary supply disruptions in Alaska and the North Sea. These led to the U.S. crude oil benchmark price (West Texas Intermediate) jumping from $13 per barrel in November 1988 to $19 per barrel in early May 1989, and then remaining between $19 and $20 per barrel into June. The increase of food prices by 6.7 percent (annual rate) in the first half of 1989 stemmed from shortages lingering from the drought in 1988 and additional damage to crops in 1989. In the second half of 1989, about one-third of the largely OPEC-driven price increase in the first half of 1989 was reversed.5 This was given a temporary fillip by tighter standards applied on the composition of gasoline in the summer months, which expired after the summer. Supply problems in some agricultural markets, largely arising from a poor wheat crop and a shortfall in dairy production, had a large role in keeping food increases as high as 4.4

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Figure 10.3 Consumer Prices in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

percent (annual rate), though noticeably lower than the jump in the first half of 1989. In the first half of 1990, the higher price increases in food of 6.8 percent, and in energy of 6.7 percent, reflected weather-related conditions in the first part of the year, which held down some food production and raised heating oil prices.6 keep second call-out Some of these impacts were reversed in the second quarter of 1990. Because of the transitory nature of food and oil price changes, the concept of underlying or core inflation is a useful measure in assessing price movements. However, this measure eliminates only the first-round impacts of the immediate period in which changes in food and energy prices occur. Thus, while price increases in one period can be lessened or reversed to some extent in the following period, cumulated price increases in food and energy in previous periods filter into the wider spectrum of manufacturing and service

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Table 10.5 Consumer Price Index, with Food and Energy Components (percentage change at annual rates)

All Items

Food

Energy

All Items Less Food and Energy

5.7 3.6 5.8

6.7 4.4 6.8

17.0 –5.5 6.7

4.5 4.4 5.4

Dec 88–June 89 June 89–Dec 89 Dec 89–June 90

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Annualized rates calculated by author.

industries that use these products. By becoming embedded in the economy at large, the spurt in food and energy price increases either drives up inflation, or holds down a deceleration of inflation. In my judgment, either movement does not reflect an overheating of the economy because of the presence of excess demand. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 10.4 shows the monthly percentage change in the IPI from January 1989 to September 1990 on a real-time basis. During 1989, monthly increases in the IPI peaked at 0.7 in one month, with increases of 0.3 to 0.4 percent in four months, and of 0.1 percent in two months. Decreases (below the zero line) of 0.4 percent occurred in one month, of 0.2 percent in one month, and of 0.1 percent in three months. In 1990, from January to June preceding the onset of the 1990–91 recession in July, monthly increases in the IPI of 0.6 percent occurred in three months, and of 0.5 percent in one month. A monthly decrease of 1 percent occurred in one month, and of 0.4 percent in another. In the three recession months, zero change occurred in one month, a decrease of 0.2 in one month, and an increase o 0.3 percent in one month. While the number of monthly increases in IPI exceeded the number of monthly decreases during 1989 and the first six months of 1980, the decreases were sufficiently frequent to result in overall modest increases over the eighteen months preceding the onset of the 1990–91 recession.

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Figure 10.4 Industrial Production Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capacity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries from 1988 to 1990 was: 1988 1989 1990

83.9% 83.1% 81.6%

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The CUR at 83.9 percent in 1988 was strong, but not at a full utilization of manufacturing capacity, though toward the end of the year it was approaching 85 percent, which is considered full capacity. The lessening in the CUR to 83.1 percent in 1989 reflected a decline from 85.4 percent in January to 81.8 percent in December. The drop in the CUR in 1990 to 81.6 percent resulted when a rate slightly above 82 percent from January to June drifted down from 81.9 percent in July to 79.2 percent in December. The few instances of full-capacity CURs were not sufficient to draw on older, less productive, and less reliable equipment, whose use would have pushed up production costs, causing inflationary price pressures. Thus, in the eighteen months preceding the onset of the 1990–91 recession, industrial production costs did not contribute to inflation. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 10.5 shows the monthly percentage change in housing starts on a real-time basis from January 1989 to September 1990. During 1989, monthly increases in housing starts occurred in four months, and declined (below the zero line) in eight months. From January to June of 1990, preceding onset of the 1990–91 recession in July, housing starts increased in one month, and declined in five months. Housing starts declined in the three months of the recession from July to September. Housing starts were, with few exceptions, a weak area of the economy in the eighteen months preceding the onset of the 1990–91 recession. Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 10.6 (page 263) shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from January 1989 to September 1990. During 1989, earnings increased by 1.3 percent in two months, 0.7 and 0.8 percent each in one month, 0.4 and 0.5 percent each in one month, and 0.2 percent in two months, and declined (below the zero line) in four months. In 1990 from January to June, preceding the onset of the 1990–91 July, earnings declined slightly in January, and then increased monthly by 0.3 to 0.8 percent. In the recession months, earnings declined in July, increased slightly in August, and increased 1.2 percent in September.

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Figure 10.5 Housing Starts in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

Table 10.6 (page 264) shows the six-month movements of worker earnings between December 1988–June 1989 and December 1989–June 1990 in current dollars and in 1982 dollars, based on data as of 2008. In the current dollar measure, worker earnings increases accelerated from an increase of 1.2 percent in the December 1988–June 1989 period to 2.2 percent in the December 1989–June 1990 period. In the 1982 dollar measure, which is adjusted for inflation, worker earnings decreased in two of the three periods, at 1.7 and 0.1 percent, and earnings increased in one period by 0.2 percent. Worker earnings increased at accelerated rates in current dollars, in the six-month periods from December 1988–June 1989 to December 1989–June 1990. In contrast, worker earnings adjusted for inflation fell in two of the three six-month periods, which resulted in workers falling behind in the spending power of their incomes, and consequently in their living conditions.

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Figure 10.6 Job Earnings in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all private nonfarm industries. Note: The 1990–91 recession began in July 1980 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.7 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally

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Table 10.6 Worker Earnings

Six-Month Periods

Percentage Change in Current Dollars

Percentage Change in 1982 Dollars

1.2 1.9 2.5

–1.7 0.2 –0.1

December 1988 to June 1989 June 1989 to December 1989 December 1989 to June 1990

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on seasonally adjusted data as of 2008.

revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 10.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from January 1989 to September 1990. Interest rates rose early in 1989 to a high of 9.6 percent in March. They fell to 7.8 percent in July, and after rising to 8.0 to 8.3 percent between August and October, declined to 7.8 percent in November and December. In 1990, interest rates rose to a peak of 8.8 percent in April, and fell to 8.4 percent in June preceding the onset of the 1990–91 recession in July. During the three recession months of July to September, interest rates ranged between 8.2 and 8.3 percent. Figure 10.7b (page 266) shows the monthly federal funds interest rate from January 1989 to September 1990. The federal funds rate rose early in 1989 to a high of 9.81 to 9.85 percent between March and May. It then declined to 8.2 percent in January 1990, followed by fluctuations between 8.2 and 8.3 percent through June, the last month before the onset of the recession. During the three recession months of July to September, the federal funds rate was between 8.13 and 8.2 percent. Interest rates declined from peak levels early in 1989, to a lower fluctuating level from July to December. During 1990, interest rates rebounded partially through April, and declined to levels above the low points of 1989. The federal funds rate declined from the high levels in early 1989 to relatively steady low points during 1990 in the run-up to the recession. This indicated an easing by the Federal Reserve in making more credit available to stimulate the economy. Commercial and Industrial Bank Loans During 1989, commercial and industrial loans by U.S. commercial banks for working capital and investment, unrelated to loans for mergers, were about the same in 1989 as in 1988.8 Based on the Lending Practices Survey (LPS)

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Figure 10.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

of sixty large banks conducted by the Federal Reserve, the major reasons for little change in the loan volume between 1988 and 1989 were, in order of importance, weaker loan demand, tighter credit standards applied to borrowers, and greater use of commercial paper by large businesses. During 1990, bank loans for working capital and investment, unrelated to mergers, held down the demand for such loans because of a decline in economic activity and tightened credit terms and standards, based on the LPS.9 Before the beginning of the recession in July 1990, banks had tightened nonprice terms of credit to small and medium firms, such as collateral requirement and loan covenants. (After Iraq invaded Kuwait in August 1990, which was during the recession, banks raised the credit terms and standards on large firms as well.) Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings,

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Figure 10.7b Federal Funds Interest Rate in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 1990–91 recession began in July 1990 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

and garden equipment. The data are adjusted for price change, and thus represent real movements in consumer durable goods spending. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 10.8 shows the monthly percentage change at an annual rate in real consumer durable goods spending on a real-time basis from January 1989 to September 1990. During 1989, consumer durable goods spending increased in five months, declined (below the zero line) in six months, and had zero change in one month. In the first six months of 1990 preceding the onset of the 1990–91 recession in July, consumer durables spending increased in three months and declined in three months. In the recession months, consumer durables spending increased in July, declined in August, and increased in September. The volatility occurred both in motor vehicles and in furniture and household equipment. Consumer durable goods spending was volatile during the eighteen

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Figure 10.8 Real Consumer Durable Goods Spending in Expansion Preceding the 1990–91 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1990–91 recession began in July 1980 and ended in March 1991, so only July to September 1990 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, September 1989 data became available in October 1989). Data from January 1989 to February 1990 represent data available as of March 1990. Data from March 1990 to September 1990 represent data when they first became available one month after each data month. The monthly patterns of the March 1990 to September 1990 data are similar to the later data for those months that first became available in November 1990.

months preceding the onset of the 1990–91 recession. There was no underlying strength, as monthly increases were interrupted with continuing monthly declines. Gross National Product The gross national product (GNP) is the most comprehensive measure of economic growth. The data are adjusted for price change, and thus represent real quarterly movements in the GNP. The data are provided quarterly, not monthly like most of the other economic indicators used in the book. For more detail on the attributes of the GNP data, see Chapter 2 under Gross National Product. Figure 10.9 shows the quarterly percentage change at an annual rate in the real GNP on a real-time basis from the first quarter of 1989 to the third quarter

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Figure 10.9 Real Gross National Product in Expansion Preceding the 1990–91 Recession, Plus One Recession Quarter, in Real Time

s2ECESSIONQUARTER Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 1990–91 recession began in July 1980 and ended in March 1991, so only the third quarter of 1980 is shown in the figure as a recession quarter. Each quarter’s data became available one month after the data quarter (for example, October–December 1989 data became available in January 1990). Data from January–March 1989 to January–March 1990 represent data available as of April 1990. Data from April–June to July–September 1990 represent data when they first became available one month after each data quarter. The April–June 1990 increase of 1.2 percent compares with an increase of 0.4 percent for that quarter that first became available in November 1990, while the July–September 1990 increase of 1.8 percent is similar to the increase of 1.7 percent for that quarter that first became available in November 1990.

of 1990. During 1989, GNP growth fell from 3.7 percent in the first quarter to 1.1 percent in the fourth quarter. In 1990, after rising to 2.1 percent in the first quarter, GNP growth fell to 1.2 percent in the second quarter, preceding the onset of the 1990–91 recession in the third quarter. In the third quarter, GNP growth increased to 1.8 percent. GNP was tepid in the five quarters preceding the onset of the 1990–91 recession. This overall slow growth also occurred among most of the major GNP components.10 Assessment of Economic Policies Preceding the 1990–91 Recession The movements of the economic indicators during the months preceding the onset of the 1990–91 recession described above are summarized as follows:

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s *OBGROWTHBECAMEPROGRESSIVELYWEAKERFROM*ULYTO*UNE the last month of the expansion. s 5NEMPLOYMENTDURINGTHEEIGHTEENMONTHSPRECEDINGTHEONSETOFTHERECESsion was well above the full employment level of 4 percent, indicating the economy had a fair amount of unused resources during the expansion. s #OREINmATION WHICHEXCLUDESFOODANDENERGYPRICES ACCELERATEDAT relatively high levels of 4.4 percent during 1989 to 5.4 percent during the first half of 1990. Transitory price increases resulting from temporary supply shortages in food and energy, though subsequently reversed, became embedded in the economy, which in turn led to greater inflation. However, this inflation did not reflect an overheating of the economy due to excess demand. s )NDUSTRIAL PRODUCTION SHOWED ONLY MODEST GAINS DURING THE EIGHTEEN months preceding the onset of the recession. s (OUSINGSTARTSWEREAGENERALLYWEAKAREAINTHEEXPANSIONPRECEDING the onset of the recession. s 7ORKEREARNINGSINCREASEDINMONEYWAGES BUTEARNINGSADJUSTEDFOR inflation fell in the expansion preceding the onset of the recession, resulting in a loss of spending power and living conditions of workers. s )NTERESTRATES ANDTHEFEDERALFUNDSRATE DECLINEDDURINGTHEEXPANSION preceding the onset of the recession. Tighter credit standards were applied to borrowers at banks. s 4HEREWASNOUNDERLYINGSTRENGTHINCONSUMERDURABLEGOODSSPENDING as monthly increases were interrupted with continuing monthly declines in the eighteen months preceding the onset of the recession. s 'ROSSNATIONALPRODUCTGROWTHWASTEPIDINTHElVEQUARTERSPRECEDING the onset of the recession. This slow growth also occurred among most of the major GNP components. As noted in the beginning of the chapter, several domestic and international events had an impact upon the American economy during the expansion preceding the onset of the 1990–91 recession: the federal deregulatory program, federal income tax cuts, large increases in defense spending, savings and loan association failures, sharp fluctuations in the value of the dollar, the stock market crash, Hurricane Hugo and the San Francisco Bay Area earthquake, and the breakup of the Soviet Union. My notions of the economic impacts of these events are: s &EDERALINCOMETAXCUTSANDINCREASEDDEFENSESPENDING ACCOMPANIED by the sharp jump in federal government deficits, bolstered economic growth and employment.

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s &EDERALDEREGULATORYACTIVITIES did not foster an increase in productivity. s 3AVINGS AND LOAN ASSOCIATION FAILURES led to higher interest rates for homebuyers, but I am not sure of the impact on mortgage lending and housing starts. s &LUCTUATIONSINTHEFOREIGNEXCHANGEVALUEOFTHEDOLLAR improved the competitive position of U.S. exports when the dollar value declined, but the dollar decline also may have resulted in the United States becoming less attractive for foreign investments. s 4HESTOCKMARKETCRASHPROBABLYTAMPEDDOWNECONOMICGROWTHINLATE 1987 and part of 1988. s (URRICANE(UGOIN3OUTH#AROLINAANDTOASMALLEREXTENTIN.ORTH#AROlina, and the San Francisco Bay Area Earthquake, undoubtedly lessened national economic growth in 1989 and 1990 preceding the 1990–91 recession, though by small amounts. s 4HEBREAKUPOFTHE3OVIET5NION relieved the concerns from the threats of a long-time enemy in the Cold War, which lessened the military spending associated with the Cold War. My overall conclusion on what precipitated the 1990–91 recession is that the expansion had run out of steam. I attribute this weakening of the expansion to the fact that the stimuli from the federal tax cuts of the early 1980s, together with the sharp increases in defense spending and the federal government deficits that began in the early 1980s, had run their course. Two secondary aspects of the economy contributed to the downturn. One aspect is that business cycles occur in countries in which the economies are mainly market driven, as noted in Chapter 1 under Business Cycles and Recessions. Business cycles are associated with industrially advanced nations that have highly developed business and financial structures, and in which the marketplace does not always adapt smoothly to the complexities of a host of factors affecting economic life. There also is the ongoing problem faced by businesses of accurately gauging the demand for their products in setting their production schedules. The second aspect is the combined effect of selected domestic events noted above, all of which had negative effects on national economic growth, though they are difficult to quantify. Notes 1. I chose the initial and terminal years of the three long expansions to avoid having the depressed level of an interim cyclical recession distort the long-term growth rates. In this case, the 1980 and the 1981–82 recessions were only one year

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apart. This had a virtual effect of one long recession, which depressed the 1981 levels of economic activity. In addition, the 1981–82 recession began in mid-1981, which further depressed the 1981 annual level of economic activity. The outcome of using 1981–89 as the period of the expansion of the 1980s, in contrast to the 1979–89 period, is as follows: Expansion period 1959–69 1979–89 1981–89 1989–2000

Real GDP (annualized rates) 4.4 3.0 3.5 3.1

Labor productivity (annualized rates) 3.1 1.5 1.7 3.4

Use of the 1981–89 period shows a real GDP growth rate of 3.5 percent, still noticeably below the 1959–69 growth rate of 4.4 percent, though above the 1989–2000 growth rate of 3.1 percent. Use of the 1981–89 period shows a labor productivity annual increase of 1.7 percent, still much below the 1959–69 increase of 3.1 percent and much below the 1989–2000 increase of 3.4 percent. 2. This review is based on Mark Carlson, “A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response,” Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System, Staff Working Paper 2007–13, 2007. 3. Program trading is based on computer models that quickly trade particular amounts of a large number of stocks when certain conditions are met. 4. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” submitted July 20, 1989, Federal Reserve Bulletin, August 1989, p. 535. 5. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” submitted February 20, 1990, Federal Reserve Bulletin, March 1990, p. 114. 6. Ibid. 7. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 8. John V. Duca and Mary M. McLaughlin, “Developments Affecting the Profitability of Commercial Banks,” Federal Reserve Bulletin, July 1990, p. 479. 9. Allan D. Brunner, John V. Duca, and Mary M. McLaughlin, “Recent Developments Affecting the Profitability and Practices of Commercial Banks,” Federal Reserve Bulletin, July 1991, p. 508. 10. “The Business Situation,” Survey of Current Business, July 1990, p. 1.

11 The Recession of 2001

The recession of 2001 began in March 2001 and ended in November 2001. It followed an expansion of 120 months, or ten years, from March 1991 to March 2001. The expansion was the longest since the end of World War II. Topics covered here on the expansion period preceding the 2001 recession are: s %CONOMICRECORD s &ISCALPOLICY s -ONETARYPOLICY s 3TOCKMARKETANDTELECOMMUNICATIONSCOMPANIESBUBBLES Economic Record In reviewing the pattern of economic growth during the 1990s plus the year 2000, I chose to gauge the growth from the full recovery year of 1992 as the base year of the calculation. This measure results in an expansion of eight years, from 1992 to 2000. The eight years, in contrast to the ten years of the expansion noted above, extended from the end of the 1990–91 recession in March 1991 to the end of the expansion in March 2001. I began with the full recovery year of 1992 so as not to skew the effect of the initial recovery movement from a low recession base. Table 11.1 divides the 1992–2000 period into two segments, 1992–95 and 1995–2000. This highlights the improved performance of the economy as the expansion progressed. It summarizes annual trends of major macroeconomic indicators during the expansion: real gross domestic product (real GDP), employment, consumer price index, productivity, and unemployment. The data represent the measures available at the time of this writing in 2009. An Overall Glance Economic growth based on the increase in the real GDP accelerated from an annual rate of 3.1 percent during 1992–95 to 4.1 percent during 1995–2000. 272

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Table 11.1 Economic Trends, 1992–2000 (annual percentage rates)

a

Real gross domestic product Employmentb Consumer price indexc Productivityd Unemploymente 1992 1995 2000 Absolute number of jobs createdb

1992–95

1995–2000

1992–2000

3.1 2.6 2.8 0.5

4.1 2.4 2.5 2.7

3.7 2.4 2.6 1.9

7.5 5.6 4.0 8,572,000

14,487,000

23,059,000

a

Sources: Bureau of Economic Analysis, U.S. Department of Commerce; Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on data available in 2008.

b, c, d, e

Employment growth based on the increase in the number of jobs declined from an annual rate of 2.6 percent during 1992–95 to 2.4 percent during 1995–2000. The unemployment rate fell from 7.5 percent in 1992, to 5.6 percent in 1995, to 4.0 percent in 2000. Inflation based on the increase in the consumer price index declined from an annual rate of 2.8 percent during 1992–95 to 2.5 percent during 1995–2000. Labor productivity increased from an annual rate of 0.5 percent during 1992–95 to 2.7 percent during 1995–2000. Job Growth and Unemployment The rate of job growth declined slightly in the 1995–2000 period, but in absolute levels, the net increase of jobs was impressive. The number of jobs created rose from 8.6 million during 1992–95 to 14.5 million during 1995–2000, for a total increase of 23.1 million from 1992 to 2000. The drop in unemployment to 4.0 percent in 2000 represented a recognized level of full employment, as discussed in Chapter 6 under Definition of Full Employment. The drop in the unemployment rate occurred while the labor force participation rate (LFPR) continued its long-term rise through 1997, peaking at 67.1 percent in that year, and leveling at 67.1 percent through 2000. The LFPR is the sum of civilian employed and unemployed workers as a percentage of the civilian noninstitutionalized population sixteen years of age or older. Inflation Inflation declined from an annual rate of 2.8 percent during 1992–95 to 2.5 percent during 1995–2000. Alan Blinder and Janet Yellen attribute most of the

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disinflation during 1995–2000 to a decline in fringe benefit payments by employers to workers both for health insurance costs and for employer contributions to retirement benefits.1 The decline in fringe benefits occurred during 1995–98 or 1996–98, depending on two different models cited by the authors. The decline in health insurance costs occurred when employers moved workers from fee-for-service to managed-care plans, and it also reflected decreases in health insurance coverage and increases in co-payments and deductibles. The decline in retirement benefits resulted from the rise in the stock market, which allowed employers to put less into defined-benefit worker retirement plans. Blinder and Yellen suggested two possible explanations for the acquiescence of workers to the decline of these fringe benefits. One is a “traumatizedworker hypothesis,” which is that American workers placed more value on job security than on real wage increases because of three factors: (a) the restructuring of American industry during the 1980s, in which domestic firms cut back on employment in order to reduce their production costs, in response to their loss of competitive position to foreign products; (b) job losses suffered from the 1990–91 recession; and (c) the “jobless recovery” in the early years following the end of the 1990–91 recession, as discussed in Chapter 1 under Jobless Recoveries from Recent Recessions. The other explanation is the declining bargaining position of American unions. This is reflected in the continuous decline of the total work force represented by union workers—for example, union membership of wage and salary workers fell from 24 percent in 1973 to 13.5 percent in 2000 and 2001.2 In a broader view, this second explanation probably was operating as a fourth factor in the first explanation. The authors also noted smaller transitory effects that lowered the inflation rate in the late 1990s. These were associated with the rise in the value of the dollar, which lowered the price of imports (and forced domestic producers to control costs in order to compete with imports), a decline in oil prices, and a methodological change in calculating the consumer price index that lowered the measured inflation rate. Productivity Dale Jorgenson, Mun Ho, and Kevin Stiroh estimate the average annual rate of labor productivity growth changing from 1.5 percent between 1973 and 1995, to 2.7 percent between 1995 and 2000, to 2.5 percent between 2000 and 2006.3 The authors largely attribute the increase during 1995–2000 to a widespread surge in the production and use of information technology among business firms, particularly the use of computers and telecommunications equipment.

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However, they attribute the increase during 2000–2006 to a shift from an increasing accumulation of capital information technology to possible factors as investments in unmeasured capital inputs for research and development, organizational change, and other business processes, which allowed a slowdown in the growth of hours worked. They also note a variety of other possible factors, such as a cyclical recovery from the 2001 recession, which would imply that the gains were temporary; increased competitive pressures on industry; and lags in the application of information technology in learning how to use the technology investments most efficiently. The authors also note that to make the investments in information technology pay off, firms typically have to make large complementary investments in such areas as business organization, workplace practices, and human capital. High rates of productivity increase lessen the effects on business production costs of increased prices for purchased materials and services, labor, and capital equipment, and consequently help in containing inflation. Fiscal Policy Federal government budget surpluses and deficits represent the difference between government receipts (mainly taxes) and government expenditures (outlays for goods, services, structures, income support programs, and interest on the federal debt). I use the estimates of the federal economic transactions that are developed from the national income and product accounts (NIPAs), rather than from the official federal budget data in the budget laws passed each year. The levels and yearly movements of the two data series are similar, though they differ because of variations in the coverage of certain items, in the timing of when items are recorded, and in accounting definitions. I use estimates from the NIPAs of federal expenditures and receipts because they are fully integrated with the measures of economic growth as summarized by the gross domestic product, and thus are more relevant for assessing their economic impacts. The terminology of the difference between expenditures and receipts in the NIPAs is “net federal government saving,” which is positive if receipts exceed expenditures, and negative if expenditures exceed receipts. This differs from the “surplus” and “deficit” terminology of the official budget data in recording the difference between receipts and expenditures noted above. Terminology aside, “net federal saving” in the NIPAs is akin to the official budget nomenclature of “surplus” and “deficit,” but because the NIPAs federal economic transactions are not a legislated budget, use of the more neutral economic term “net federal government saving” avoids confusing it with the official budget.

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The Budget Shifts from a Deficit to a Surplus Table 11.2 shows federal receipts minus expenditures from 1992 to 2000. The difference between the two was negative from 1992 to 1997 because expenditures exceeded receipts in those years. However, the deficit declined continuously in those years, from $297.4 billion in 1992 to $55.8 billion in 1997. The budget then shifted into a surplus, rising from $38.8 billion in 1998 to $189.5 billion in 2000. The decline in the budget deficit and change to a surplus position resulted from three factors: s Increase in federal income tax rates in 1993, as discussed below under Federal Government Receipts s 3LOWDOWNINTHEINCREASEOFTOTALFEDERALEXPENDITURESBETWEEN and 1998, including a decline in national defense spending, as discussed below under Federal Government Expenditures s #ONTINUED ECONOMIC GROWTH OVER THE PERIOD AS NOTED IN THE ABOVE section on Economic Record. This increased federal receipts because of the increase in household and business incomes, and also decreased federal expenditures on income support programs because of the healthy economy. In addition, the decline in the rate of inflation lessened the cost-of-living allowances for Social Security benefits and other income maintenance programs that are indexed to inflation. Federal Government Receipts Individual income tax rates were increased in 1993 as part of the Omnibus Budget Reconciliation Act of 1993 (OBRA93), which was enacted in August 1993. These tax increases were confined to the highest-income households.4 In addition, OBRA93 expanded the Earned Income Tax Credit, which lowered taxes for low-income workers. Table 11.3 shows the distribution, based on household income, of changes in marginal tax rates among married individuals filing jointly under OBRA93. There were no changes in the marginal tax rates for such households with annual income under $140,000. The tax rates were increased from 31 percent to 36 percent for households with annual income of $140,000 to under $250,000, and the tax rates were increased from 31 percent to 39.6 percent for households with income of $250,000 and over. OBRA93 also expanded the Medicare payroll tax to apply to all wage and salary incomes, in place of the previous limit on the first $135,000 of earnings; raised the taxable portion of Social Security benefits for the top 13 percent of recipients; increased the motor fuels tax; raised the top corporate tax rate;

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Table 11.2 Federal Government Receipts Minus Expenditures Billions of Dollars 1992 1993 1994 1995 1996 1997 1998 1999 2000

–297.4 –273.5 –212.3 –197.0 –141.8 –55.8 38.8 103.6 189.5

Source: Bureau of Economic Analysis, U.S. Department of Commerce, as part of the national income and product accounts. Table 11.3 Marginal Tax Rates on Married Individuals Filing Jointly, Before and After Omnibus Budget Reconciliation Act of 1993 Taxable Income (dollars)

Marginal Percent Rate of Previous Law

0–36,899 36,900–89,149 89,150–139,999 140,000–249,999 250,000 and over

15 28 31 31 31

Marginal Percent Rate of 1993 Law 15 28 31 36 39.6

Source: “Annual Report of the Council of Economic Advisers,” Economic Report of the President, February 1994, Table 1-4, p. 34. Based on data from the U.S. Department of the Treasury.

and closed various business tax loopholes, along with providing various tax incentives for business investment.5 In addition to the rise in federal government receipts stemming from the increases in tax rates, federal receipts rose from the growth in the economy, as noted above under Economic Record. This reflected the increase in household and business incomes arising from the greater economic growth, which in turn generated greater federal receipts. Federal Government Expenditures Total federal spending covers civilian and defense needs. It includes transfer payments for Social Security benefits, Medicare, Medicaid, and Unemployment Insurance, and interest on the federal debt.

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Table 11.4 Federal Government Expenditures (billions of dollars)

1992 1995 1998 Three-year change 1992-95 1995-98

Total

National defense

1,444.6 1,603.5 1,734.9

376.9 348.7 345.7

158.9 131.4

–28.2 –3.0

Source: Bureau of Economic Analysis, U.S. Department of Commerce, as part of the national income and product accounts.

Table 11.4 shows federal spending between the three-year periods of 1992–95 and 1995–98 for the total of all federal spending and for defense spending. Total federal spending increased $158.9 billion from 1992 to 1995, and then increased $131.4 billion from 1995 to 1998. The change in spending between the three-year periods resulted in a decline in the increases of $27.5 billion (158.9–131.4). National defense spending decreased $28.2 billion from 1992 to 1995, and decreased $3.0 billion from 1995 to 1998. The total decrease in defense spending was $31.2 billion from 1992 to 1998 (28.2 + 3.0). The effect of the budget shift from a deficit to a surplus in 1998 noted above in Table 11.2 also resulted in a decline in the federal debt, upon which federal interest payments are made to holders of the debt. The decline in the debt lowered federal spending for interest payments. From a peak level of $300.0 billion in 1997, interest payments fell to $283.3 billion in 2000. In addition to lower spending for defense and interest on the federal debt, the containment of federal spending increases benefited from two overall developments—the Budget Enforcement Act of 1990 and the above-noted Omnibus Budget Reconciliation Act of 1993. Both introduced spending disciplines, though in varying ways, by linking proposed spending increases for particular programs in the budget process by either having offsetting decreases in other programs or raising taxes. The other overall development in helping to contain spending increases was the decline in the rate of inflation. The decline in inflation lessened cost-of-living allowances for Social Security benefits and other federal income maintenance programs that are indexed to inflation. Federal spending continued to increase in 1999 and 2000, bolstered in part by increases in defense spending for American participation in the war with

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Serbia. Prior to this “hot war,” 20,000 U.S. troops were sent along with 40,000 troops from other NATO nations to supervise a hoped-for peaceful transition in the breakup of Yugoslavia between Serbia and Bosnia-Herzegovina in 1995. Nonetheless, receipts increased more than spending in 1999 and 2000, leading to the increased surpluses for those years noted above in Table 11.2. Monetary Policy Alan Blinder and Janet Yellen chronicled the monetary policy of the Federal Reserve during the 1993–2000 expansion. Both authors were members of the Board of Governors of the Federal Reserve during part of the 1990s, from which they had an inside view; later in the decade they used a close reading of the published minutes of the policy makers of the Federal Open Market Committee (FOMC) of the Federal Reserve System.6 In addition to reporting on the monetary policy actions taken both during and after their tenures, they provided the economic analyses and thinking behind those actions. The thrust of their review was that the monetary policymakers were continually concerned with a prospective accelerating inflation during the expansion, and yet continually surprised, particularly from 1995–99, that inflation remained so low. An early example of the concern with inflation was the monetary restraint the FOMC applied on making bank loans more expensive by influencing higher interest rates from February 1994 to February 1995, in order to lessen economic growth. This restraint began three years into the recovery and early expansion from the 1990–91 recession, which had ended in March 1991. This was a preemptive strike to stave off expected accelerating inflation, though the six-month annual rate of increase in the consumer price index (CPI) during 1992–93 was fluctuating within 1.9 to 3.6 percent:

December 1991–June 1992 June 1992–December 1992 December 1992–June 1993 June 1993–December 1993

Annual Percentage Increase in the CPI 3.4 2.4 3.6 1.9

As noted in Table 11.1, the inflation rate declined from an average annual increase of 2.8 percent from 1992 to 1995, to 2.5 percent from 1995–2000. The factors considered to have blunted inflation, despite the increase in economic growth and employment, and the decrease in unemployment, were discussed above under Economic Record as components of “Inflation” and “Productivity.” Still, by 1997, Blinder and Yellen felt that the FOMC was

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ready to restrain credit and economic growth. But with the currency crises in Asian countries in 1997, Russia’s devaluation and default in 1998, and the collapse of the Long Term Capital Management hedge fund in 1998, the FOMC decided it was too risky given the deteriorating international financial situation. Blinder and Yellen also cite what they refer to as “Good Luck,” which is associated with price and wage shocks that held down inflation during the mid-1990s. Shocks are extraordinary events, which if they are economically significant, change an expected path of economic growth, employment, and inflation that would otherwise appear in econometric forecasting models. The major shocks are the above-noted fringe benefit cutbacks in worker compensation for health insurance and retirement and productivity improvements in the Economic Record section. Less important shocks are the previously noted smaller transitory effects in the Economic Record under “Inflation” associated with the rise in the value of the dollar, which lowered the price of imports, and a decline in oil prices. There was also a methodological change in calculating the consumer price index that lowered the measured inflation rate, which was not a shock, though it made the performance of the economy look better than it was during 1995–99. The attribution of good luck stemming from price and wage shocks that contained inflation assumed, of course, that econometric forecasting models accurately forecast that inflation would have accelerated had the shocks not occurred. An econometric forecasting model is based on an average of past trends in the economy over several business cycles, and as averages, does not necessarily capture the particular aspects of each cycle, even if giving more weight to the more recent cycles. I do not have confidence in the “What If” nature of the hypothetical forecasts leading to the good luck interpretation on inflation. By mid-1999, the FOMC decided that despite the low inflation and the lower inflationary expectations, the economy was pushing toward excessive demand that exceeded the economy’s potential to grow without creating inflation. That majority view within the FOMC, though not agreed with by several other members, led to a tightening of monetary policy in mid-1999. Stock Market and Telecommunications Company Bubbles Speculation in the stock market, and the appearance of financially shaky telecommunications companies, were prominent in the late 1990s. I believe they had a role in bringing on the recession of 2001. I also believe they aggravated the recession once it started, and added to the jobless recovery in the early years after the end of the recession.

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Stock Market Speculation Table 11.5 shows the movement of common stock prices, earnings-price ratios, and dividend-price ratios from 1994 to 2000 for the Standard & Poor’s Composite 500 Price Index (S&P 500). Following an annual increase in stock prices of 2.0 percent in 1994, annual increases in stock prices jumped to a range of 17.7 percent to 30.3 percent between 1995 and 1999. The price increase dropped sharply to 7.5 percent in 2000. The stock price increases were driven by the expectation of investors that prices would continue to rise sharply in the future. This expectation of price appreciation was far into the future of the actual growth, profits, and dividends of the publicly traded companies, which ultimately drive the value of a company’s stock. The earnings-price ratio drop from 6.09 in 1995 to 3.17 in 1999 signified an implicit discounting of profits well into the future. The dividend-price ratio drop from 2.82 in 1994 to 1.15 in 2000 signifies a continuing transference by investors, from an already exceptionally low dividend payout, to the feeling that their future earnings were wholly tied to future rises in the stock price. It is unclear what the foundation of the actual and potential financial health of the companies was that drove this psychology, other than an unrealistic speculation. Alan Greenspan, chairman of the Board of Governors of the Federal Reserve, referred to the speculation in 1996 as “irrational exuberance.” I believe that the Federal Reserve should have tried to stem the stock market speculation by raising the margin requirement of bank loans for the purchase of stock from the existing margin rate of 50 percent to a higher level, but that it did not do. Rise and Fall of Telecommunications Dot-Coms New telecommunications companies sprang up in the 1990s because of the perceived market potential in the wider application of the Internet. The companies were financed in part by the realized and unrealized capital gains of investors in the stock market, which created an overly optimistic outlook for economic ventures. Many so-called dot-coms were unprofitable and vastly overrated in their economic potential and in their stock market value. When the mirage could no longer be contained, some became much smaller and some went out of business. The stock market S&P 500 index peaked at 1461 in April 2000, and fell to 1331 in December 2000, for a decline of 8.9 percent (this decline continued into 2003). There were substantial job losses in the telecommunications industry, which spread to other industries that supplied goods and services to the dot-coms.

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Table 11.5 Stock Market Prices, Earnings-Price Ratios, and Dividend-Price Ratios (Standard & Poor’s Composite 500 Index)

1994 1995 1996 1997 1998 1999 2000

Common Stock Prices (annual percentage change)

Earnings/Price Ratio

Dividend/Price Ratio

2.0 17.7 23.8 30.3 24.3 22.3 7.5

5.83 6.09 5.24 4.57 3.46 3.17 3.63

2.82 2.56 2.19 1.77 1.49 1.25 1.15

Source: Economic Report of the President, February 2008, Appendix B, Statistical Tables, Table B-96, p. 337. Based on Standard & Poor’s data.

Economic Indicators in Real Time During 1999–2000 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 2001 recession in March 2001 are referred to as real-time data, as discussed under the analogous section of Chapter 2. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSDOMESTICPRODUCT The last section of this chapter is an assessment of the economic policies preceding the 2001 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are of course complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around

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such a sequence. All of the indicators are available monthly, except for the gross domestic product, which is available only quarterly. Monthly data on personal consumption expenditures were first published in 1979, but I used the quarterly data for consumer durable goods spending because real-time monthly data for personal consumer spending were not readily available. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 2001 recession is dated as beginning in March 2001 and ending in November 2001. So March to May 2001 in the figures that follow were the first three months of the recession. To assess what was available to policy makers as 1999 and 2000 progressed, the figures chart the real-time data from October 1999 to December 2000. The starting point for the real-time data is what the economic policy makers—the Federal Reserve, president, and Congress—saw in January 1999. Because economic data became available one month after the month to which they refer, the October 1999 data first appeared in November 1999. Thus, the October starting point provides the most reliable data, including revisions from that time up to October 2000, of the October 1999–October 2000 period. The data from November 2000 to May 2001 reflect the real-time data on a monthly and quarterly basis up to May 2001 as they were produced. Revisions that occurred to the November 2000–May 2001 data as of July 2001 changed the monthly and quarterly patterns at most slightly. I chose October 2000 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in November, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in March 2001. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. As it turned out, the Federal Reserve began easing monetary policy in January 2001. Now, what did the economic policy makers see during late 1999 to 2001 INWHATTURNEDOUTTOBETHERUN UPTO ANDTHEONSETOF THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the at-

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Figure 11.1 Jobs in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural private industry and government payrolls from the establishment survey. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). Data from October 1999 to October 2000 represent data available as of November 2000. Data from November 2000 to May 2001 represent data when they first became available one month after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001.

tributes of the employment data, see Chapter 2 under Employment. Figure 11.1 shows the monthly percentage change in jobs from October 1999 to May 2001 on a real-time basis. Job growth was relatively strong from October 1999 to April 2000, increasing at monthly rates of 0.2 to 0.3 percent, with offsetting increases of 0.1 percent in February 2000 and 0.4 percent in March 2000. Employment growth became sluggish from May 2000 to February 2001, with five months at 0.1 percent, two months at zero change, one month in a decline (below the zero line) of 0.1 percent, and one month at 0.2 percent. In the recession months of March to May 2001, the number of jobs declined in two months and was unchanged in one month. Job growth weakened from May 2000 to February 2001, up to the onset of the recession in March 2001. The annual rate of growth during this ninemonth span was about 20 percent of the growth in the preceding years of the 1990s. Some of this slowdown arose from the decline of the telecommunica-

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tions companies, as noted in the earlier section, “Stock Market and Telecommunications Company Bubbles.” Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 11.2 shows the unemployment rate on a real-time basis from October 1999 to May 2001. Unemployment ranged from 3.9 percent to 4.1 percent from October 1999 to December 2000. During this fifteen-month period, unemployment was 3.9 percent in three months, 4.0 percent in five months, and 4.1 percent in seven months. Unemployment rose to 4.2 percent in January and February 2001, and to 4.3–4.5 percent in the recession months of March to May 2001. Unemployment was at the lowest rates of 3.9 percent and 4.0 percent from April to December 2000, except for rates of 4.1 percent in May and August 2000. Actual unemployment ranged from 5.5 million to 6.3 million workers between October 1999 and May 2001. Thus, a one-percentage-point change in the unemployment rate affected 55,000 to 63,000 workers. The 4 percent unemployment rate represented full employment, as noted in the earlier section on “Job Growth and Unemployment” under Economic Record. The drop in unemployment represented a steady decline in the unemployment rate from 7.5 percent in 1992 to 5.6 percent in 1995 to 4.0 percent in 2000. The 4 percent unemployment rate occurred along with a steady labor force participation rate (LFPR) of 67.1 percent from 1997 to 2000. The LFPR is the sum of civilian employed and unemployed workers as a percentage of the civilian noninstitutionalized population sixteen years of age or older. The stable LFPR from 1997 to 2000 was a change from the continuing increase in the LFPR in previous years. It is the net effect of a cessation of the decline of the LFPR of workers of both sexes aged 16 to 24 years, slowdown in the decline of the LFPR of men workers aged 25 to 64 years, cessation of the rise in the LFPR of women workers aged 25 to 64 years, and an increase in the LFPR of both sexes 55 years and older.7 Unemployment averaged 4.2 percent in 1999 and 4.0 percent in 2000, which is a generally accepted measure of full employment. The lowest rates of unemployment of 3.9 percent and 4.0 percent occurred from April to December 2000.

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Figure 11.2 Unemployment Rate in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). Data from October 1999 to October 2000 represent data available as of November 2000. Data from November 2000 to May 2001 represent data when they first became available one month after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001.

Inflation and Deflation The measure of inflation used here is the consumer price index. It shows the monthly change in the overall cost of the basket of items typically bought by all urban households, including workers in all urban occupations, the unemployed, and retired persons. For a discussion of inflation and deflation and of price indexes in general, and for more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 11.3 shows the monthly percentage change in the CPI from October 1999 to May 2001 on a real-time basis. The monthly movements were volatile, with upward and downward changes of several tenths of a percentage point occurring. Over the seventeen months from October 1999 to February 2000, the range was a decline of 0.1 percent (below the zero line) in one month

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Figure 11.3 Consumer Prices in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). Data from October 1999 to October 2000 represent data available as of November 2000. Data from November 2000 to May 2001 represent data when they first became available one month after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001.

to 0.8 percent in one month. Increases of 0.5 to 0.6 percent occurred in four months, increases of 0.3 to 0.4 percent occurred in two months, increases of 0.1 to 0.2 percent occurred in seven months; zero change occurred in two months. In the recession months of March–May 2001, the CPI increased from 0.2 percent to 0.5 percent. The volatility reflected short-term variations in food and energy prices. Table 11.6 shows six-month changes at annual rates in the all-items CPI and in the CPI minus food and energy, between June 1999–December 1999 and June 2000–December 2000. Pronounced differences in the two measures appeared in the June 1999–December 1999 and the December 1999–June 2000 periods. In both cases, the CPI minus food and energy increased less than 3 percent, at 2.4 and 2.7 percent, compared with increases in the all-items CPI of 3.4 percent and 4.1 percent. The CPI minus food and energy also increased less than the all-items CPI between June 2000–December 2000, at 2.4 percent and 2.8 percent, respectively.

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Table 11.6 Consumer Price Index (percentage change at annual rates)

June 99–Dec 99 Dec 99–June 00 June 00–Dec 00

All Items

All Items Minus Food and Energy

3.4 4.1 2.8

2.4 2.7 2.4

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Annualized rates calculated by author.

Other than the transitory fluctuations in food and energy prices due to changes in crop harvests and the cartel pricing of the Organization of Petroleum Exporting countries, inflation during this period was contained at annual rates below 3 percent. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 11.4 shows the monthly percentage change in the IPI from October 1999 to May 2001 on a real-time basis. The IPI increased in a range of 0.4 percent to 0.8 percent from October 1999 to September 2000, except for a 0.2 percent increase in November 1999 and a 0.1 percent decline (below the zero line) in July 2000. The IPI then declined in all months between October 2000 and February 2001, up to the onset of the recession in March. The declines in this period fell from 0.1 percent to 0.5 percent. In the recession months of March to May 2001, the IPI fell from an increase of 0.4 percent in March to declines of 0.3 and 0.8 percent in April and May. After a strong period of growth from October 1999 to September 2000, the IPI weakened considerably from October 2000 to February 2001 before the onset of the recession in March. This weakening occurred in the most highly cyclical part of the economy. Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capac-

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Figure 11.4 Industrial Production Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). Data from October 1999 to October 2000 represent data available as of November 2000. Data from November 2000 to May 2001 represent data when they first became available one month after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001.

ity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries in 1999 and 2000 was: 1999 2000

80.8% 80.1%

The CUR at 80.8 percent in 1999 and 80.1 percent in 2000 were both well below 85 percent, which is considered full capacity. These relatively low levels did not necessitate drawing on older, less productive, and less reliable equipment, the use of which would have pushed up production costs, causing inflationary price pressures.

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Thus, in the seventeen months preceding the onset of the 2001 recession, industrial production costs did not contribute to inflation. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts. Figure 11.5 shows the monthly percentage change in housing starts on a real-time basis from October 1999 to May 2001. Housing starts were very volatile in that period, with increases in five months ranging from 0.5 percent to 6.4 percent, and declines (below the zero line) in three months ranging from 1.4 percent to 10.5 percent. Starts declined from May to August 2000, ranging from 0.5 percent to 3.7 percent; increased from September 2000 to January 2001, ranging from 0.1 percent to 5.3 percent; and declined in February by 0.4 percent, before the onset of the recession in March. In the March to May recession months, starts increased in one month and declined in two months. The pattern of housing starts in six-month periods between June–December 1999 and June–December 2000, at annual rates, indicates largely offsetting increases and declines: June 1999–December 1999 December 1999–June 2000 June 2000–December 2000

28.3% –21.3% 0.5%

Housing starts ranged from 1.5 million to 1.8 million units over the October 1999–May 2001 period. The monthly movements were volatile, with no pronounced upward or downward trend. Starts for the year 2000 totaled 1,569,000, which was a decline from the 1999 starts of 1,641,000. Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 11.6 (page 292) shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from October 1999 to May 2001. Worker earnings increased between 0.1 percent and 0.7 percent over the seventeen-month period preceding the onset of the recession in March 2001, except for one month of zero change and two months of

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Figure 11.5 Housing Starts in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). Data from October 1999 to October 2000 represent data available as of November 2000. Data from November 2000 to May 2001 represent data when they first became available one month after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001.

decline (below the zero line). In the March to May 2001 recession months, worker earnings increased in two months and declined in one month. Table 11.7 shows the six-month movements of worker earnings between June 1999–December 1999 and June–December 2000 in current dollars and in 1982 dollars, based on data as of 2008. The basic difference between the current-dollar and the 1982-dollar six-month changes appeared in December 1999–June 2000. While the current-dollar increase of 1.9 percent was the largest of the three periods, the 1982-dollar decrease of 1.2 percent was the only decrease of the three periods. The 1982-dollar decrease reflected the large consumer price index increase of 4.1 percent (at an annual rate) for December 1999 to June 2000, as noted above under Inflation and Deflation, in Table 11.6.

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Figure 11.6 Job Earnings in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics for all private nonfarm industries. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available two months after the data month (for example, March 2000 data became available in May 2000). Data from October 1999 to October 2000 represent data available as of December 2000. Data from November 2000 to May 2001 represent data when they first became available two months after each data month. The monthly patterns of the November 2000 to May 2001 data are similar to the later data for those months that first became available in July 2001. Table 11.7 Worker Earnings Six-Month Period June 1999 to December 1999 December 1999 to June 2000 June 2000 to December 2000

Percentage Change in Percentage Change in Current Dollars 1982 Dollars 1.5 1.9 1.1

1.0 –1.2 0.9

Source: Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on seasonally adjusted data available in 2008.

The increases in worker earnings in 1982 dollars of 0.9–1.0 percent between June 1999–December 1999 and June 2000–December 2000 resulted in improved living conditions for workers in the two periods. However, the decline of 1.2 percent in 1982 dollars in December 1999–June 2000 resulted from inflation causing a decline in living conditions.

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Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.9 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 11.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from October 1999 to May 2001 at the beginning of each month. Interest rates rose from 5.9 percent in October and November 1999 to a peak of 6.8 percent in May 2000, and then declined to 4.7 percent in February 2001, one month before the onset of the recession in March. In the March to May 2001 recession months, interest rates declined to 4.4 to 4.5 percent. Figure 11.7b (page 295) shows the monthly federal funds interest rate from October 1999 to May 2001 at the beginning of each month. The federal funds rate rose from 5.2 percent in October 1999 to peak levels of 6.5 percent during June–November 2000. It then declined to 5.5 percent in February 2001, one month before the onset of the recession in March. In the March to May 2001 recession months, the federal funds rate declined to 4.2 percent in May. Federal Reserve monetary policy maintained a peak restraining posture during June–November 2000, when it influenced the federal funds rate at a steady peak level of 6.5 percent. This contrasted with the rates of three-year constant maturities, which peaked much earlier, in May 2000. Commercial and Industrial Bank Loans During 1999, U.S. commercial banks applied tighter credit standards to the issuance of new commercial and industrial loans, according to the Bank

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Figure 11.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

Lending Practices Survey.10 This continued the higher standards adopted in the fourth quarter of 1998 following the Russian government’s default on its domestic debt. The tighter standards were substantiated by the Survey of Terms of Business Lending, which showed that loans secured by collateral and made under commitment were near the top of the historical range, and the dollar volume of loans rated as minimal or low risk increased from 29 percent of total loans in 1998 to 33 percent of loans in 1999. These also led to increased interest rates on all business loans in general and riskier loans in particular, which resulted in businesses relying more on financing their needs through issuing commercial paper and bonds than on bank loans. However, the share of bank loans rose in the fourth quarter of 1999, particularly for large banks, possibly because of the desire among businesses to invest against computer disruptions that might occur in the year 2000 date change. During 2000, U.S. commercial banks tightened their business lending standards on commercial and industrial loans, according to the Bank Lend-

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Figure 11.7b Federal Funds Interest Rate in Expansion Preceding the 2001 Recession, Plus Three Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 2001 recession began in March 2001 and ended in November 2001, so only March to May 2001 are shown in the figure as recession months. Each month’s data became available one month after the data month (for example, March 2000 data became available in April 2000). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

ing Practices Survey.11 In the third quarter of 2000, the proportion of banks tightening standards to large and medium-sized firms rose to over 30 percent, which was comparable to that during the financial turmoil in the second half of 1998. This was substantiated by the Survey of Terms of Business Lending (STBL), which showed that higher-risk loans not made under commitment fell “significantly” to 6 percent of all commercial and industrial loans reported in the STBL. This contrasted with the “marked rise” in the share of lower-risk loans made under previous commitments. Commercial banks increasingly applied more stringent credit terms on commercial and industrial loans to prospective business borrowers from the last quarter of 1998 through 2000. This posture helped weed out speculative loans that had a low chance of being repaid. It also probably discouraged some businesses from borrowing for their operations and investments, as well as leading some borrowers into issuing commercial paper and bonds to raise additional funds.

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Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings, and garden equipment. The data are adjusted for price change, and thus represent real movements in consumer durable goods spending. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 11.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending on a real-time basis from the fourth quarter of 1999 to the second quarter of 2001. Consumer durables spending was volatile in the six quarters up to the first quarter of 2001, which included one month, March 2001, as the beginning of the recession. The spending increase jumped from an already-high rate of 13 percent in the fourth quarter of 1999 to 23.6 percent in the first quarter of 2000, declined (below the zero line) 5 percent in the second quarter of 2000, rose 7.5 percent in the third quarter of 2000, declined 3.4 percent in the fourth quarter of 2000, rose 11.9 percent in the first quarter of 2001, and continued with a strong increase in the second quarter of 2001, the first full recession quarter. The sharp spending increase in the first quarter of 2000 included a surge in purchases for motor vehicles and a rebound in purchases of computers and software, which apparently had been postponed in the fourth quarter of 1999 because of concern about problems with these goods in the year 2000 century date change.12 The subsequent volatile movements as the year 2000 progressed reflect two broad crosscurrents, one weakening and the other strengthening. The weakening crosscurrent was the sluggish job growth beginning in May 2000; a peaking of the stock market in April 2000, as the Standard & Poor’s 500 index declined by 8.9 percent from April to December, probably diminishing the “wealth effect” associated with capital gains that stimulate consumer spending, and lackluster growth in housing starts throughout 2000. The strengthening crosscurrent that stimulated consumer durables spending during 2000 reflected the continuing rise in real disposable personal income, though at slower rates than in 1999. There was also continuing strength in household optimism about the state of the economy through most of the year, but following a mild softness that appeared in late autumn, optimism dropped sharply in December 2000 and January 2001, stemming from the decline in the stock market and more frequent reports of job layoffs.13 This mixed picture of the factors affecting consumer durables spending in the run-up to the 2001 recession is suggestive of the volatile spending patterns during 2000. The strong spending increase in the first quarter of 2001,

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Figure 11.8 Real Consumer Durable Goods Spending in Expansion Preceding the 2001 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time

s2ECESSIONQUARTER4HE*ANUARYn-ARCHQUARTERINCLUDESONEMONTHOFRECESSION (March 2001), and April–June 2001 is a full quarter of recession. Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 2001 recession began in March 2001 and ended in November 2001, so only the first and second quarters of 2001 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, January– March 2000 data became available in April 2000). Data from October–December 1999 to July–September 2000 represent data available as of October 2000. Data from October– December 2000 to April–June 2001 represent data when they first became available one month after each data quarter. The quarterly patterns of the October–December 2000 to April–June 2001 data are similar to the later data for those quarters that first became available in August 2001.

which also appears in the revised data as of 2008, is puzzling. But the strong increase in the real-time data during the second quarter of 2001, which is a full recession quarter, was changed to a decline in the revised data. Gross Domestic Product The gross domestic product (GDP) is the most comprehensive measure of economic growth. The data are adjusted for price change, and thus represent real quarterly movements in the GDP. The data are provided quarterly, not monthly like most of the other economic indicators used in the book. For more detail on the attributes of the GDP data, see Chapter 2 under Gross National Product (GNP). This is the first recession in which the GDP, instead of the GNP, is the featured measure of economic growth, as designated by

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the Bureau of Economic Analysis in the U.S. Department of Commerce, the agency that prepares both measures.14 Figure 11.9 shows the quarterly percentage change at an annual rate in the real GDP on a real-time basis from the fourth quarter of 1999 to the second quarter of 2001. Beginning with the GDP increase of 8.3 percent in the fourth quarter of 1999, the GDP growth rate declined to 2.0 percent in the first quarter of 2001, which included one month, March 2001, as the beginning of the recession, and then to 0.5 percent in the second quarter of 2001, the first full quarter of the recession. There were only slight interruptions in the downward trend over the seven quarters, taking place in the second quarter of 2000 and the first quarter of 2001. GDP growth ranged from 4.8 percent to 8.3 percent between the fourth quarter of 1999 and the second quarter of 2000. These were strong, and fostered relatively strong employment growth during the period (Figure 11.1). The GDP growth rate slowed, though, to a range of 1.4–2.7 percent in the following three quarters, leading to a weakening of employment growth during the period. GDP growth weakened noticeably, beginning in the third quarter of 2000, in the run-up to the 2001 recession. Assessment of Economic Policies Preceding the 2001 Recession The expansion between the end of the 1990–91 recession and the beginning of the 2001 recession was 120 months, or ten years, the longest expansion since the end of World War II. This was a notable achievement. In the overall statistical assessment of the expansion, I began with the full recovery year of 1992, so as not to skew the effect of the initial recovery movement from a low recession base. This focuses on eight years of the expansion, as noted at the beginning of the chapter. The expansion was unique in several ways: s %XCEPTFORTHEWARWITH3ERBIA THEEXPANSIONWASTHElRSTLONGPERIOD of peace from hot wars and the Cold War in which defense spending declined. s %CONOMIC GROWTH AND EMPLOYMENT INCREASES ACCELERATED DURING THE expansion. Unemployment fell to its lowest rate since the end of World War II, other than during hot wars or the Cold War. The unemployment rate of 4 percent, as the expansion evolved in the late 1990s and 2000, conformed to the goal of full employment as enunciated in the Full Employment Act of 1978 (Humphrey-Hawkins Act), as discussed in Chapter 6 under Definition of Full Employment.

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Figure 11.9 Real Gross Domestic Product in Expansion Preceding the 2001 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time

s2ECESSIONQUARTER4HE*ANUARYn-ARCHQUARTERINCLUDESONEMONTHOFRECESSION (March 2001), and April–June 2001 is a full quarter of recession. Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 2001 recession began in March 2001 and ended in November 2001, so only the first and second quarters of 2001 are shown in the figure as recession quarters. Each quarter’s data became available one month after the data quarter (for example, January– March 2000 data became available in April 2000). Data from October–December 1999 to July–September 2000 represent data available as of October 2000. Data from October– December 2000 to April–June 2001 represent data when they first became available one month after each data quarter. The quarterly patterns of July–September 2000 to the April– June 2001 data differ from the later data for those quarters that became available in August 2001, with the data in the figure showing increases of 2.7, 1.4, and 2.0 percent for the three quarters, compared with increases of 1.3, 1.9, and 1.3 percent in the later data.

s )NmATIONWASCONTAINEDATPERCENTORBELOWDURINGTHEEXPANSION OTHER than transitory fluctuations in food and energy prices due to changes in crop harvests and cartel pricing of the Organization of Petroleum Exporting Countries, with a deceleration in inflation occurring from the early to the later stages of the expansion. The containment of inflation benefited from a marked improvement in productivity during 1995–2000, which has been attributed largely to a widespread surge in the production and use of information technology among business firms, particularly the use of computers and telecommunications equipment. s 4HEFEDERALGOVERNMENTBUDGETDElCITSHIFTEDTOASURPLUSDURINGTHE expansion. From a budget deficit of approximately $300 billion in 1992, the budget position reached a surplus in 1998, which continued rising to $190 billion in 2000. The shift to a surplus resulted mainly, though

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not solely, from an increase of federal income taxes on higher-income households, applying budget legislative controls in containing the growth of federal expenditures, and rising economic growth, which generated rising tax receipts. On a negative note, the stock market and telecommunications bubbles of the late 1990s diminished these achievements during the expansion. They gave an artificial boost to the economy that was not sustainable. In the period preceding the onset of the 2001 recession in March 2001, several economic indicators began showing weak growth during various periods of 2000. First appearances of weaknesses among the economic indicators were: gross domestic product in the third quarter of 2000; employment growth in May 2000; industrial production in October 2000; housing starts, which showed no upward or downward trend during 2000, with starts having declined from 1999; and in the financial sector, interest rates on three-year constant maturities of U.S. securities began declining in June 2000. While unemployment continued to decline during the expansion, inflation was contained. And excess capacity utilization in manufacturing industries allowed manufacturers to use their most efficient equipment. Despite these weaknesses, the Federal Reserve continued a restraining posture on economic growth by maintaining the federal funds rate at its peak level of 6.5 percent during June–November 2000, based on the federal funds rate at the beginning of each month. A slight decline to 6.4 percent in federal funds occurred in December. Sharp declines began occurring in January 2001, just two months before the onset of the recession in March, as the rate dropped to 6.0 percent in January, 5.5 percent in February, 5.3 percent in March, 4.8 percent in April, and to 4.2 percent in May. In maintaining the monetary restraint to the end of December 2000, I believe the Federal Reserve placed too great an emphasis on containing inflation. Weaknesses in economic growth were already occurring in several economic indicators during 2000, as well as in commercial interest rates. Inflation had been contained during the expansion, except for transitory increases in food and energy prices, which were not related to excessive demand in the economy. The bursting of the stock market and telecommunications dot-com bubbles contributed to bringing on the recession. At the same time, it appears that even had the Federal Reserve not engaged in monetary restraint during 2000, the 2001 recession might still have occurred. This reflects the complexities of maintaining smooth transitions with changing product demands in market-driven countries, as noted in Chapter 1 under Business Cycles and Recessions. With these caveats, I conclude that the monetary policy restraint of the Federal Reserve was instrumental in bringing on the recession.

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Notes 1. Alan S. Blinder and Janet L. Yellen, “The Fabulous Decade: Macroeconomic Lessons from the 1990s,” in The Roaring Nineties: Can Full Employment Be Sustained? ed. Alan B. Krueger and Robert Solow (New York: Russell Sage Foundation and Century Foundation Press, 2001), pp. 117–27. 2. Barry T. Hirsch and David A. Macpherson, “Union Membership and Coverage Database from the Current Population Survey: Note,” Industrial and Labor Relations Review, January 2003, pp. 349–54. 3. Dale W. Jorgenson, Mun S. Ho, and Kevin J. Stiroh, “A Retrospective Look at the U.S. Productivity Growth Resurgence,” Journal of Economic Perspectives (Winter 2008). It should be noted that the productivity estimates by the authors modify the methodology used by the U.S. Bureau of Labor Statistics (BLS) cited in Table 11.1. The authors include the use value of consumer durables in the measure of output, which is not in the BLS output measure, and they also vary the methodology in calculating inputs. The result in two recent periods is that the BLS and the authors’ productivity estimates are the same for 1995–2000, but show slightly different movements for 2000–2006 as compared with 1995–2000: Average Annual Increase in Business Sector Labor Productivity

1995–2000 2000–2006

U.S. Bureau of Labor Statistics 2.7% 2.8%

Article by Jorgenson, Ho, and Stiroh 2.7% 2.5%

4. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, February 1994, pp. 32–34. 5. Ibid., p. 34. 6. Blinder and Yellen, “The Fabulous Decade: Macroeconomic Lessons from the 1990s,” pp. 97–131. As members of the Board of Governors of the Federal Reserve, Blinder and Yellen were also members of the Federal Open Market Committee (FOMC). The twelve-member FOMC, which determines the monetary policy of the Federal Reserve System, is composed of the seven governors as permanent members, four presidents of the twelve regional Federal Reserve banks on a one-year rotating basis, and the president of the Federal Reserve Bank of New York as a permanent member. 7. Abraham Mosisa and Steven Hippie, “Trends in Labor Force Participation in the United States,” Monthly Labor Review, October 2006, Table 1, p. 36. 8. Norman Frumkin, Tracking America’s Economy, 4th ed. (Armonk, NY: M.E. Sharpe, 2004), pp. 106–7 and 317. 9. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 10. William F. Bassett and Egon Zakrajsek, “Profits and Balance Sheet Developments at U.S. Commercial Banks in 1999,” Federal Reserve Bulletin, June 2000, pp. 369–71. 11. William F. Bassett and Egon Zakrajsek, “Profits and Balance Sheet Developments at U.S. Commercial Banks in 2000,” Federal Reserve Bulletin, June 2001, pp. 370–71.

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12. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” forwarded July 20, 2000, Federal Reserve Bulletin, August 2000, p. 543. 13. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” submitted February 13, 2001, Federal Reserve Bulletin, March 2001, p. 109. 14. The GDP measures production in the fifty states and the District of Columbia, while the GNP is a residency definition based mainly on nationality. The difference between the two is the treatment of dividends and retained earnings of multinational corporations, interest derived from foreign investments, and wages and salaries derived from working in foreign countries. In the GDP, profits and interest from U.S. operations of foreign-owned companies are included as business income, as are wages and salaries of foreign residents working in the United States. But profits and interest from foreign operations of U.S.-owned companies are excluded as business income in the GDP, as are wages and salaries of U.S. residents working abroad. For the GNP, these definitions are reversed. In practice, there is little difference in these measures from the standpoint of this book.

12 The Recession of 2007–9

The recession of 2007–9 began in December 2007. Because the recession was in progress in June 2009 when the manuscript for this book was completed, I cite no monthly ending date to the recession. But I believe it will be designated as ending sometime in 2009, and so refer to it as the 2007–9 recession. The expansion preceding the recession extended from November 2001 to December 2007, which was seventy-three months, or just over six years. The events of the expansion highlighted here are: s %CONOMICRECORD s &ISCALPOLICYANDWAR s (OUSEPRICEBUBBLE s (URRICANE+ATRINA Economic Record The expansion during 2002–7 appears as three phases: s *OBLESSRECOVERYOFn s 'REATERGROWTHOFn s 3LOWDOWNINGROWTHDURING Table 12.1 summarizes trends in the real gross domestic product (GDP), employment, unemployment, consumer price index, and productivity during the three phases. Real GDP (GDP adjusted for price change) was robust for only two quarters of the six and two-thirds quarters in the run-up to the 2007–9 recession. The average annual increase in real GDP in the six years from 2002 to 2007 was 2.6 percent, compared with 3.5 percent in the six years from 1992 to 1997 following the end of the 1990–91 recession. Employment declined in the recovery years of 2002 and 2003 by 1.1 percent and 0.3 percent, respectively. After peaking at 1.8 percent in 2006, 303

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Table 12.1 Economic Trends, 2002–7

Consumer Real Gross Price Indexc Domestic Producta Employmentb Unemploy- of All Items (percentage (percentage (percentage mente (percent) change) changes) change) 2002 2003 2004 2005 2006 2007

1.6 2.5 3.6 2.9 2.8 2.0

–1.1 –0.3 1.1 1.7 1.8 1.1

5.8 6.0 5.5 5.1 4.6 4.6

1.6 2.3 2.7 3.4 3.2 2.8

Consumer Price Index of All Items Excluding Food and Energy Productivityd (percentage (percentage change) change) 2.4 1.4 1.8 2.2 2.5 2.3

4.1 3.8 2.9 1.8 0.9 1.5

Sources: Based on data available in 2008. a Bureau of Economic Analysis, U.S. Department of Commerce; b, c, d, e Bureau of Labor Statistics, U.S. Department of Labor. Note: Net increase in absolute number of jobs during 2002–7b: 5,797,000.

employment growth was 1.1 percent in 2007. The net increase in the number of jobs, the difference between gross job increases and gross job decreases, was 5.8 million jobs over 2002–7. This compares with a net increase in jobs in the six years between 1992 and 1997, of 14.0 million jobs. The unemployment rate rose from 5.8 percent in 2002 to 6.0 percent in 2003, and then fell to 4.6 percent in 2006 and 2007. Part of the decline reflected the increase in employment noted above, and part reflected the decline in the labor force participation rate (LFPR) from 66.6 percent in 2002 to 66.0 percent in 2007. This compares with a fall in the unemployment rate in the six years between 1992 and 1997, from 7.5 percent in 1992 to 4.9 percent in 1997. The fall in the unemployment rate was due entirely to the increase in employment during the expansion, as the LFPR rose from 66.4 percent in 1992 to 67.1 percent in 1997. The consumer price index (CPI) accelerated from an increase of 1.6 percent in 2002 to 3.4 percent in 2005, and then decelerated to increases of 3.2 percent in 2006 and 2.8 percent in 2007. But price movements excluding the volatile food and energy components were noticeably smaller, ranging from 1.4 percent to 2.5 percent over the six-year period. For the entire 2002–7 period, the CPI increased at an average annual rate of 2.7 percent, while the

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CPI excluding the food and energy components increased at a noticeably lower rate of 2.1 percent, indicating that inflation was not driven by excessive demand in the economy. This compares with an annual increase in the CPI, in the six years between 1992 and 1997 during the expansion following the end of the 1990–91 recession, of 2.8 percent—only slightly higher than the 2.7 percent during the 2002–7 expansion. However, the CPI excluding the volatile food and energy components increased in the six years between 1992 and 1997 at an annual rate of 3.0 percent, indicating that inflation accelerated along with the increasing growth in the real economy in that period. Productivity growth, the change in output per hour worked of all employed persons in the private business sector of the economy, increased to an annual peak of 4.1 percent in 2002, and then declined to 0.9 percent in 2006, followed by an increase of 1.5 percent in 2007. For the entire six-year period, productivity increased at an average annual rate of 3.0 percent. This compares with an annual increase in productivity in the six years from 1992 to 1997 of 2.1 percent, noticeably below the 3.0 percent rate during the 2002–7 expansion. However, the difference between the two periods was more a cyclical phenomenon associated with existing workers filling the jobs of laid-off workers, rather than a long-term improvement in efficiency. Thus, multifactor productivity, which measures changes in efficiency in the economy by abstracting from cyclical changes, increased during 1992–97 at an annual rate of 1.0 percent, compared with an annual increase during 2002–7 of 0.6 percent. Fiscal Policy and War Federal government budget surpluses and deficits represent the difference between government receipts (mainly taxes) and government expenditures (outlays for goods, services, structures, income support programs, and interest on the federal debt). I use the estimates of these federal economic transactions that are developed from the national income and product accounts (NIPAs), rather than from the official federal budget data in the budget laws passed each year. The levels and yearly movements of the two data series are similar, though they differ because of variations in the coverage of certain items, in the timing of when items are recorded, and in accounting definitions. I use estimates from the NIPAs of federal expenditures and receipts because they are fully integrated with the measures of economic growth as summarized by the gross domestic product, and thus are more relevant for assessing their economic impacts. The terminology of the difference between expenditures and receipts in

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the NIPAs is “net federal government saving,” which is positive if receipts exceed expenditures and negative if expenditures exceed receipts. This differs from the “surplus” and “deficit” terminology of the official budget data in recording the difference between receipts and expenditures noted above. Terminology aside, “net federal saving” in the NIPAs is akin to the official budget nomenclature of “surplus” and “deficit,” but because the NIPAs federal economic transactions are not a legislated budget, use of a more neutral economic term of “net federal government saving” avoids confusing it with the official budget. Shift to Budget Deficits Table 12.2 on federal government finances shows federal receipts minus expenditures from 2000 to 2007. The inclusion of 2000 and 2001 in Table 12.2 diverges from the focus in this discussion, which otherwise begins with the 2002–7, because I believe it illuminates the sharp change in the budget position beginning in 2002. The federal budget began showing a surplus in 1998, which rose to a high of $189.5 billion in 2000 (see Chapter 11 under Fiscal Policy). The surplus then dropped to $46.7 billion in the 2001 recession. Subsequently, during the expansion of 2002 to 2007, the budget deficit peaked at $372.1 billion in 2003 and fell to $201.1 billion in 2006. The deficit increased to $229.3 billion in 2007. The budget deficits resulted from three factors: s $ECREASEINFEDERALINCOMETAXRATESINAND WHICHLESSENED federal receipts, as discussed below under Federal Government Receipts. s )NCREASE OF TOTAL FEDERAL EXPENDITURES BETWEEN  AND  DUE considerably to the jump in national defense spending following the September 11, 2001, attacks, followed by the wars in Iraq, and to smaller extent in Afghanistan, as discussed below under Federal Government Expenditures. s 2ELATIVELYSLOWECONOMICANDJOBGROWTHOVERTHEPERIOD ASNOTEDIN the Economic Record section above. This moderated federal receipts because of the associated slower increases in household and business incomes. Federal Government Receipts Federal tax rates on individual incomes were reduced in 2001 and 2003 through the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA),

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Table 12.2 Federal Government Finances (in billions of dollars) Receipts Minus Expenditures 2000 2001 2002 2003 2004 2005 2006 2007

189.5 46.7 –247.9 –372.1 –370.6 –291.7 –201.1 –229.3

Source: Bureau of Economic Analysis, U.S. Department of Commerce, as part of the national income and product accounts.

and Jobs and Growth Tax Reconciliation Act of 2003 (JGTRA).1 The summary of these tax cuts below is based on “effective tax rates” as developed by the Congressional Budget Office. Effective tax rates are the federal taxes paid by or imputed to households as a percentage of their pre-tax income. In this calculation of income subject to federal taxation, households bear the burden of all taxes they pay directly—income taxes, Social Security taxes, and federal excise taxes on the purchase of goods. In addition, because it is assumed that taxes levied on businesses actually fall on households, the employer’s share of Social Security taxes is allocated to households as their income and taxes, and corporate income taxes are allocated to households in proportion to their income from interest, dividends, rents, and capital gains. Effective tax rates exclude federal estate and gift taxes, tariffs, and other miscellaneous items. (Contrary to these Congressional Budget Office assumptions regarding the impact of business income taxes, others may believe that these taxes are passed along in higher prices to consumers.) Summaries of the tax laws are: s 4HE %'422! LOWERED INDIVIDUAL INCOME TAXES FOR ALL TAXPAYERS BY restructuring tax rates and brackets, increasing the child credit and dependent care credit, providing relief from marriage penalties and the alternative minimum tax, and increasing the earned income credit for married couples. s 4HE*'42!ACCELERATEDTHEPACEATWHICHPROVISIONSOF%'422!PHASE in, reduced taxes on capital gains and qualified dividends, raised the alternative minimum tax exception, and increased first-year depreciation deductions.

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Table 12.3 Individual Income Tax Cuts of 2001 and 2003 Laws

Income Distribution of Households Lowest quintile Second quintile Third quintile Fourth quintile Highest quintile Top 1 percent

Effective Tax Rates for 2001 Based on 2000 Tax Law (percent)

Effective Tax Rates for 2004 Based on 2001 and 2003 Laws (percent)

Difference Between the 2000 Tax Law and the 2001 and 2003 Tax Laws (percentage points)

–5.6 0.3 3.8 7.2 16.3 24.1

–5.7 –0.1 3.5 6.6 14.2 19.7

–0.1 –0.4 –0.3 –0.6 –2.1 –4.4

Source: Congressional Budget Office, “Effective Federal Tax Rates Under Current Law, 2001 to 2014,” a CBO Paper, August 2004, Table 2, p. 19. Note: The tax laws are: Economic Growth and Tax Relief Reconciliation Act of 2001, and Jobs and Growth Tax Relief Reconciliation Act of 2003. The quintiles show each 20 percent of the households in ascending order of their shares of the total individual incomes of the nation. Mean money income of household quintiles (—lowest fifth, second fifth, etc.) in 2004: lowest quintile, $11,245; second quintile, $28,773; third quintile, $48,749; fourth quintile, $76,867; highest quintile, $166,232. Based on U.S. Bureau of the Census data.

Table 12.3 shows effective tax rates of the 2000, 2001, and 2003 laws for five income groups, referred to as quintiles. The quintiles show each 20 percent of the households in ascending order of their shares of the total individual incomes of the nation. The table also includes the top 1 percent of the households with the greatest incomes. The reduction in effective tax rates for all five income groups and the top 1 percent of the highest income households instituted by the EGTRRA and JGTRA is apparent by comparing the tax rates in column 1 of Table 12.3, which are based on the tax law existing in 2000, with the tax rates in column 2, which combine the effect of the 2001 and 2003 tax laws. Column 3 shows the change in percentage points between the 2000 law on the one hand and the 2001 and 2003 laws on the other. This indicates that the tax cuts in the 2001 and 2003 laws increased from 0.1 percentage point in the lowest quintile to 2.1 percentage points in the highest quintile, and to 4.4 percentage points in the top 1 percent. No tax payments were made in the lowest quintile under all three laws in 2001 and 2004, and no tax payments were made in the second quintile under the 2001 and 2003 tax laws in 2004.

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Table 12.4 National Defense Expenditures

2000 2001 2002 2003 2004 2005 2006 2007

Defense Expenditures (billions of dollars)

Change in Defense from Previous Year (billions of dollars)

Defense as a Percentage of the Gross Domestic Product (percent)

370.3 392.6 437.1 497.2 550.7 588.1 624.1 662.2

9.7 22.3 44.5 60.1 53.5 37.4 36.0 38.1

3.8 3.9 4.2 4.5 4.7 4.7 4.7 4.8

Source: Bureau of Economic Analysis, U.S. Department of Commerce, as part of the national income and product accounts. Note: Based on data available in 2008.

Federal Government Expenditures Total federal spending covers civilian and defense needs. It includes transfer payments for Social Security benefits, Medicare, Medicaid, and Unemployment Insurance, and interest on the federal debt. Table 12.4 shows defense expenditures, the annual change in defense spending, and defense spending as a percentage of the gross domestic product from 2000 to 2007. I have included 2000, instead of the usual beginning year of 2002, because it shows the sharp increase in defense spending after the September 11, 2001, attacks on the United States. Defense spending in 2000, before the September 11 attacks, which totaled $370.3 billion, had increased $9.7 billion from 1999 and accounted for 3.8 percent of the GDP in 2000. In the subsequent wars in Iraq and, to a smaller extent, Afghanistan, defense spending increased annually from $44.5 billion to $60.1 billion, and rose to 4.7 percent of the GDP from 2002 to 2004. Defense spending increased annually by $36.0–$38.1 billion from 2005 to 2007, and increased to 4.8 percent of the GDP in 2007. While increases in defense spending slowed between 2002–4 and 2005–7, total defense spending grew to $662.2 billion in 2007, which was $292 billion greater than the $370.3 billion in 2000. Defense spending also rose at a faster rate than the GDP during 2000–7, resulting in the defense share of the GDP increasing from 3.8 percent in 2000 to 4.8 percent in 2007.

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Taxes During Wars The United States departed from the tradition of financing most wars by raising taxes when taxes were lowered after military action against Iraq began on March 19, 2003. This happened through the Jobs and Growth Tax Reconciliation Act of 2003, noted above under Federal Government Receipts; it was signed into law on May 28, 2003. In reviewing the use of taxes to finance wars from the American Revolution to the Iraq War, Steven Bank, Kirk Stark, and Joseph Thorndike note that although there was not always full support by the public, Congress, or the president, ultimately taxes were raised to finance sustained wars, but not for the Iraq war.2 The American Revolution was a notable exception, as currency was printed and loans obtained from domestic and foreign creditors, but taxes were not imposed. The authors attribute the financing reversal during the Iraq War, of not only not increasing taxes but lowering taxes, to three changed conditions in the country: s There was no fear of inflation. Had inflation or its prospect been present, it would have exerted political pressure for greater taxes in order to restrain demand. But while the 2001 recession ended in November 2001, the recovery had been sluggish. Employment declined in the recovery years of 2002 and 2003, and unemployment was at 6 percent in 2003, as noted above under the Economic Record. s Marginalization of deficit concerns. There had been an increasing political polarization between the Democratic and Republican parties since the mid-1970s, with Democrats being “deficit hawks,” and Republicans being “growth hawks.” Some so-called moderates in both parties broke rank, with the Democrats emphasizing growth and their Republican counterparts emphasizing deficit control. But they were a minority. The majority in power during 2003 emphasized economic growth, which called for tax cuts as the priority. s Replacement of the military draft with a volunteer military in 1972. The draft provides a moral force to the idea of shared sacrifice during war, making increased taxes more acceptable. But while a volunteer military still offers individual life as the supreme sacrifice, there is little evidence of the idea of shared sacrifice in war when there is a volunteer military compared as opposed to a draft. Household Income, Spending, and Saving, Grouped by Household Income The effect of the 2001 and 2003 tax cuts on household spending was determined by how much of that increased household income was spent and how

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much was saved. Because the proportion of spending lessens as household incomes rise up the income ladder, the greater tax cuts apportioned to the higher-income households make the amount of income released to them by these tax cuts less likely to be spent than if more of the income from tax cuts had gone to middle and lower income groups. Table 12.5 shows household money income, percentage of families that saved, and household saving rates, by income quintiles of each fifth of the income distribution for 2007. Panel A covers household money income, Panel B covers families that saved, and Panel C covers household saving rates. Household Money Income (Panel A) is income that is regularly received by households as cash income, which includes wages and salaries, profits from self-employment, Social Security, retirement, unemployment insurance, other income maintenance benefits, interest, dividends, rents, royalties, estates, and trusts. Money income excludes noncash benefits such as food stamps, health benefits, subsidized housing, and goods produced and consumed on farms. Money income represents income before the payment of federal and state income taxes, Social Security taxes, federal employee retirement taxes, Medicare deductions, property taxes, and union dues. The Bureau of the Census in the U.S. Department of Commerce prepares the household income data. Money income increased strikingly as a proportion of total from the lowest to the highest quintile, which is a measure of inequality. The lowest quintile accounted for 3.4 percent of total income and the highest quintile accounted for 50.3 percent of total income. A household consists of all persons who live in a single-family house or an apartment. A household includes families and unrelated individuals living in the house or apartment. The Percentage of Families That Saved is depicted in Panel B. A family is defined as the dominant single person or couple, either married or living together as partners, and all other persons in the household who are financially interdependent with that economically dominant person or couple. The Division of Research and Statistics of the Federal Reserve Board prepares the data. The percentage of families that saved increased from the lowest to the highest quintile, with the highest quintile divided into deciles of 80–89.9 percent and 90–100 percent. Families that saved rose from 33.7 percent in the lowest quintile to 72.9 percent and 84.8 percent in the two highest deciles. This rise in the proportion of savings up the income ladder indicates that the total amount of saving rises with increasing incomes. Household Saving Rates (Panel C) depicts saving as a percentage of income, before the payment of taxes. I calculated the saving rates by deducting the expenditures from income, before the payment of taxes, as shown in the Consumer Expenditure Survey (CEX). The Bureau of Labor Statistics (BLS) in the U.S. Department of Labor prepares the CEX.

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Table 12.5 Household Money Income, Percentage of Families That Saved, and Household Saving Rates, Grouped by Income, 2007 Panel A: Money Income Shares as a Percentage of Total Income Lowest quintile Second quintile Third quintile Fourth quintile Highest quintile Total

3.4 8.8 14.7 22.8 50.3 100.0

Source: Bureau of the Census, U.S. Department of Commerce, “Income, Earnings, and Poverty: 2007,” American Community Survey, ACS-09, 2008, Table 5, p. 10. Note: A household consists of all persons who live in a single-family house or an apartment. A household includes families and unrelated individuals living in the house or apartment. Money income is cash income before the payment of income taxes, Social Security taxes, and other items. See text for a detailed definition of income. Quintiles are the five income groups that show each fifth in ascending order of the income distribution. Panel B: Percentage of Families That Saved Within Each Income Quintile Lowest quintile Second quintile Third quintile Fourth quintile 80–89.9 percentile 90–100 percentile

33.7 45.1 57.8 66.8 72.9 84.8

Source: “Changes in U.S. Family Finances from 2004 to 2007: Evidence from the Survey of Consumer Finances,” Federal Reserve Bulletin, February 2009. Note: Family is defined as covering the dominant single person or couple (either married or living together as partners), and all other persons in the household who are financially interdependent with that economically dominant person or household. Panel C: Household Saving Rates Lowest quintile Second quintile Third quintile Fourth quintile Highest quintile

–94.4 –12.6 6.0 18.2 35.9

Source: Bureau of Labor Statistics, U.S. Department of Labor, “Consumer Expenditure Survey,” 2007, Table 45. Note: Saving is derived by deducting expenditures from income before the payment of taxes, and expressing it as a percentage of income. The author calculated these saving rates. Negative saving rates in the lowest and second quintiles mean that households depleted existing saving and/or borrowed to finance their expenditures. See text for the factors contributing to the negative saving rates. Average money income of household quintiles: lowest quintile, $10,531; second quintile, $27,674; third quintile, $46,213; fourth quintile, $72,460; highest quintile, $158,388.

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The income items in the CEX are: wages and salaries, self-employment income, Social Security and private and government retirement income, interest, dividends, rental and other property income, unemployment and workers’ compensation and veterans’ benefits, public assistance, Supplemental Security Income (SSI), food stamps, rent or meals or both as pay, and regular contributions for support, such as alimony and child support. The expenditure items in the CEX are: food at home and in eating places, housing, apparel, transportation, health care, education, entertainment, reading, personal care and services, personal insurance and pensions, cash contributions, alcoholic beverages, tobacco products, and miscellaneous items. The lowest quintile had a negative saving rate of 94.4 percent, the second lowest quintile had negative saving of 12.6 percent, and the subsequent quintiles had positive saving rates that increased with income, from 6.0 percent in the third quintile to 35.9 percent in the highest quintile. This shows a direct relationship between saving and income, even in the decline in the negative saving rate from the lowest to the second quintile. The negative saving rates mean that the households in those groups on average “dissaved,” that is, spent more than their income, and depleted their existing savings and/or borrowed to finance their expenditures. The high negative saving rate of 94.4 percent in the lowest quintile and the lower but still prominent negative saving rate of 12.6 percent in the second quintile raise a question about the validity of the saving estimates. The factors contributing to the negative rates in these quintiles, as listed below, are qualitative, as they are only currently being researched by BLS. All of the contributing factors lower the income estimates of the CEX in relation to spending, and therefore the derived saving measure. The factors have a greater importance in the two lowest quintiles than in the higher quintiles, as well as a greater importance in the lowest quintile than in the second quintile. Factors contributing to the negative saving rates in the first two quintiles are: s "USINESSLOSSESFROMSELF EMPLOYMENT s 2ENTLOSSESOFPROPERTYOWNERS s 2ETIREDPERSONS WHOHAVELOWERINCOMES s 5NEMPLOYEDPERSONS s 3TUDENTS WHOSPENDUSINGCREDITCARDSPROVIDEDBYTHEINCOMEOFTHEIR families s (ARD TO QUANTIFYUNDERREPORTINGOFINCOMEFROMTHEHOUSEHOLDSURVEY respondents It is noteworthy that the CEX methodology implicitly includes the paying down of a housing mortgage principle as a saving. Thus, the paying down of a mortgage principle is included in the data as a saving.

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The three items discussed here show: (a) the high proportions of total household income accounted for by the higher-income households, (b) the greater proportion of higher-income households that save, and (c) the higher saving rates of the higher-income households. The lower tax rates stimulated total household spending, but much of the tax cuts was apportioned to the higher-income households that have high saving rates. These high saving rates led to lower spending and economic growth than would have occurred had the tax cuts been targeted more to middle and lower income households. And the slower economic growth resulted in lower household and business incomes, which led to lower increases in tax receipts during 2002–7. House Price Bubble The sharp rise in house prices was a prominent feature of the expansion from 2002 to 2006. During this time, “prime mortgage” and “subprime mortgage” entered into the general vocabulary. The main difference between the two is the risk associated with the borrower. Prime mortgages are offered to lower-risk borrowers and subprime mortgages are offered to higher-risk borrowers.3 The rise in house prices was driven by the following: s -ORTGAGELENDERSWHOENCOURAGEDPROSPECTIVENEWHOMEOWNERS AND homeowners wishing to upgrade their current housing, to take mortgages that were beyond their means, together with the mortgagors who were willing to take on that excessive debt. s #ONTINUEDDESIREOFHOUSEHOLDSTOLIVEINCITIESORCLOSETOCITIES BOTH for the shorter commute to work and for the available amenities. s 4HE0ONZIMENTALITYFUELINGTHEBELIEFTHATHOUSEPRICESWOULDCONTINUE to rise indefinitely, making holders of the housing increasingly wealthy. Homeowners had the expectation that this paper wealth could be turned into realized capital gains easily by selling their houses, because of an expected continued strong demand for housing. Table 12.6 shows the rise in the house prices of existing houses and of consumer prices in six-month periods between 2002 and 2007. The house price index is prepared quarterly by the Office of Federal Enterprise Oversight in the U.S. Department of Housing and Urban Development. The index covers the resale price, as well as the revaluation of the same house over time to obtain mortgage refinancing, with adjustments for the price effect from changing demographic, socioeconomic, or land-use characteristics in the same neighborhoods over time. The index does not adjust for improvements to the house or landscaping, or for depreciation or maintenance of the house.

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Table 12.6 House Prices and Consumer Prices

Dec. 2001–June 2002 June 2002–Dec. 2002 Dec. 2002–June 2003 June 2003–Dec. 2003 Dec. 2003–June 2004 June 2004–Dec. 2004 Dec. 2004–June 2005 June 2005–Dec. 2005 Dec. 2005–June 2006 June 2006–Dec. 2006 Dec. 2006–June 2007 June 2007–Dec. 2007

House Price Indexa (percentage change)

Consumer Price Indexb (percentage change)

3.2 3.6 2.4 4.5 4.2 6.2 6.2 5.6 3.0 2.5 1.0 0.0

1.2 1.2 0.7 1.3 1.8 1.5 1.0 2.4 1.9 0.7 1.9 2.1

Sources: a Office of Federal Housing Enterprise Oversight, U.S. Department of Housing and Urban Development; b Bureau of Labor Statistics, U.S. Department of Labor. Note: Based on data available in 2008.

House price increases grew between 3 and 4 percent from 2002 through the first half of 2004, to the 6 percent range from the second half of 2004 through 2005 (the increase declined to 5.6 percent in the second half of 2005), in the sixmonth periods. House price increases decelerated to 3 percent and 2.5 percent in the first and second halves of 2006, and still further to 1 percent and zero change in the first and second halves of 2007, on the eve of the 2007–9 recession. The consumer price index (CPI) increased in a range of 0.7 percent to 2.4 percent over each six-month period between 2002 and 2007. These increases in the price level in the economy were several percentage points lower than the house price increases noted above, except for 2007, when the CPI increased more than house prices (house prices were unchanged in the second half of 2007). The fallout from the cessation of the increase in house prices arose in 2005 in the negative impact it had on the lives of people who bought houses that were above their means to carry the payments. As portrayed by Christian Weller, these resulted in:4 s 3LOWINGOFTHE!MERICANDREAMOFHOMEOWNERSHIP ASHOMEOWNERSHIP rates leveled out. The rise in house prices, before the above-noted cessation of the price rise, made it more difficult for some aspiring households to become homeowners because the higher prices made prospective housing less affordable, even with the greater availability of mortgage credit.

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s (OMEOWNERSEQUITYINTHEIRHOMESFELL WHICHLESSENEDBOTHTHEIRHOUSing wealth and their overall wealth. s (OMEOWNERSBECAMEVULNERABLETOAFURTHERDECLINEINTHEIRWEALTHIF house prices continued to decline. Hurricane Katrina Hurricane Katrina landed on the Gulf of Mexico coast in August 2005, causing massive flooding in the city of New Orleans as well as great damage along the Alabama, Mississippi, and Louisiana coasts. Two subsequent hurricanes in 2005—Rita in Louisiana and Texas on September 24 and Wilma in Florida on October 24—wreaked further havoc. Katrina was one of the most devastating storms ever to hit the United States. Michael Dolfman, Solidelle Wasser, and Bruce Bergman report estimates of over 1,200 deaths and damages of over $200 billion, and give a detailed accounting of job losses.5 Job losses in the city of New Orleans peaked at 105,300 in November 2005, declining to 92,900 in June 2006, based on data of workers covered by state and federal unemployment insurance. Because a disproportionate part of the job loss occurred in low-wage industries of hotels, food services, tourism, and retail trade, the average weekly wage for the jobs remaining in the city increased 33.7 percent between the first quarters of 2005 and 2006. The loss of 92,900 jobs in June 2006 represented a 41 percent drop in total New Orleans employment. This job loss was much larger than the job loss due to the declining growth of the New Orleans economy preceding Katrina. From 2000 to 2004, New Orleans lost over 16,000 jobs, accounting for 6.2 percent of all employment in New Orleans. According to the President’s Council of Economic Advisers (CEA), the effect of Hurricane Katrina, and to a lesser extent Hurricane Rita, on the overall economy was in lowering growth of the real gross domestic product about 0.7 percentage point in the third quarter of 2005, mostly through the destruction of oil and gas operations.6 Continuing disruptions further reduced real GDP in the fourth quarter of 2005 about 0.5 percentage point. The CEA noted Red Cross estimates that Katrina, Rita, and Wilma destroyed 213,000 housing units, with most destroyed by Katrina. An additional 169,000 housing units suffered major damage, enough to make them uninhabitable, and 235,000 had “extremely minor damage.” Many New Orleans residents left the city to restart their lives elsewhere. One of those places was the Houston, Texas, metropolitan area, as discussed by Molly McIntosh.7 Unofficial estimates indicate that 100,000 to 150,000 evacuees moved to the Houston area.

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Economic Indicators in Real Time During 2006–7 The economic data on employment, production, prices, and other economic indicators that were available to policy makers preceding the onset of the 2007–9 recession in December 2007 are referred to as real-time data, as discussed under the analogous section in Chapter 2. As noted in the beginning of the chapter, the recession was still in progress when this manuscript was completed in April 2009, and I expect it will be designated as ending sometime in 2009. The economic indicators discussed here are: s %MPLOYMENT s 5NEMPLOYMENT s )NmATIONANDDEmATION s )NDUSTRIALPRODUCTION s (OUSINGSTARTS s 7ORKEREARNINGSINNONFARMINDUSTRIES s )NTERESTRATESANDBANKLOANS s #ONSUMERDURABLEGOODSSPENDING s 'ROSSDOMESTICPRODUCT The last section of the chapter is an assessment of the economic policies preceding the 2007–9 recession. I have used this sequence of the indicators as one that I believe would be monitored by economic analysts in trying to relate one aspect of the economy to the other. The interrelationships are of course complex, and I do not mean to suggest that the economy flows from one indicator to the next in this order, though I think it is helpful to organize a review around such a sequence. All of the indicators are available monthly, except the gross domestic product, which is available only quarterly. Monthly data on personal consumption expenditures were first published in 1979, but I used the quarterly data for consumer durable goods spending because real-time monthly data for personal consumer spending were not readily available. Of course, monthly indicators give a more timely assessment of the economy than quarterly ones. The data are seasonally adjusted, unless otherwise noted. The 2007–9 recession is dated as beginning in December 2007. So December 2007 to March 2008 in the figures that follow were the first four months of the recession. To assess what was available to policy makers as 2006 and 2007 progressed, the figures chart the real-time data from May 2006 to November 2007. The starting point for the real-time data is what the economic policy

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makers—the Federal Reserve, president, and Congress—saw in May 2006. Because economic data became available one month after the month to which they refer, the May 2006 data first appeared in June 2006. Thus, the May starting point provides the most reliable data, including revisions from that time up to August 2007, of the May 2006–August 2007 period. The data from August 2007 to March 2008 reflect the real-time data on a monthly and quarterly basis up to March 2008 as they were produced. Revisions that occurred to the September 2007–March 2008 data as of May 2008 changed the monthly and quarterly patterns at most slightly. I chose August 2007 as a breakpoint for the most reliable data because it provided a late look at current economic conditions to see whether economic policy should have shifted from a concern about inflation to a concern about unemployment. Of course, even if economic policies had been promptly changed in September, it would have been too short a lead time for changes to occur in the market economy to prevent the recession from beginning in December 2007. At best, such a reversal in policy at that time might have lessened the severity of the recession, as depicted in Chapter 1. Now, what did the economic policy makers see from the spring of 2006 into the fall of 2007 in what turned out to be the run-up to, and the onset of, THERECESSION Employment Employment represents the monthly number of nonfarm civilian jobs based on the payroll records of businesses, not-for-profit organizations, and federal, state, and local governments in the United States. For more detail on the attributes of the employment data, see Chapter 2 under Employment. Figure 12.1 shows the monthly percentage change in jobs from May 2006 to March 2008 on a real-time basis. Monthly employment increased at a predominantly steady rate of 0.1 percent between May 2006 and November 2007, with interruptions of 0.2 percent in July and December 2006, and zero change in August 2007. Employment remained unchanged in the first three months of the recession from December 2007 to February 2008, and decreased by 0.1 percent (below the zero line) in March 2008. Employment changes varied among broad industry categories from the second half of 2006 through 2007. Typically, these showed increases in health, education, restaurant, professional, and technical services, while declines appeared in manufacturing and construction. The typical monthly increase in employment of 0.1 percent between May 2006 and November 2007 preceding the onset of the recession in December 2007 was a sluggish rate of growth.

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Figure 12.1 Jobs in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all jobs on nonagricultural and government payrolls from the establishment survey. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later data for those months that first became available in May 2008.

Unemployment The unemployment data used here represent the number of persons without jobs who were actively seeking work every month in the civilian sector of the economy. The data cover nonfarm and farm workers aged sixteen years and older. For more detail on the attributes of the unemployment data, see Chapter 2 under Unemployment. Figure 12.2 shows the unemployment rate (UR) on a real-time basis from May 2006 to March 2008. The UR fluctuated around 4.6 percent from May 2006 to November 2007. After rising from 4.6 percent in May and June 2006 to 4.8 percent in July 2006, the UR fell to 4.4 percent in October 2006. The UR was lowest at 4.4–4.5 percent between October 2006 and June 2007, except for 4.6 percent in January 2007. The UR rose from 4.6 percent in July and August 2007 to 4.7 percent between September and November 2007, and to 4.7–5.1 percent in the recession months of December 2007 to March 2008.

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Figure 12.2 Unemployment Rate in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data comprising all civilian workers from the household survey. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available as of August 2007. Data from August 2007 to March 2008 represent data when they first became available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later data for those months that first became available in May 2008.

Actual unemployment ranged from 6.7 million to 7.8 million workers between May 2006 and March 2008. Thus, a one-percentage-point change in the unemployment rate affected 67,000 to 78,000 workers. The unemployment rate, at levels of 4.4 percent to 4.8 percent, reflected the increases of 0.1 percent in employment noted above and the decline in the labor force participation rate (LFPR) from 66.6 percent in 2002 to 66.0 percent in 2007, as noted earlier in the chapter under Economic Record. The fall in the LFPR meant that relatively fewer people were looking for work, which led to fewer people being counted as unemployed. The lowest unemployment rates of 4.4–4.5 percent reached during the expansion from October 2006 to June 2007 approached the “full employment” designation of 4.0 percent. However, the fall in the labor force participation rate exaggerated the low rates of unemployment. For a discussion of full employment, see Chapter 6 under Definition of Full Employment.

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Figure 12.3 Consumer Prices in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was competed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available as of August 2007. Data from August 2007 to March 2008 represent data when they first became available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later data for those months that first became available in May 2008.

Inflation and Deflation The measure of inflation used here is the consumer price index (CPI). It shows the monthly change in the overall cost of the basket of items typically bought by all urban households, including workers in all urban occupations, the unemployed, and retired persons. For a discussion of inflation and deflation and of price indexes in general, and for more detail on the attributes of the CPI, see Chapter 2 under Inflation and Deflation. Figure 12.3 shows the monthly percentage change in the CPI from May 2006 to March 2008 on a real-time basis. The movements were volatile. From an increase of 0.5 percent in May 2006, the CPI decelerated to declines (below the zero line) of 0.5 percent in September and October 2006, rose to an increase of 0.9 percent in March 2007, fell to a decline of 0.2 percent in August 2007, rose to an increase of 0.6 percent in November 2007, and

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in the recession months, moved from a decline of 0.1 percent in December 2007 to an increase of 0.9 percent in March 2008. On an annual basis, the CPI decelerated from an increase of 3.2 percent in 2006 to an increase of 2.8 percent in 2007. The volatility reflected the changes in food and energy prices during the twenty-two-month period. As noted earlier in the chapter under Economic Record, price movements for the total CPI were noticeably greater than those for the CPI excluding the volatile food and energy sectors. Industrial Production The industrial production index (IPI) shows the monthly percentage change in the production of manufacturing, mining, and utilities industries. For more detail on the attributes of the IPI, see Chapter 2 under Industrial Production. Figure 12.4 shows the monthly percentage change in the IPI from October 1999 to May 2001 on a real-time basis. The monthly movements were volatile, from robust increases to declines (below the zero line). The IPI rose from zero change in May 2006 to an increase of 0.9 percent in June 2006, decelerated to a 0.4 percent gain in November 2006, followed by saw-tooth movements of large increases and declines from December 2006 to June 2007. From an increase of 0.6 percent in June 2007, the IPI fell to a decline of 0.5 percent in October 2007, and then increased to 0.3 percent in November. The recession period included two months of increase of 0.1 percent and 0.3 percent, one month of zero change, and one month of decline of 0.5 percent. Due to the continuing monthly volatility, there was no sustained growth in the IPI over the twenty-two-month period. Capacity Utilization Rate The capacity utilization rate (CUR) is a counterpart indicator to the IPI. It is useful in gauging the underlying demand for the output of industries in the IPI, and for assessing if there is a shortage or an excess of industrial capacity that bears on the rate of inflation. For more detail on the attributes of the CUR, see Chapter 6 under Capacity Utilization Rate. I have chosen to use the latest CUR data that were available at the time of this writing in 2008. The CUR for all manufacturing industries in 2005–7 was: 2005 2006 2007

78.6% 79.4% 79.4%

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Figure 12.4 Industrial Production Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was competed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available as of August 2007. Data from August 2007 to March 2008 represent data when they first became available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later data for those months that first became available in May 2008.

The CURs at 78.6 in 2005 and 79.4 percent in 2006 and 2007 were well below 85 percent, which is considered full capacity. These relatively low levels did not necessitate drawing on older, less productive, and less reliable equipment, the use of which would have pushed up production costs, causing inflationary price pressures. The low CUR levels reinforce the lack of sustained growth in the industrial production index noted above. Housing Starts The housing starts data represent the beginning of construction on privately owned nonfarm single-family and multifamily housing. For more detail on the attributes of the housing starts data, see Chapter 2 under Housing Starts.

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Figure 12.5 Housing Starts in the Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of the Census data for privately owned nonfarm housing units. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was competed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available as of August 2007. Data from August 2007 to March 2008 represent data when they first became available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later date for those months that first became available in May 2008, except for January and February 2008, for which the initial data showed changes of 0.8 and –0.6 percent, respectively, compared with 6.4 percent and 4.0 percent in the later, May 2008 data.

Figure 12.5 shows the monthly percentage change in housing starts on a real-time basis from May 2006 to March 2008. These changes were volatile, with more months of decline (below the zero line) than of increase up to the onset of the recession in December 2007. Table 12.7 indicates a decrease of 267,400 housing starts in 2006 from the previous year, and a decrease of 445,900 housing starts in 2007 from the previous year. As apparent in the table, the 2006 and 2007 declines interrupted annual increases in housing starts from 2001 to 2005. 7HAT CAUSED THIS SHARP TURNAROUND IN HOUSING STARTS ) BELIEVE IT WAS sparked by the outsized speculation in house prices, which was expected to continue indefinitely, and the extension of mortgages by lenders to households who could not afford them, including the willingness of such households to take the mortgages, as noted earlier in the chapter under House Price Bubble.

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Table 12.7 Private Housing Starts

2001 2002 2003 2004 2005 2006 2007

Total Starts

Change from Previous Year

1,602,700 1,704,900 1,847,700 1,955,800 2,068,300 1,800,900 1,355,000

34,000 102,200 142,800 108,100 112,500 –267,400 –445,900

Source: Bureau of the Census, U.S. Department of Commerce.

This was an unrealistic and overly optimistic view of current and aspiring homeowners, as well as of mortgage lenders. Mortgage lenders, including banks, lowered their standards in encouraging less affluent people to take subprime mortgages. They also encouraged more affluent people to take prime mortgages. Many of the prime and subprime mortgages were built on a shaky foundation of excessively high house prices in relation to the mortgagors’ income. This speculation was facilitated by the easing of credit standards by the Federal National Mortgage Corporation (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) in their purchase of secondary mortgages of subprime mortgages. Fannie Mae and Freddie Mac are for-profit federal government sponsored enterprises that are owned by private shareholders. The moment of truth began appearing in 2006 with a rise in delinquency rates in subprime mortgages, which in turn led banks to tighten their credit standards.8 The rise in delinquencies was driven when the interest rates on variable-rate subprime mortgages were raised above their initial levels. This was exacerbated in 2007, when delinquencies and defaults on subprime mortgages rose further, which resulted in secondary mortgage markets lessening the availability of subprime mortgages.9 Banks also tightened their credit standards further. These mortgage developments, together with concern about falling house prices and the high inventories of new unsold houses, led homebuilders to continue to lower their rate of housing starts. The lesson of the sharp turnaround in housing starts in 2006 and 2007 is to avoid adopting a mentality of speculating in unfounded hopes of limitless financial gain. It applies both to households who expect to ride the wave of ever-increasing house prices, and to mortgage lenders who lower their credit standards in order to increase their issuance of mortgages.

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Earnings of Workers Earnings of workers represent the weekly wages of production workers in all private nonfarm industries. For more detail on the attributes of the earnings data, see Chapter 2 under Earnings of Manufacturing Workers. Figure 12.6 shows the monthly percentage change in worker earnings in all private nonfarm industries on a real-time basis from May 2006 to March 2008. The monthly movements of worker earnings were volatile from May 2006 to July 2007. The largest increases were 0.7 percent to 0.9 percent, with smaller changes ranging from declines (below the zero line) of 0.1 percent, to zero change, to increases of 0.1 percent and 0.2 percent. Earnings increased 0.3 percent per month from August to November 2007, except for a 0.2 percent increase in October. In the recession months of December 2007 to March 2008, earnings increased 0.2 percent in two months, 0.6 percent in one month, and had zero change in one month. On an annual basis during 2006 and 2007, worker earnings increased in both current and 1982 dollars: Change from previous year

2006 2007

Current dollars 4.3% 3.8

1982 dollars 1.1% 0.9

Due to the earnings increase in inflation-adjusted 1982 dollars in 2006 and 2007, earnings showed an improvement in the living conditions of workers for the first years since 2000. During 2001–5, living conditions of workers declined in inflation-adjusted earnings. Interest Rates and Bank Loans This section includes two forms of interest rates. One is for three-year constant maturities of U.S. securities that represent yields on U.S. Treasury default-free outstanding issues sold with a coupon interest rate and at a premium or discount from the par value. It is the average of notes and bonds that encompass a range of remaining maturities of both longer and shorter durations. The other interest rate covers federal funds, which is the interest rate charged for loans between banks.10 The loans are typically overnight and allow banks to meet reserve requirements, though there are “term” federal funds with maturities from a few days to over one year (the average being less than six months). The Federal Reserve targets the federal funds rate to reach

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Figure 12.6 Job Earnings in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on U.S. Bureau of Labor Statistics data for all private nonfarm industries. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was competed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). Data from May 2006 to July 2007 represent data available as of August 2007. Data from August 2007 to March 2008 represent data when they first became available one month after each data month. The monthly patterns of the August 2007 to the March 2008 data are similar to the later data for those months that first became available in May 2008.

a specified level through its open market operations. Therefore, federal funds are the clearest indicator of ongoing Federal Reserve monetary policy. Interest rates are not seasonally adjusted. Interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation. Figure 12.7a shows the monthly interest rates of three-year constant maturities of U.S. securities from May 2006 to March 2008. Interest rates declined from 5.1 percent in June and July 2006 to 4.7 percent in September, and fluctuated around 4.7 to May 2007. After increasing to 5.0 percent June 2007, interest rates fell to 3.35 percent in November on the eve of the 2007–9 recession, and further in the recession months to 1.8 percent in March 2008. Figure 12.7b (page 329) shows the monthly federal funds interest rate from May 2006 to March 2008. The federal funds rate rose from 4.9–5.0 percent in

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Figure 12.7a Interest Rates on Three-Year Constant Maturities of U.S. Securities in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve data. The data are not seasonally adjusted. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

May and June 2006 to almost 5.25 percent between July 2006 and July 2007. Federal funds fell to 4.5 percent in November 2007, on the eve of the 2007–9 recession, and further in the recession months to 2.6 percent in March 2008. Federal Reserve monetary policy maintained a restraining posture during July 2006 to July 2007, when the federal funds remained at 5.25 percent. Then federal funds declined before the onset of the recession in December 2007. This was similar to the pattern of interest rates of three-year constant maturities. Commercial and Industrial Bank Loans During 2006, U.S. commercial banks mostly eased lending standards and lending terms on the issuance of new commercial and industrial loans, according to the Bank Lending Practices Survey.11 Banks mostly cited competition from other lending sources as the reason for easing the lending policies. A small number of banks tightened lending terms, particularly on riskier loans, citing

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Figure 12.7b Federal Funds Interest Rate in Expansion Preceding the 2007–9 Recession, Plus Four Recession Months, in Real Time

s2ECESSIONMONTH Source: Based on Federal Reserve Bank of New York data. The data are not seasonally adjusted. Note: The 2007–9 recession began in December 2007, so only December 2007 to March 2008 are shown in the figure as recession months. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each month’s data became available one month after the data month (for example, April 2007 data became available in May 2007). The interest rate data are not normally revised. The exception occurs when an error is found, such as in a rounding calculation.

a less favorable or uncertain economic outlook and a reduced tolerance for risk. An increased demand for loans reflected increased capital expenditures by nonfinancial companies. The demand for commercial and industrial loans softened during 2007, as the economic outlook worsened, according to the Bank Lending Practices Survey.12 Banks also tightened lending standards during the year. Banks changed their lending standards for commercial and industrial loans between 2006 and 2007, from easing standards in 2006 to tightening them in 2007. Consumer Durable Goods Spending Consumer durable goods represent items that last three years or more. Examples are cars, household appliances, furniture and household furnishings,

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and garden equipment. The data are adjusted for price change, and thus represent real movements in consumer durable goods spending. For more detail on the attributes of the consumer durable goods data, see Chapter 2 under Consumer Durable Goods Spending. Figure 12.8 shows the quarterly percentage change at an annual rate in real consumer durable goods spending on a real-time basis from the second quarter of 2006 to the first quarter of 2008. Real consumer durable goods spending was strong in four of the six quarters preceding the onset of the recession, plus the fourth quarter of 2007, which included two months of expansion and one month of recession (December 2007). The strong rates of growth ranged from 3.9 percent in the fourth quarter of 2006 to 8.8 percent in the first quarter of 2007. Exceptions were 0.8 percent in the second quarter of 2006 and 1.6 percent in the second quarter of 2007. In the first quarter of 2008, the first full quarter of the recession, real consumer durable goods spending declined (below the zero line) 6.1 percent. Wealth Effect The “wealth effect” on consumer durable goods spending reflects changes in the asset values of house prices and of common stock market prices. The idea of the wealth effect is that greater increases in house and stock prices encourage households to buy more consumer durables, while slowdowns in the increase or declines in house and stock prices discourage spending on consumer durables. During 2006 and 2007, increases in house prices slowed considerably, as noted earlier in the chapter under House Price Bubble. Stock market prices (as gauged by Standard and Poor’s 500 index) increased strongly during 2006, but the increases slowed during the first half of 2007 and stock prices declined slightly in the second half of 2007. The slowdown and decline in house prices and stock market prices, for house prices in 2006 and 2007, and for stock market prices in 2007, resulted in a negative wealth effect in those years. However, the generally strong increases in consumer durables spending in the six quarters preceding the onset of the 2007–9 recession, as well as in the fourth quarter of 2007 that included one month of recession, indicate little impact of the negative wealth effect. Gross Domestic Product The gross domestic product is the most comprehensive measure of economic growth. The data are adjusted for price change and thus represent quarterly movements in the real GDP. The data are provided quarterly, not monthly like

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Figure 12.8 Real Consumer Durable Goods Spending in Expansion Preceding the 2007–9 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time

s2ECESSIONQUARTER4HE/CTOBERn$ECEMBERQUARTERINCLUDEDONEMONTHOFRECESsion (December 2007) and January–March 2008 was a full quarter of recession. Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 2007–9 recession began in December 2007, so only the fourth quarter of 2007 and the first quarter of 2008 are shown in the figure as recession quarters. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each quarter’s data became available one month after the data quarter (for example, January–March 2007 data became available in April 2007). Data from April–June 2006 to April–June 2007 represent data available as of August 2007. Data from July–September 2007 to January–March 2008 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September 2007 to the January–March 2008 data are similar to the later data for those quarters that first became available in May 2008.

most of the other economic indicators used in the book. For more detail on the attributes of the GDP data, see Chapter 2 under Gross National Product (GNP). Figure 12.9 shows the quarterly percentage change at an annual rate in the real GDP on a real-time basis from the second quarter of 2006 to the first quarter of 2008. Real GDP increases fell from 2.4 percent in the second quarter of 2006 to 0.6 percent in the first quarter of 2007, which was interrupted by an increase of 2.1 percent in the fourth quarter of 2006. Real GDP increased 3.4 and 3.9 percent in the second and third quarters of 2007, respectively, and then growth fell to 0.6 percent in the fourth quarter of 2007 (December was the beginning of the 2007–9 recession) and in the first quarter of 2008.

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Figure 12.9 Real Gross Domestic Product in Expansion Preceding the 2007–9 Recession, Plus One Partial Quarter of Recession and One Full Quarter of Recession, in Real Time

s2ECESSIONQUARTER4HE/CTOBERn$ECEMBERQUARTERINCLUDEDONEMONTHOFRECESsion (December 2007) and January–March 2008 was a full quarter of recession. Source: Based on U.S. Bureau of Economic Analysis data as part of the national income and product accounts. Note: The 2007–9 recession began in December 2007, so only the fourth quarter of 2007 and the first quarter of 2008 are shown in the figure as recession quarters. The recession was in progress when this manuscript was completed in April 2009 (see beginning of Chapter 12). Each quarter’s data became available one month after the data quarter (for example, January–March 2007 data became available in April 2007). Data from April–June 2006 to April–June 2007 represent data available as of August 2007. Data from July–September 2007 to January–March 2008 represent data when they first became available one month after each data quarter. The quarterly patterns of the July–September 2007 to the January–March 2008 data are similar to the later data for those quarters that first became available in May 2008.

Overall, real GDP growth was weak between the second quarter of 2006 and the first quarter of 2007, strong in the second and third quarters of 2007, and weak in the fourth quarter of 2007 and the first quarter of 2008 (the first full quarter of the recession). Thus, real GDP growth was robust only for two quarters of the six-and-two-thirds quarters in the run-up to the 2007–9 recession. Assessment of Economic Policies Preceding the 2007–9 Recession The expansion between the end of the 2001 recession in November 2001 and the beginning of the 2007–9 recession in December 2007 was seventy-

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three months, or just over six years. The expansion during 2002–7 appears as three phases: s *OBLESSRECOVERYOFn s 'REATERGROWTHFROMTOTHElRSTHALFOF s #ONTINUEDSLOWDOWNINGROWTHDURING Fiscal Policy Fiscal policy during the expansion was heavily influenced by: (a) federal individual income tax cuts of 2001 and 2003; (b) the Iraq War, beginning in 2003, and a continuation of the Afghanistan War from 2001; and (c) relatively slow economic growth during the expansion. This shifted the federal budget surpluses of 2000 and of 2001 (there was a surplus during the 2001 recession) to deficits: the peak annual deficit of $372 billion in 2003 fell to $201 billion in 2006, with the deficit increasing to $229 billion in 2007. The absence of tax increases in the United States at some point after the commencement of the Iraq and Afghanistan wars was a major departure in financing sustained wars, with the notable exception of the American Revolution. Not only were taxes not increased, but to the contrary, taxes were decreased in both 2001 before the September 11 attacks, and in 2003. The tax cuts also were proportionately greater for the higher income groups than for the lower income groups. While the tax cuts were somewhat stimulative—although higher income groups have greater saving rates than lower income groups—the cuts would have stimulated greater economic growth had they been proportionately larger for lower-income households. House Price Bubble The extreme speculation in house prices during 2002–5 drove house prices much above what many homeowners, who took mortgages in buying both existing and new houses, could afford, encumbering them with substantial increases in their personal debt. This was encouraged by mortgage lenders who lowered their credit standards in order to increase their issuance of mortgages. This was a Ponzi scheme on the part of lenders, and a herd mentality on the part of homeowners, reflecting the expectation on both sides that house prices would rise indefinitely. The mentality encumbered homeowners with excessive debt. And it made lenders vulnerable to losses on their mortgage loans. Reality set in when house price increases decelerated in the first and second halves of 2006, declining still further to zero change in the second half of 2007, on the eve

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of the 2007–9 recession. This led to increasing delinquency and defaults on subprime mortgages. Hurricane Katrina Hurricane Katrina, and to a lesser extent Hurricane Rita, affected the overall economy by lowering growth of the real gross domestic product about 0.7 percentage point in the third quarter of 2005, mostly by the destruction of oil and gas operations. Continuing disruptions further reduced real GDP in the fourth quarter of 2005 about 0.5 percentage point. Tepid Economic Growth Movement of the economic indicators over the May 2006 to November 2007 period, preceding the onset of the 2007–9 recession in December 2007, shows the following: s 2EAL'$0GROWTHWASROBUSTONLYFORTWOQUARTERSOFTHESIX AND TWO thirds quarters between the second quarter of 2006 and the start of the recession in December 2007. s 4HE TYPICAL MONTHLY INCREASE IN EMPLOYMENT OF  PERCENT BETWEEN May 2006 and November 2007 represented a sluggish rate of growth. s 4HELOWESTUNEMPLOYMENTRATESOFTOPERCENTREACHEDDURINGTHE expansion from October 2006 to June 2007 approached the “full employment” designation of 4.0 percent. However, the drop in unemployment was exaggerated because of the fall in the labor force participation rate. s )NmATION AS MEASURED BY THE CONSUMER PRICE INDEX DECLINED FROM AN increase of 3.2 percent in 2006 to an increase of 2.8 percent in 2007. Inflation was noticeably greater for the total CPI than for the CPI excluding the volatile food and energy sectors. s )NDUSTRIAL PRODUCTION DID NOT HAVE SUSTAINED GROWTH OVER THE -AY 2006–November 2007 period. This was underscored by the low capacity utilization rates of manufacturing plants. s 0RIVATEHOUSINGSTARTSFELL UNITSINAND UNITSIN 2007. These declines contrasted with annual increases in housing starts from 2001 to 2005. s 7ORKER EARNINGS INCREASED IN INmATION ADJUSTED DOLLARS IN BOTH  and 2007. These were the first years since 2000 that earnings showed an improvement in the living conditions of workers. During 2001–5, living conditions of workers declined in inflation-adjusted earnings.

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s &EDERAL2ESERVEMONETARYPOLICYMAINTAINEDARESTRAININGPOSTUREDURING July 2006 to July 2007. Then federal funds declined before the onset of the recession in December 2007. This was similar to the pattern of interest rates of three-year constant maturities. s #ONSUMERDURABLEGOODSSPENDINGWASGENERALLYSTRONGINTHESIXQUARters preceding the onset of the 2007–9 recession, as well as in the fourth quarter of 2007, which included one month of recession. This indicates little impact of the negative wealth effect associated with the end of house price increases and the fall in stock market prices. The above record depicts the jobless recovery in 2002–3 from the 2001 recession, greater economic growth in 2004 to the first half of 2006, followed by a continued slowdown in growth into 2007. It suggests that the fiscal stimuli from both the 2001 and 2003 tax cuts, and from the increased defense spending for the wars in Iraq and Afghanistan, had run their course. Superimposed on this evolving weakness in the economy was the moment of truth resulting from the irrational rise in house prices, when the house price inflation came to a halt in 2007. The end of the house price bubble brought with it contractionary developments affecting employment, industrial production, and housing starts. While these weaknesses were appearing, inflation was contained. Nevertheless, the Federal Reserve continued to restrain economic growth through July 2007, just five months before the onset of the recession in December. I conclude that the recession of 2007–9 was brought on by two factors: s ,ATERECOGNITIONBYTHE&EDERAL2ESERVEINRESPONDINGTOTHEWEAKENING economy by restraining economic growth in its monetary policy, due to an excessive concern with inflation. s "URSTING OF THE HOUSE PRICE BUBBLE WHICH INTENSIlED THE ALREADY weak movements of employment, industrial production, and housing starts. The proportionately greater tax cuts to high-income households, who spend smaller shares of their income than lower-income households, lessened the fiscal stimulus of the tax cuts in the years after the cuts occurred. A stronger stimulus, by apportioning a greater share of the cuts to middle- and lowerincome households, might have helped in propping up part of the broad weaknesses appearing in the economy noted above. However, it is unlikely that this shift in the tax cuts would have staved off the recession.

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Notes 1. This description of the 2001 and 2003 tax laws is based on Congressional Budget Office, “Effective Federal Tax Rates Under Current Law, 2001 to 2014,” CBO Paper, August 2004, pp. 8–11. 2. Steven A. Bank, Kirk J. Stark, and Joseph J. Thorndike, War and Taxes (Washington, DC: Urban Institute Press, 2008), Chapter 6 and Conclusion. 3. Sumit Agarwal and Calvin T. Ho, “Comparing the Prime and Subprime Mortgage Markets,” Chicago Fed Letter, August 2007, p. 1 (unnumbered). 4. Christian E. Weller, The End of the Great American Housing Boom (Washington, DC: Center for American Progress, December 2006), pp. 1–8. 5. Michael Dolfman, Solidelle Fortier Wasser, and Bruce Bergman, “The Effects of Hurricane Katrina on the New Orleans Economy,” Monthly Labor Review, June 2007. 6. “Annual Report of the Council of Economic Advisers,” Economic Report of the President, February 2006. pp. 26–27. 7. Molly Fifer McIntosh, “Measuring the Labor Market Impacts of Hurricane Katrina Migration: Evidence from Houston, Texas,” American Economic Review, Papers and Proceedings, May 2008, p. 54. 8. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” Federal Reserve Bulletin, July 18, 2007, p. 8. 9. Board of Governors of the Federal Reserve System, “Monetary Policy Report to the Congress,” Federal Reserve Bulletin, February 27, 2008, p. 1. 10. The name “federal funds” reflects the transfer of these funds at regional Federal Reserve Banks. 11. Mark Carlson and Gretchen C. Weinbach, “Profits and Balance Sheet Developments at U.S. Commercial Banks in 2006,” Federal Reserve Bulletin, July 2007, p. A41. 12. William Bassett and Thomas King, “Profits and Balance Sheet Developments at U.S. Commercial Banks in 2007,” Federal Reserve Bulletin, June 2008, pp. 7 and 11.

13 Findings and Recommendations

This assessment of what brought on the eleven recessions since the end of World War II has three parts: s 0RECIPITATINGELEMENTSOFEACHRECESSION s 4HEMESANDAGENTSOFTHEPRECIPITATINGELEMENTS s 0OLICYRECOMMENDATIONSTOAVOIDAMELIORATEFUTURERECESSIONS Precipitating Elements of Each Recession The following sections summarize the events leading up to each recession. These are detailed in the preceding chapters. The Recession of 1948–49 The recession of 1948–49 began in November 1948 and ended in October 1949. The recession followed the aftermath of the U.S. conversion to a civilian economy after Germany and Japan were defeated in World War II in 1945. The conversion was dominated by a working down of the backlog of demands for household goods, housing, and business equipment and structures that had built up from the Depression of the 1930s and World War II. The backlogs were largely eliminated between the spring of 1947 and the summer of 1948, with the notable exceptions of cars and housing. The Cold War with the Soviet Union, which began in 1946, did not lead to large, sustained levels of defense spending until the outbreak of the Korean War in 1950. The further elimination of the backlogs was not affected by either of those wars. Only the basic necessities were produced for the civilian economy during World War II. The consequent accumulated household and business savings easily bid up the prices of items in short supply. Inflation was high, though not accelerating between the spring of 1947 and the summer of 1948. In this environment, the Federal Reserve, the president, and Congress viewed inflation as the major economic problem of the times. 337

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In response, the Federal Reserve raised reserve requirements in stages on commercial banks from February to September 1948, beginning with large city banks and extending to all Federal Reserve member banks. But banks still had adequate funds for lending at low interest rates, so the increase in banks’ reserve requirements did not dissuade households and businesses from borrowing. The federal budget surpluses during 1947 and 1948 were considered a major tool for damping demand and thus inflation. In April 1948, the Republican-controlled Congress passed legislation to cut individual income taxes, which was enacted over President Harry Truman’s veto. While policy makers considered inflation the main economic problem across the political spectrum, the tax cuts undermined the policy of containing inflation through the budget surpluses. Thus, the tax cuts appear more as a reflection of political philosophy distinguishing Republicans from Democrats on the issue of the role of government in the economy, which could be significant in the coming presidential election in November 1948. However, the tax cuts added fuel to the concern about inflation. This led to a tripartite agreement between President Truman, Congress, and the Federal Reserve to reimpose previous credit controls that had been discontinued, in order to contain inflation. In the marketplace, interest rates continued to rise. The Federal Reserve instituted credit controls in September 1948 despite the continued rising interest rates. While concern about inflation continued unabated during 1948, other developments arose that lessened inflationary pressures and the demand for goods and services, and thereby contributed to the recession. These developments were the working off of the backlog of demand for household durable goods, a decline in housing starts that began in June 1948, and demographic changes in the population. The continuous working off of the durable goods backlogs lessened the demand for those products. The decline in housing starts not only had the direct effect of lessening expenditures for building materials and construction labor, but affected related spending on home appliances, furniture, home furnishings, and garden equipment that occurs when homeowners move into new housing. The demographic changes in the population resulted from the slowdown in marriages and birthrates, and the internal migration of families and households around the country. All of these factors contributed to lessening the demand for new housing. The imposition of consumer credit controls in September 1948, two months before the onset of the 1948–49 recession, appeared as a tipping point leading the economy into the recession. It was the only economic policy change triggering the recession. By contrast, the weaknesses related to the working

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down of household durable goods backlogs and the decline in housing starts were market driven. The demographic changes reflected both market and social changes. I conclude that the actions of the Federal Reserve, the president, Congress, and the events of the marketplace all had important roles in bringing on the 1948–49 recession. The Recession of 1953–54 The recession of 1953–54 began in July 1953 and ended in May 1954. Most of the expansion following the end of the 1948–49 recession occurred during the Korean War, which started in June 1950 and ended with the armistice in July 1953. Defense spending surged during the war, rising from 6.7 percent of the gross domestic product (GDP) in 1950 to 14.7 percent of the GDP in 1953. Defense spending began falling in the third quarter of 1953, which corresponded to the armistice in July 1953. The defense share of the GDP in 1952 was maintained in 1953, though defense spending decreased in the third and fourth quarters of 1953. In the nineteen months preceding the onset of the recession in July 1953, modest growth appeared in various parts of the economy, with both shortterm increases and decreases. Unemployment generally ranged from 2 to 3 percent during this period. President Harry Truman instituted mandatory price and wage controls in January 1951. Price controls on many products were removed during 1952, but wage controls were left unchanged in 1952. Wage controls were removed in early 1953, and all prices were decontrolled in October 1953. The consumer price index for urban workers increased by 5.9 and 6.0 percent in 1950 and 1951, respectively, before falling back to 0.8 and 0.7 percent in 1952 and 1953, based on the twelve-month movements from December to December of each year. Federal income taxes were increased on individuals, and an excess profits tax was put on businesses in 1950 and 1951. Federal excise taxes on certain items were increased in 1951. The federal government budget was in near balance during the Korean War, despite the large incremental defense spending, which was offset by increased federal income taxes on individuals and businesses, increased federal excise taxes, and increased economic growth, all of which raised federal receipts. The near balance of the fiscal position resulted in overall federal spending and receipts having a neutral effect on the economy prior to the recession. A major change in monetary policy occurred in 1951. This change re-

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versed the policy that had existed since World War II whereby the Federal Reserve maintained low interest rates in order to lessen the cost of financing federal deficits during the war. The monetary policy change, referred to as the Treasury-Federal Reserve Accord, freed the Federal Reserve to influence interest rates upward or downward depending on the course of the economy. Interest rates rose by one percentage point from April 1952 to June 1953 as a result of the Federal Reserve’s monetary policy of restraining demand in order to contain inflation. In lowering reserve requirements in June 1953, the Federal Reserve noted that the policy had become too restrictive. In the environment of modest economic growth and low inflation preceding the onset of the recession in July 1953, the Federal Reserve’s restrictive monetary policy, which began in the spring of 1952, led to a weakening of civilian markets and triggered the recession. The cutback in defense beginning in the third quarter of 1953 aggravated the recession of 1953–54, but it did not start it. I conclude that the actions of the Federal Reserve had the primary role in bringing on the 1953–54 recession. The Recession of 1957–58 The recession of 1957–58 began in August 1957 and ended in May 1958. The recession began only thirty-nine months after the 1953–54 recession ended in May 1954. During the nineteen months preceding the onset of the recession in August 1957, economic growth among various parts of the economy was modest. Unemployment fluctuated between 2.8 percent and 4.9 percent, which suggested periods of both tight and slack labor markets. Inflation accelerated from an annual rate of 2.6 percent during January–June 1956 to 3.8 percent between January and June 1957. It is noteworthy, however, that prices increased by only 0.4 percent in 1955, which was the first full recovery year following the 1953–54 recession. Yet the Federal Reserve began to preemptively raise interest rates early in 1955 in order to head off potential future inflation. At most, a preemptive monetary policy would have been justified during the first half of 1956, when inflation began accelerating. This timing would have lessened the likelihood of bringing on a recession, just three years after the previous recession had ended. The Federal Reserve apparently took preemptive action because of its experience that monetary policy impacts the economy with a lag. I conclude that the Federal Reserve had the primary role in bringing on the recession of 1957–58.

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The Recession of 1960–61 The recession of 1960–61 began in April 1960 and ended in February 1961. It began only two years after the end of the 1957–58 recession, making the recovery-expansion period between the two recessions the second shortest of the postwar period. Economic developments during the sixteen months preceding the onset of the recession were erratic, including several months of decline. Price increases were relatively small and inflation was not a problem. There were no signs suggesting the economy might be heading into an inflationary spiral. Yet the Federal Reserve began tightening credit in August 1958, only four months after the 1957–58 recession ended in April 1958, because of its concern that “inflationary expectations” would bring on inflation. The Federal Reserve intensified the restraint through December 1959, and it did not begin easing monetary policy until March 1960, just one month before the onset of the 1960–61 recession. I conclude that the Federal Reserve had the primary role in bringing on the 1960–61 recession. The Recession of 1969–70 The recession of 1969–70 began in December 1969 and ended in November 1970. The recession followed what now ranks as the second longest expansion since the end of World War II, from February 1961 to December 1969, lasting 106 months, or close to nine years. The expansion of the 1960s occurred against the backdrop of President Lyndon Johnson’s Great Society initiatives, the Vietnam War, the assassinations of President John Kennedy, Martin Luther King, Jr., and Robert Kennedy, and an outbreak of social upheaval and urban riots around the country. Unemployment was below the 4 percent “full employment” threshold during 1966–69, and reached a low of 3.5 percent in 1969 (unemployment in selected months in 1969 fell to 3.3 and 3.4 percent). Inflation was mild through the mid-1960s and then accelerated sharply. The annual increase in the consumer price index ranged from 1 to 2 percent during 1962–65 and then rose continuously to 6 percent in 1969. Federal income taxes were increased on individuals and corporations in 1968. Until then, the Federal Reserve’s monetary policy restraint was the sole economic policy instrument used to contain inflation. The voluntary price and wage guidelines instituted by President John Kennedy in 1962 were no longer in effect by the fall of 1966. The 1960s expansion was the most impressive economic performance

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since the end of World War II. On the other hand, one might ask whether the expansion would have been as long, or unemployment as low, without the large increases for defense spending for the Vietnam War. While the war led to rising defense spending, several commercial markets showed weaker demand in 1969. Industrial production peaked in July 1969, and then declined for the rest of 1969. Housing starts declined for ten months during 1969. Spending on consumer durable goods was strong during the first half of 1969, although below the rates of 1968, and declined sharply in the last half of 1969. The gross national product growth rate began declining in the second half of 1968, before falling to low rates in the second and third quarters of 1969. The economy contracted in the fourth quarter. The late increase in federal income taxes to finance the war in 1968, and the absence of price and wage controls when inflation was accelerating in 1968 and 1969, made for poor economic policy by President Johnson. It is likely that an earlier increase in federal income taxes together with the use of price and wage controls would have lessened increases in inflation and in interest rates. I conclude that the main factors bringing on the recession of 1969–70 were President Johnson’s limited effort to combat inflation in a “fully employed” economy, and the various marketplace weaknesses appearing in 1969. The Recession of 1973–75 The recession of 1973–75 began in November 1973 and ended in March 1975. Although U.S. involvement in the Vietnam War continued throughout this period, U.S. troop levels were significantly reduced. The recession began as the mandatory price and wage controls instituted by President Richard Nixon in 1971 were being phased out. The controls were initiated during a period of high unemployment at 6 percent that persisted in the recovery from the 1969–70 recession, and at the same time, witnessed an acceleration in inflation in the second quarter of 1971; the acceleration in inflation had followed a general decline in inflation during the recovery. The turnaround in inflation, when unemployment was high, raised fears that inflation could reignite, even in the face of the existing weak demand. Two other economic changes preceded the onset of the 1973–75 recession: (a) the foreign exchange value of the dollar, and (b) the Arab oil embargo. President Nixon initiated a change in the determination of the value from the fixed rate of $35 per ounce of gold that had been formalized in 1944, to a floating market rate that evolved from 1971 to 1973. This led to a devaluation of the dollar and an associated rise in import prices, which increased inflation. The Arab oil embargo began in October 1973, only one month before the

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onset of the recession, resulting in much higher oil prices. The embargo did not precipitate the recession, though it deepened and lengthened it. Four areas of economic weakness emerged during 1973: s !CCELERATINGINmATION s &ALLINGHOUSINGSTARTS s $ECLININGSPENDINGFORCONSUMERDURABLEGOODS s 3HARPDECELERATIONOFGROSSNATIONALPRODUCTGROWTH This confluence of contrary economic developments—accelerating inflation and falling economic growth—occurred when the price and wage controls were being phased out. In this environment, the Federal Reserve opted to continue tightening credit, which it had begun during the third quarter of 1972, so as to combat inflation. I conclude that President Nixon, in terminating the short life of the price and wage controls, prematurely ended an important direct effort to contain inflation. That action reinforced the Federal Reserve’s predilection to restrain bank credit in order to combat inflation, regardless of its source, even though economic growth had been weakening. That monetary restraint is what brought on the 1973–75 recession. The Recession of 1980 The recession of 1980 began in January 1980 and ended in July 1980. Three developments in 1978 and 1979 pushed up inflation in the two years preceding the onset of the recession. These inflationary pressures came from supply cost aspects of the economy, not from excessive demand: s -ARKEDSLOWDOWNINPRODUCTIVITYINCREASESDURINGTHES WHICHLESSened the possibility of offsetting increases in labor costs of production s 4HE)RANIANRevolution of 1979, which resulted in much higher gasoline and other oil prices s $ECLINEINTHEVALUEOFTHEDOLLAR WHICHRAISEDIMPORTPRICES Economic growth, other than employment, was not strong during 1978 and 1979, as indicated by diminished and negative rates of growth in industrial production, housing starts, consumer durable goods spending, and the gross national product. By contrast, employment increased strongly in 1978 and 1979, although unemployment remained just under 6 percent, well above the “full employment” level of 4.0 percent. Unemployment remained at this level because of the rising number of women entering the job market due to

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the cultural shift that opened many more occupations to women, and to the greater numbers of teens entering the job market. Also, there was less shortage of skilled, experienced workers at this time than even in previous periods that had tight job markets. The overall weakness in economic growth was exemplified when President Jimmy Carter’s Council of Economic Advisers published a forecast of a recession for 1980. This was the first time a presidential agency had made public a forecast of a recession. Inflation accelerated from 9 percent in 1978 to 13 percent in 1979, based on the consumer price index. Interest rates on U.S. Treasury securities and federal funds rose to high levels in 1978 and 1979, reaching 11 percent (Treasury) and 14 percent (federal funds) in 1979. President Carter tried to counteract the sources of inflation by instituting voluntary price and wage standards in 1978. However, the allowable price and wage increases under the standards were considerably relaxed in 1979, the second and last year of the program. To combat inflation, the Federal Reserve increasingly acted to restrain credit in 1978 and 1979. The tight monetary restraints were heightened in October 1979 by a still more rigorous regimen of raising interest rates, which continued into March 1980, two months after the start of the 1980 recession. I conclude that President Carter, in terminating the short life of the wage and price standards, prematurely ended an important direct effort to contain inflation. That action reinforced the Federal Reserve’s predilection to restrain bank credit in order to combat inflation, regardless of the source of the inflation, even though economic growth had been weakening. That monetary restraint brought on the 1980 recession. The Recession of 1981–82 The recession of 1981–82 began in July 1981 and ended in November 1982. It began only one year after the end of the 1980 recession, ending the shortest economic expansion since the end of World War II. Economic growth, strong during the first six months of the expansion, slowed considerably in the next six months preceding the onset of the 1981–82 recession. Unemployment remained high during the expansion, declining only from 7.4 percent in August 1980 (the first full month of the expansion) to 7.0 percent in June 1981 on the eve of the recession, far above the “full employment” level of 4 percent. Although inflation declined somewhat after the end of the 1980 recession, it was still high during the first half of 1981, just before the onset of the 1981–82 recession. The consumer price index, measured at annual rates,

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rose 10.2 percent for all items and 8.5 percent for all items excluding energy during this six-month period. I believe the high inflation rate reflected inflationary expectations of businesses and workers, not excessive demand in the economy. Inflationary expectations occur when people believe that a wage/price spiral will continue indefinitely. Higher prices lead workers to call for higher wages in order to maintain the purchasing power of their earnings. The higher wages lead businesses to raise prices to offset increases in production costs, and so on in subsequent rounds, further fueling the spiral. In order to curb the inflation, the Federal Reserve pursued an active policy of monetary restraint aimed at slowing economic growth during the expansion, despite the high rate of unemployment and the low rate of industrial capacity utilization. This was a blunt tool for curbing inflationary expectations. The direct way to combat the inflationary expectations would have been to institute mandatory price and wage controls or voluntary price and wage standards. But President Ronald Reagan was against these options because of his philosophic opposition to such government action. I conclude that the Federal Reserve’s monetary restraint brought on the 1981–82 recession, just one year after the end of the 1980 recession. However, had President Reagan instituted price and wage controls or standards with meaningful enforcement, it would have lessened the degree of the Federal Reserve’s monetary restraint and so probably would have avoided bringing on the 1981–82 recession. The Recession of 1990–91 The recession of 1990–91 began in July 1990 and ended in March 1991. It followed an expansion of ninety-two months, or approaching eight years, from November 1982 to July 1990, which ranks as the third longest expansion since the end of World War II. Prominent economic and political events occurred during the 1980s preceding the 1990–91 recession: s ,ARGEFEDERALINCOMETAXCUTSWEREENACTEDINTHEEARLYS s The federal deficit continued to grow during the 1980s. s ,ARGE INCREASES IN DEFENSE SPENDING FOR THE #OLD 7AR DURING THE 1980s. s 3AVINGSANDLOANASSOCIATIONFAILURES WHICHRESULTEDINRISINGINTEREST rates for homebuyers and whose full effect on the overall economy remains unclear. s 3TOCKMARKETCRASHIN WHICHPROBABLYLESSENEDECONOMICGROWTH in late 1987 and early 1988.

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s 3HARPDECREASEINTHEFOREIGNEXCHANGEVALUEOFTHEDOLLARINTHELATE 1980s, which stimulated U.S. exports. But this may have increased U.S. import prices, thereby raising inflation and making the United States less attractive for foreign investments. s (URRICANE(UGOIN3OUTH#AROLINAANDTOASMALLEREXTENTIN.ORTH#AROlina, and the San Francisco Bay Area earthquake, lessened national economic growth in 1989 and 1990, though probably by small amounts. Economic growth during the 12 to 18 months preceding the onset of the 1990–91 recession was modest: s *OBINCREASESBECAMEPROGRESSIVELYWEAKER s 5NEMPLOYMENTATMORETHANPERCENTEXCEEDEDTHEhFULLEMPLOYMENTv rate of 4.0 percent. s #OREINmATION WHICHEXCLUDESFOODANDENERGYPRICES ACCELERATEDAT relatively high levels of 4.4 percent during 1989 to 5.4 percent during the first half of 1990. Transitory price increases resulting from temporary supply shortages in food and energy became embedded in the economy, which in turn led to greater inflation. However, the inflation did not reflect an overheating of the economy due to excessive demand. s )NDUSTRIALPRODUCTIONSHOWEDONLYMODESTGAINS s (OUSINGSTARTSWEREGENERALLYWEAK s #ONSUMERDURABLEGOODSSPENDINGWASVOLATILE WITHMONTHLYINCREASES interrupted by monthly declines. s 'ROSSNATIONALPRODUCTGROWTHWASTEPID I conclude that the expansion preceding the 1990–91 recession had run out of steam, as the stimuli from the tax cuts of the early 1980s and the large increase in defense spending during the 1980s no longer had the effects of the previous years. This was accompanied by a general attribute of business cycles, in which the marketplace does not always adapt smoothly to the complex interactions of changing demands for various products. The Recession of 2001 The recession of 2001 began in March 2001 and ended in November 2001. It followed the longest expansion since the end of World War II—120 months, or ten years, from March 1991 to March 2001. The expansion had several positive attributes: s $EFENSESPENDINGWASDECLINING GIVENTHEENDOFTHE#OLD7ARANDTHE breakup of the Soviet Union. Except for limited war with Serbia, the United States was not engaged in any hot wars.

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s %CONOMICGROWTHANDEMPLOYMENTACCELERATEDDURINGTHEEXPANSION5Nemployment fell to 4 percent by the late 1990s and 2000, the recognized definition of full employment. This was the only time full employment was achieved other than during 1948, the Korean War in the early 1950s, and the Vietnam War in the late 1960s. s )NmATIONWASCONTAINEDATPERCENTORBELOW ANDDECELERATEDASTHE expansion progressed, except for transitory fluctuations in food and energy prices. This record on inflation, which occurred during a period of sustained economic growth and full employment, benefited from the marked increase in productivity during 1995–2000. The productivity improvement has been attributed to the surge in the production and use of computers and telecommunications equipment. s 4HEFEDERALGOVERNMENTBUDGETDElCITSHIFTEDINTOASURPLUSIN with the surplus rising to $190 billion in 2000. The shift into a surplus reflected an increase in federal income tax rates on higher-income households, legislative controls limiting the growth in federal expenditures, and rising economic growth, which generated rising tax receipts. On a negative note, the stock market and telecommunications speculative bubbles in the late 1990s diminished these achievements during the expansion. While artificially boosting economic growth, the subsequent bursting of the bubbles contributed to bringing on the 2001 recession. Unemployment remained low in 2000, inflation was contained, and excess capacity utilization in manufacturing industries allowed manufacturers to use their most efficient equipment. However, as the economy progressed during 2000, preceding the onset of the 2001 recession in March 2001, weaknesses began appearing in several economic indicators: employment, housing starts, industrial production, the gross domestic product, and commercial interest rates. Despite these weaknesses, the Federal Reserve maintained a restraining monetary policy by keeping the federal funds rate at its peak level of 6.5 percent from June to November 2000, with a slight decline to 6.4 percent in December. It was only in January 2001 that the Federal Reserve began sharp cuts in the federal funds rate, just two months before the onset of the 2001 recession in March. The bursting of the stock market and telecommunications “dot-com bubbles” contributed to bringing on the recession. At the same time, it appears that even had the Federal Reserve relaxed its tight monetary policy during 2000, the 2001 recession might still have occurred. This reflects the complexities of maintaining smooth transitions with changing product demands in market-driven countries, as noted in Chapter 1 under Business Cycles and Recessions.

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With these caveats, I conclude that the Federal Reserve and the weakening demands of the marketplace were instrumental in bringing on the 2001 recession. The Recession of 2007–9 The recession of 2007–9 began in December 2007. Because the recession was in progress when the manuscript for this book was completed in June 2009, I cite no monthly ending date to the recession. But I believe it will be designated as ending sometime in 2009, and so I refer to it as the 2007–9 recession. The expansion between the end of the 2001 recession in November 2001 and the beginning of the 2007–9 recession in December 2007 lasted seventythree months, or just over six years. The expansion was characterized by a sluggish recovery in 2002–3, with an actual loss of jobs in those years; a pickup in economic and job growth in 2004 through the first half of 2006; and then a slowdown in growth up to the onset of the recession in December 2007. Unemployment peaked at 6.0 percent in 2003 before falling to 4.6 percent in 2006 and 2007. Part of this decline reflected the decrease in the labor force participation rate from 66.6 percent in 2002 to 66.0 percent in 2007. Inflation, based on the consumer price index (CPI), increased at an average annual rate of 2.7 percent between 2002 and 2007. But the CPI, excluding the volatile food and energy components, increased at a noticeably lower rate of 2.1 percent. These developments indicated that inflation was not driven by excessive demand in the economy. In fiscal policy, the economy was dominated by the federal income tax cuts in 2001 and 2003, and increased defense spending for the wars in Iraq and Afghanistan. These shifted the federal budget position from surpluses during 1998–2001 to deficits in 2002–7. In a departure from the tradition of financing sustained wars by raising taxes (with the notable exception of the American Revolution), taxes were not increased to finance the Iraq and Afghanistan wars. Extreme speculation drove up house prices at rates much greater than increases in the consumer price index during 2002–5. These differentials peaked in the two six-month periods of June 2004–December 2004 and December 2004–June 2005, with house prices increasing by 6.2 percent in each period and the CPI increasing by 1.0 and 1.5 percent. When house prices began decelerating in 2006, the inflated purchase prices of the houses led homeowners to being encumbered with debt they could not afford. Increasing delinquency and defaults appeared on subprime mortgages as house prices continued to fall in 2007. The house price speculation reflected the assumption on the part of homeowners and mortgage lenders that prices would rise indefinitely.

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Hurricane Katrina, and to a lesser extent Hurricane Rita, lowered the real gross domestic product growth rate by an estimated 0.7 percentage point in the third quarter of 2005, and an additional 0.5 percentage point in the fourth quarter of 2005. Employment, industrial production, and economic growth, as reflected in the gross domestic product, were sluggish from May 2006 to November 2007, the period preceding the onset of the 2007–9 recession in December 2007. Housing starts fell in both 2006 and 2007. Inflation was contained, and capacity utilization in manufacturing industries was low. Overall, the economy experienced modest growth, inflation was under control, and the decline in house prices emerged as an increasing problem. Despite these conditions, the Federal Reserve continued to restrain economic growth by maintaining its tight monetary policy through July 2007, just five months before the onset of the recession in December. This restraint reflected an excessive concern with inflation. I conclude that the recession of 2007–9 was brought on by two factors: the Federal Reserve’s late recognition of a weakening economy, which led to its continuing its monetary restraint policy for too long; and the bursting of the house price bubble, which intensified the already weak movements in employment, industrial production, and housing starts. Themes and Agents of the Precipitating Elements Several themes emerge from the actions of the economic policy makers— the Federal Reserve, the president, and Congress—and the events in the marketplace. I identify the roles of these four agents in precipitating each recession. Table 13.1 summarizes the relative roles of the three economic policy makers and the marketplace as agents during the one to two years preceding the onset of each recession. In the complexity of the U.S. economy, all four agents contributed to bringing on each recession. However, the table highlights those agents that had prominent roles in precipitating each recession. Federal Reserve actions appeared to be important in contributing to nine recessions. Presidential actions appeared important in five. Congressional actions appeared important in one recession, and marketplace events appeared important in five recessions. More than one agent played a critical role in contributing to seven recessions, defined as “joint” in the table. A single agent played a critical role in the other four recessions, defined as “primary” in the table.

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Table 13.1 Relative Importance of Agents Precipitating the Eleven Recessions

Recessions

Totals

Federal Reserve

President

Congress

Marketplace

1948–49* 1953–54** 1957–58** 1960–61** 1969–70* 1973–75* 1980* 1981–82* 1990–91** 2001* 2007–09* Totals Joint* Primary**

4 1 1 1 2 2 2 2 1 2 2 20 16 4

X X X X — X X X — X X 9 6 3

X — — — X X X X — — — 5 5 0

X — — — — — — — — X — 1 1 0

X — — — X — — — X X X 5 4 1

*Joint: Multiple agents had important roles in precipitating the recession. **Primary: One agent had the key role in precipitating the recession.

Federal Reserve The Federal Reserve had an important role in precipitating nine of the eleven recessions. The two cases in which the Federal Reserve was not an important agent were the 1969–70 and the 1990–91 recessions. The three instances in which the Federal Reserve was the primary agent were the early recessions: 1953–54, 1957–58, and 1960–61. Federal Reserve actions in bringing on these recessions resulted from the fact that it had been overly concerned with inflation. This concern existed despite the lack of evidence that inflation stemmed from the economy’s overheating from excess demand, which would have been associated with a “fully employed” economy, as reflected in an unemployment rate of four percent or less. Such conditions would have called for restrictive monetary policies to restrain demand if inflation had been accelerating. But the economy had not been at full employment prior to the nine recessions in which the Federal Reserve had an important role in precipitating the downturns. Instead, the inflation stemmed from three sources: s ! PRICE WAGE SPIRAL OF INmATIONARY EXPECTATIONS THAT APPEARED TO BE continuing indefinitely. The expectations reflected an anticipated future inflation, not one that had already occurred.

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s #ARTELPRICINGOFOILBYTHE/RGANIZATIONOF0ETROLEUM%XPORTING#OUNtries that had increased oil prices, which then became embedded in the general price structure. s 4HECHAIRMANOFTHE"OARDOF'OVERNORSOFTHE&EDERAL2ESERVE3YSTEM had set the bar for inflation at less than 2 percent annually in the 1950s, which was too low for triggering an anti-inflation response. In seeking to combat the effects of inflationary expectations, oil cartel pricing, and the excessively low inflation rate bar, the Federal Reserve restrained demand, which led to increased unemployment. The use of monetary policies was a blunt economic tool inappropriate for curbing the type of inflation present in the economy. In addition, the Federal Reserve did not take timely, appropriate action to curb speculation in the stock market in the late 1990s and in house prices in the 2000s. There is no published report by the Federal Reserve forecasting any of the eleven recessions. President Presidential actions were important in contributing to five of the eleven recessions. The presidents in question were weak in their efforts to contain inflation preceding the onset of the 1969–70, 1973–75, 1980, and 1981–82 recessions. By contrast, the president, the Federal Reserve, and Congress helped bring on the 1948–49 recession by initiating consumer credit controls when demand in the marketplace was softening. Inflation occurred in a fully employed economy preceding the onset of the 1969–70 recession, when the Vietnam War was proceeding at peak levels. President Johnson was late in supporting a tax increase to finance the war when the economy was expanding above full employment, which was inflationary. He also did not impose mandatory price and wage controls or voluntary price and wage standards to curb inflation. President Nixon began phasing out the mandatory price and wage controls in 1973, too early to break the inflationary psychology of the times. This reinforced the Federal Reserve’s policy of restraining demand to contain inflation, despite weaknesses appearing in various parts of the economy. President Carter began phasing out the voluntary price and wage standards in 1978, too early to break the inflationary psychology of the times. This reinforced the Federal Reserve’s policy of proceeding with restraining economic demand to curb inflation, despite weaknesses in economic growth in the economy. President Reagan did not impose price and wage controls or standards be-

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cause of his philosophic opposition to such government action. This reinforced the Federal Reserve’s policy of proceeding with restraining economic demand to curb inflation, despite only a one-year recovery from the 1980 recession before the 1981–82 recession began. President Carter’s Council of Economic Advisers published a forecast of a recession for 1980. And President Carter noted at that time that this Budget of the United States Government assumed the occurrence of that recession. Of the eleven recessions, this was the only forecast of a recession made public by a presidential agency. President George W. Bush did not support an increase in federal income taxes to finance the Iraq War when the economy was expanding from the jobless recovery of 2002–3. This substantially increased the federal budget deficit. Congress Congress was an important joint agent, together with the three other agents, in precipitating the 1948–49 recession. While this linkage was limited to only one of the eleven recessions, it does not address the responsibility that Congress has for overseeing the actions of the Federal Reserve. In its oversight of the Federal Reserve, Congress engaged in pro forma reviews during all periods preceding the onset of the eleven recessions. Congress was late in increasing income taxes to finance the Vietnam War when the economy’s demand exceeded full-employment levels. And it did not support an increase in federal income taxes to finance the Iraq War when the economy was approaching full employment. This substantially increased the federal budget deficit. Marketplace Changes in market conditions were an important joint agent in precipitating four recessions, and a primary agent in precipitating one. The marketplace represents the economy as it evolves in the everyday lives of people, businesses, governments, and not-for-profit groups buying, selling, working, investing, borrowing, and lending. It is the result of all economic endeavors to make a living, raise children, and enhance the quality of all aspects of life. The marketplace differs fundamentally from the three other agents— Federal Reserve, president, and Congress. It is a summation of all economic events—those stemming from all individuals and groups going about their daily lives and those stemming from the actions of the other three agents. The marketplace influences the economy by the conglomeration of its anonymous

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movements. Recessions occur because the marketplace does not always adapt smoothly to the complexities of a host of factors affecting economic life, including the policy decisions of the Federal Reserve, the president, and Congress. Unlike the other three agents, the marketplace does not make policy decisions. Policy Recommendations for Avoiding or Ameliorating Future Recessions The following recommendations are designed to reduce the frequency and severity of recessions. In addition to the recommendations for the three agents that are the focus of the book—the Federal Reserve, the president, and Congress—I have added here recommended actions for the five federal banking supervisory agencies—Federal Reserve, Controller of the Currency, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration. Table 13.2 summarizes the recommendations. Federal Reserve Recommendations for the Federal Reserve s 0UBLICLYANNOUNCEFORECASTSOFRECESSIONSWHENMOSTOFTHESENIOR&EDERAL Reserve staff and most of the Federal Open Market Committee (FOMC) conclude that a recession is likely. The FOMC determines the Federal Reserve’s monetary policies. It is composed of the seven Governors of the Federal Reserve Board, four rotating presidents of the twelve regional Federal Reserve Banks, and the president of the Federal Reserve Bank of New York who is a permanent member. s 4HEVALUEOFFORECASTINGRECESSIONSINAPUBLICMANNERISTHATITHELPS bring a national consensus of the Federal Reserve, president, Congress, and the public to promptly coordinate an array of actions designed to avoid or lessen the impact of an expected recession. s 2ESTRAINECONOMICGROWTHTOCURBINmATIONTHROUGHITSMONETARYPOLIcies only when unemployment has been sustained for several months in a range of 4.0–4.5 percent. Full employment is recognized as unemployment at 4 percent or below (see Chapter 6 under Definition of Full Employment). s 7HEN ACTING TO CURB INmATION BY RESTRAINING ECONOMIC GROWTH THE inflation should be diagnosed as stemming from excess demand in the economy. Monetary restraint on economic growth should not be used to curb inflation that is not associated with excess demand, as, for example,

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Table 13.2 Summary of Recommendations Federal Reserve s &ORECASTRECESSIONSWHENACONSENSUSOFTHE&EDERAL2ESERVESTAFFANDOFTHE twelve members of the Federal Open Market Committee (FOMC) conclude that a recession is likely. s 2ESTRAINECONOMICGROWTHTOCURBINmATIONTHROUGHITSMONETARYPOLICIESONLY when unemployment has been sustained for several months in the range of 4 percent, say 4.5 percent or below. s !CTTOCURBINmATIONBYRESTRAININGECONOMICGROWTHONLYWHENINmATIONISDIAGnosed as stemming from excess demand in the economy. s )NmATIONATVERYLOWRATESSHOULDNOTBECONSIDEREDASABASISFORMONETARY restraint to slow economic growth. s -ONETARYPOLICYSHOULDACTTOCURBSPECULATIONINTHESTOCKMARKETBYRAISING margin requirements when investors borrow money to buy stocks. s -ONETARYPOLICYSHOULDACTTOCURBMORTGAGEBORROWINGTHATSTEMSFROMSPECULAtion in house prices by raising long-term interest rates. President s &ORECASTRECESSIONSWHENACONSENSUSOFTHEPRESIDENTSECONOMICADVISERSIS that a recession is likely. s )NSTITUTEPRICEANDWAGECONTROLSSTANDARDSWHENINmATIONACCELERATESATHIGH RATESANDWHENTHEINmATIONISNOTDRIVENBYEXCESSDEMANDINTHEECONOMY s )NCREASEFEDERALINCOMETAXESTOlNANCEPROTRACTEDWARS Congress s #ONDUCTSUBSTANTIVEOVERSIGHTOFTHE&EDERAL2ESERVESACTIONSANDOUTLOOKFOR the economy in the regular congressional hearings that are held twice a year. s )NCREASEFEDERALINCOMETAXESTOlNANCEPROTRACTEDWARS Federal Bank Supervisory Agencies s )NEXAMINATIONSOFBANKS INCLUDEEXAMINATIONOFTHELENDINGPRACTICESTHATFEED an unwarranted speculation in house prices and stock market prices. s /RDERABANKTHATHASENGAGEDINUNDESIRABLESPECULATIVELOANSTOCEASEAND desist from those lending practices.

when the inflation is driven by the psychology of a price-wage spiral of inflationary expectations on the part of businesses and workers, with no end in sight; or by price hikes due to supply constraints, such as increases in the price of oil due to cartel pricing of the Organization of Petroleum Exporting Countries. s )NmATIONATVERYLOWRATESSHOULDNOTBECONSIDEREDABASISFORMONETARY restraint to slow economic growth. The bar for inflation at less than 2 percent annually in the 1950s was too low for triggering an anti-inflation response.

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s -ONETARY POLICY SHOULD ACT TO CURB A GENERALLY RECOGNIZED EXTREME speculation in stock equities by raising margin requirements to lessen borrowing used to buy stocks. An example of such speculation is when overall indexes of stock equities show price increases much above that indicated by the expected growth of profits of companies represented in the stock market indexes in the next few years. s -ONETARYPOLICYSHOULDACTTOCURBMORTGAGEBORROWINGTHATSTEMSFROM a generally recognized extreme speculation in house prices by raising long-term interest rates. An example of such speculation is when house prices increase much above the increase in general inflation as indicated by the consumer price index. This will require the Federal Reserve to include long-term interest rates as well as its usual emphasis on shortterm interest rates in its conduct of monetary policy. President Recommendations for the President s0UBLICLYANNOUNCEFORECASTSOFRECESSIONSWHENMOSTOFTHEPRESIDENTS economic advisers conclude that a recession is likely, regardless of the possible negative effect on his or her approval rating. The value of forecasting recessions in a public manner is that it helps bring a national consensus of the president, Federal Reserve, Congress, and the public to promptly coordinate an array of actions designed to avoid or lessen the impact of an expected recession. The only time in the period covered by this book that a forecast of a recession was made public by a presidential agency was when President Jimmy Carter’s Council of Economic Advisers published a forecast for the 1980 recession in the 1980 Economic Report of the President. But the forecast was too late for policy actions to be taken to prop up the economy to prevent or limit the impact of the recession. s)NSTITUTEMANDATORYPRICEANDWAGECONTROLSORVOLUNTARYPRICEANDWAGE standards when inflation accelerates at high rates and when the inflation is not driven by excess demand in the economy. The president institutes and manages price and wage controls or standards under legislated authority. However, implementation of a controls or standards program requires sufficient federal spending for the staffing and other activities that monitor whether businesses and workers adhere to the provisions of the program, for enforcing the mandatory controls with penalties for violations, for incentives to achieve the aims of both the mandatory controls and voluntary standards, and for maintaining public support for the program. Thus, Congress must

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appropriate sufficient funding to make the administration of the controls or standards program effective. Mandatory price and wage controls were used during 1951–53 and 1971–74, and voluntary price and wage standards were used during 1978–79. Mandatory controls were instituted by President Harry Truman in 1951 during the Korean War, and by President Richard Nixon in 1971 during the Vietnam War. President Jimmy Carter instituted voluntary standards in 1978. The 1951–53 controls were effective in curbing inflation. However, the 1971–74 controls and the 1978–79 standards were weakened and removed too soon, before they curbed inflationary expectations by businesses, workers, and households (see Chapters 7 and 8). Because inflation increased after the controls and standards programs of the 1970s were weakened and removed, the future use of such programs was disparaged as being ineffective. Price and wage controls and standards are at odds with the philosophy of a market economy, and they are subject to less public support with the passage of time. But there are situations in which they can be implemented successfully if the political will exists, as during the Korean War under President Truman. s)NCREASEFEDERALINCOMETAXESTOlNANCEPROTRACTEDWARSORLARGEBUILDUPS in defense spending over several years. Large increases in defense spending as the economy approaches full employment are inflationary. Large defense spending increases also absorb resources from other public needs. Congress Recommendations for Congress s #ONDUCT SUBSTANTIVE OVERSIGHT OF THE &EDERAL 2ESERVES ACTIONS AND evaluation of its outlook for the economy in the regular congressional hearings that are held twice a year. The Federal Reserve is an independent agency and should be free of political interference. However, the Federal Reserve is legislatively accountable to Congress. Substantive congressional oversight of the Federal Reserve can raise important policy issues for the Fed to consider in its policy actions. Highlighting the need for the Federal Reserve to look at alternative policy actions is not political interference. s )NCREASEFEDERALINCOMETAXESTOlNANCEPROTRACTEDWARSORLARGEBUILDups in defense spending over several years. Large increases in defense spending as the economy approaches full employment are inflationary. Large defense spending increases also absorb resources from other public needs.

FINDINGS AND RECOMMENDATIONS

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s !PPROPRIATESUFlCIENTFUNDINGFORADMINISTERINGPRICEANDWAGECONTROLS or standards instituted by the president to make the administration of the controls or standards programs effective. Federal Banking Supervisory Agencies Recommendations for the Federal Reserve, Comptroller of the Currency, Federal Deposit Insurance Corporation, Office of Thrift Supervision, National Credit Union Administration The five federal banking supervisory agencies conduct examinations of the financial soundness of commercial banks under their jurisdictions. The examinations are conducted at varying frequencies, ranging from more than once during each year to less than each year, depending on the type and size of bank. Because of the overlapping jurisdictional oversight of the federal banking supervisory agencies, an individual bank is subject to examinations by at least two federal supervisory agencies. The Federal Reserve, including the twelve regional Federal Reserve banks, oversees bank holding companies, and state banks chartered by a state agency that are members of the Federal Reserve. The Comptroller of the Currency (part of the U.S. Department of the Treasury) oversees national banks that are chartered by the Controller. The Federal Deposit Insurance Corporation (FDIC) oversees national banks, state banks that have FDIC insurance, federal savings associations (thrifts), and state savings banks (thrifts) that have FDIC insurance. The Office of Thrift Supervision (OTS) oversees federal savings associations that are chartered by the OTS. The National Credit Union Administration (NCUA) oversees federal credit unions that are chartered by the NCUA, and insures savings, checking, money market, and certificates of deposit accounts, in federal and in most state-chartered credit unions through the National Credit Union Share Insurance Fund. I have added the roles of the federal banking agencies in lessening the frequency and severity of future recessions because the extraordinary speculative rise in house prices during 2002–5 was a major factor in bringing on the 2007–9 recession. This resulted from the actions of both homeowners and mortgage lenders. Many households bought houses at prices much above what they could afford, by taking on mortgages that encumbered them with unsustainable increases in their personal debt—buying a first house, selling an existing house in upgrading to a higher-priced house, or buying an additional home. Mortgage lenders who lowered their credit standards in order to increase their issuance of mortgages exacerbated this speculative price spiral. Each, no doubt, believed the rise in house prices would continue unabated far into the future (see Chapter 12).

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I include the federal bank supervisory agencies in efforts to stabilize the overall economy because they can have a far more direct effect on the banking community than the traditional monetary policies of the Federal Reserve. The traditional Federal Reserve policies of raising interest rates in order to curb inflation were not used in the speculative run-up of house prices during 2002–5, because inflation in the overall economy, which the economy-wide Federal Reserve policies are geared to respond to, was modest. This spotlighted the limitation of those policies in containing inflation in particular parts of the economy, as evidenced by the onset of the 2007–9 recession, in which the deleterious effects of extreme house price speculation spread to, and undermined, the broader spectrum of the economy. s 4HEFEDERALBANKINGSUPERVISORYAGENCIESSHOULDINCLUDEINTHEIREXaminations the existence of lax lending practices of banks that feed an unwarranted speculation in house prices. Such speculative loans can result in driving up inflation in housing markets despite no evidence of excessive demand in the overall economy. s "ASEDONTHEBANKEXAMINERSREPORTS THEFEDERALBANKINGSUPERVISORY agencies should inform those banks that are indicated to have extended excessively speculative mortgage loans of the following: s 3UCH PRACTICES ARE INCONSISTENT WITH THE STABILITY OF THE OVERALL economy s %XTENDINGOFEXCESSIVELYSPECULATIVEMORTGAGELOANSSHOULDSTOP s )FAFTERANAPPEALS PROCESS BETWEEN A BANK AND THE BANK SUPERVISORY agency, the agency determines that a bank has engaged in excessive speculative loans, the bank will be ordered to cease and desist from those lending practices. s 0ENALTIESFORNONCOMPLIANCEWITHTHECEASEANDDESISTORDER s )NITIALPENALTYISTHEADVERSEPUBLICITYOFTHEBANKSPRACTICESBEING released by the supervisory agencies, which could affect the bank’s appeal to prospective mortgage borrowers s )F THE NONCOMPLIANCE CONTINUES THE PENALTY IS RAISED TO A lNE THAT would be sufficiently high to deter future noncompliance, including revocation of the bank’s charter. These recommendations for the federal bank supervisory agencies can be implemented under the existing authority of each of the five agencies. Any future reform of the federal banking structure and responsibilities will still require the bank examinations discussed here.

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Bank Reform to Delay the Sale of Banks’ Mortgage Loans to Other Investors or to Fannie or Freddie Mac The above recommendations for the periodic examination of the financial soundness of commercial banks by the supervisory bank agencies will only be effective if the mortgage loans remain as assets on the balance sheets of the banks until the bank examinations are completed, including the final actions taken on the examinations by the supervisory agencies. A major stumbling block in holding commercial banks accountable for issuing unwarranted speculative mortgage loans is the practice of banks’ selling their mortgages to other investors, or in the secondary markets to the Federal National Mortgage Administration (Fannie Mae) or to the Federal Home Loan Mortgage Corporation (Freddie Mac), before the examinations are completed and the final actions taken. The sale of the bank mortgages occurs by selling a single mortgage individually; or by combining several mortgages into a pool, and splitting the pool into shares in financial transactions called securitization that are sold in financial markets worldwide. The sales often occur at the same time as the mortgages are issued through electronic transfer. Such sales are based on prior arrangements with the financial investors who purchase the mortgages. The Federal Reserve, Comptroller of the Currency, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration should adopt regulations that prevent the sale of mortgage loans held by individual banks until the periodic examination of the bank’s balance sheets and the documentation of the mortgage loans is completed, as well as until the supervisory banking agencies determine that the loans are not unduly speculative. If the mortgage loans are sold before the banking supervisory agencies complete their examinations and actions, the disciplinary action will include revocation of the bank’s charter. Note on the Use of Leading Indicators in Forecasting Recessions The system of leading economic indicators is not sufficiently advanced to forecast recessions on a real-time basis. It is only with retrospective use of revised data that the leading indicator system yields early signals of a cyclical downturn, as noted in Chapter 2, endnote 1, under Evolution of New Deal Economic Policies.

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Note on More Transparency in Designating the Beginning and End of Recessions The designation of when a recession begins and when it ends is based on the judgment of the Business Cycle Dating Committee convened by the National Bureau of Economic Research, as noted in Chapter 1 under Business Cycles and Recessions. The committee assesses a wide range of economic indicators in determining the cyclical turning points, and issues a written statement of the trends in the economic data it took into consideration when announcing the beginning and end dates of a recession. The statement is based on the judgment of a majority of the seven members of the committee. However, the statement does not include the viewpoints of all of the committee members, nor the nuances and disagreements that may have arisen during the deliberations. I believe that the inclusion of the varying views of the committee members in the statement would enhance the understanding among the public and economic policy makers as to why the designation was made for the particular recession. Conclusion The purpose of this book is to analyze the U.S. experience with recessions and to alleviate the pain that recessions inflict on the American people. Recessions result in workers losing their jobs and incomes, and often not becoming re-employed, or when they do find jobs, often working at much lower rates of pay than in their previous jobs; they result in homeowners losing their homes, business owners losing their businesses, and investors losing their savings and assets. The book concentrates on preventing recessions and lessening their impact, not on curing recessions once they have started. However, in the process of lessening the depth and length of recessions, the recommended economic policies make it easier to recover from recessions, and so indirectly affect the cure. The indirect effect of more contained recessions would be to speed up recoveries in reaching and overtaking previous peaks of economic activity that were experienced before a recession set in. The economic policy recommendations for the Federal Reserve, the president, Congress, and federal banking supervisory agencies to adopt are designed to significantly lessen the deleterious effects of future recessions. Ideally, there will be fewer recessions, and those that occur will not be as severe or as prolonged as the eleven that have occurred since the end of World War II.

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Index

Italic page references indicate figures and tables.

Accelerating inflation, 62 Achuthan, Lakshman, 41 Afghanistan war, 305–310, 333 Akerlof, George, 4 American Bankers Association, 73 American Revolution, 310, 333 American Statistical Association, 41, 249 Antitrust program, 84 Arnold, Thurman, 84 Atkinson, Jay, 53 Backlogs of household durable goods, housing, and business equipment and structures, 52–54, 338 Banerji, Anirvan, 41 Bank loans Federal Reserve and, 73–74 1948–49 recession and, 71–74 1953–54 recession and, 103–104 1957–58 recession and, 122–124 1960–61 recession and, 138–142 1969–70 recession and, 164 1973–75 recession and, 187–188 1980 recession and, 214–215 1981–82 recession and, 235–237, 237 1990–91 recession and, 264–265 2001 recession and, 293–295 2007–9 recession and, 328–329 Bank reform, 359 Bergman, Bruce, 316 Blinder, Alan, 273–274, 279–280 Bretton Woods Agreement, 172–173 Bubbles house price, 314–316, 315, 333–334, 348 stock market, 280–281, 282, 347 Budget Enforcement Act (1990), 278 Burns, Arthur, 84, 188

Bush, George H.W., 250 Bush, George W., 352 Business Cycle Dating Committee, 7–8, 13–14, 35 Business cycles, 3–9, 7, 11 Business equipment and structures, backlog of, 53–54 Capacity utilization rate (CUR) 1969–70 recession and, 156–158 1973–75 recession and, 181–182 1980 recession and, 207 1981–82 recession and, 230 1990–91 recession and, 260–261 2001 recession and, 288–290 2007–9 recession and, 322–323 Car sales, 125 Carter, Jimmy, 198, 219, 222, 344, 351–352, 355–356 Cold War, 56, 77, 81, 129, 146, 337 Commercial bank loans. See Bank loans Comptroller of the Currency, 357, 359 Congress, U.S., 349, 352, 356–357, 360 Congressional Budget Office, 41, 46 Consumer credit controls, 55–56, 338 Consumer durable goods spending Federal Reserve and, 74 1948–49 recession and, 74–76, 75, 82 1957–58 recession and, 125, 126 1960–61 recession and, 142–143, 143 1969–70 recession and, 164–165, 166 1973–75 recession and, 188–191, 189 1980 recession and, 215–216, 217 1981–82 recession and, 236–238, 238 1990–91 recession and, 265–267, 267 2001 recession and, 296–297, 297 2007–9 recession and, 329–330, 331, 335 367

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INDEX

Consumer price index (CPI) 1948–49 recession and, 63–65, 65 1953–54 recession and, 91, 108 1957–58 recession and, 111, 116–118, 117, 124 1960–61 recession and, 134 1969–70 recession and, 152–153, 154, 155 1973–75 recession and, 179–180, 180 1980 recession and, 204–206, 205 1981–82 recession and, 222–223, 223, 227–228, 228 1990–91 recession and, 256–259, 258, 259 2001 recession and, 279, 286–288, 287, 288 2007–9 recession and, 304–305, 315, 315, 321–322, 321 Contraction, economic, 6, 7 Core inflation, 62 Corporate profits cyclical movements, 33–34, 34 economic indicator content, 32–33, 33 Cost of Living Council, 171 Cost-of-living allowances (COLAs), 184, 212 Council of Economic Advisers (CEA) xxii, 41, 46–47, 170, 188, 198, 219, 316, 352, 355 Council on Wage and Price Stability (CWPS), 199 CPI. See Consumer price index Creeping inflation, 63 CUR. See Capacity utilization rate Cyclical movements corporate profits, 33–34, 34 employment, 15–16, 16, 17 job earnings, real weekly, 24–26, 26 poverty, 28, 29, 30 proprietor’s income, 35, 36, 37 real GDP, 30–31, 31, 32 unemployment, 20, 21, 22, 24 Cyclical unemployment, 148 Debt. See Deficit Defense spending. See National defense spending Deficit, federal 1990–91 recession and, 251–252, 253, 345

Deficit, federal (continued) shift to surplus and, 276, 277, 289–290, 299–300 shift to, 306, 307 terminology, 252, 305–306 2001 recession and, 347 2007–9 recession and, 306, 307 Deficit Reduction Tax Act (DEFRA) (1984), 250, 251 Deflation 1948–49 recession and, 61–63 1953–54 recession and, 97–99 1957–58 recession and, 116–118 1960–61 recession and, 134 1969–70 recession and, 152–153, 155 1973–75 recession and, 179–180 1980 recession and, 204–206 1981–82 recession and, 227–228 1990–91 recession and, 256–259 2001 recession and, 286–288 2007–9 recession and, 321–322 Depression (1930s), 52–53, 57, 85–86, 173 Deregulation, 245, 270 Displaced workers, reemployment of, 38–41, 42–43, 44–45 Dolfman, Michael, 316 Dollar, value of 1973–75 recession and, 172–174, 342 1980 recession and, 198 1990–91 recession and, 244, 270, 346 Domestic International Sales Corporation, 172, 189–190 Dot-coms, rise and fall of, 281–283 Downturn, economic. See Recession, economic Durable goods. See Consumer durable goods spending; Household durable goods, backlog of Earnings of manufacturing workers 1948–49 recession and, 69–71, 71 1953–54 recession and, 102–103, 102 1957–58 recession and, 120–122, 121 1960–61 recession and, 138, 139 1969–70 recession and, 158–159, 160, 161 1973–75 recession and, 184, 185 1980 recession and, 210–212, 211

INDEX

Earnings of manufacturing workers (continued) 1981–82 recession and, 232–233, 233, 234 1990–91 recession and, 261–263, 263, 264 2001 recession and, 290–292, 292 2007–9 recession and, 326, 327, 334 Earnings of reemployed workers, relative, 40–41, 44–45 Economic Cycle Research Institute, 41 Economic growth. See Expansion, economic Economic Growth and Tax Relief Reconciliation Act (EGTRRA) (2001), 306–308 Economic indicators. See also specific type 1948–49 recession and, 57–59 1953–54 recession and, 93–94 1957–58 recession and, 111–113, 112 1960–61 recession and, 129–131 1969–70 recession and, 149–150 1973–75 recession and, 175–176 1980 recession and, 200–201 1981–82 recession and, 224–225 1990–91 recession and, 252–254, 268–269 2001 recession and, 282–283 2007–9 recession and, 317–318 Economic policy assessment changes in 1971, 170–174, 171 failure to forecast recessions and, 46–48 1948–49 recession and, 80–83 1953–54 recession and, 107–109 1957–58 recession and, 127–128 1960–61 recession and, 145 1969–70 recession and, 167–169 1973–75 recession and, 170–174, 171, 193–194 1980 recession and, 217–220 1981–82 recession and, 239–241 1990–91 recession and, 268–270 2001 recession and, 298–300 2007–9 recession and, 332–335 Economic policy recommendations bank reform and, 359 by Congress, U.S., 356–357, 360 by federal banking supervisory agencies, 357–358

369

Economic policy recommendations (continued) by Federal Reserve, 353–355, 357, 359–360 future and, 41 overview of, 353, 354, 360 by President, U.S., 355–356, 360 Economic Recovery Tax Act (ERTA) (1981), 223–224, 249–250, 251 Economic Report to Congress (1948), 73 Economy. See also Contraction; Expansion; Recession; Recovery forecasts of overall, xxv international, 172–174 before 1948, 52, 83–86 during 1948, 56–57 1960–61 recession and, 129 postwar, 85–86 volatility of U.S., 12 Eisenhower, Dwight, 188 Employment cyclical movements, 15–16, 16, 17 economic indicator content, 15 full, 148–149, 152, 341, 343 1948–49 recession and, 59–60, 60, 80 1953–54 recession and, 94–95, 95 1957–58 recession and, 113–115, 114 1960–61 recession and, 131–132, 132 1969–70 recession and, 148, 150–151, 151 1973–75 recession and, 176, 177 1980 recession and, 201–202, 202 1981–82 recession and, 225–226, 226 1990–91 recession and, 254, 255 2001 recession and, 283–285, 284, 303–304 2007–9 recession and, 303–304, 318–319, 319, 334, 349 Employment & Training Administration, 22 Employment Act (1946), 57 Energy prices, 257–259, 259 European Recovery Plan, 56, 78, 81 Exchange rates, 172–174, 193, 198, 342, 345 Expansion, economic before 1960–61 recession, 129, 130 before 1969–70 recession, 146, 341–342 before 1981–82 recession, 222, 239, 240, 344

370

INDEX

Expansion, economic (continued) after 1990–91 recession, 243 before 2001 recession, 272–275, 273, 298–300, 299, 347 before 2007–9 recession, 303–305, 304, 334–335, 348 durations of, during eleven recessions (1945–2009), 11 as stage of business cycle, 6, 7 tepid, 334–335 Expenditures of federal government, 276–279, 277, 278, 305–306, 309–310, 309. See also Deficit, federal Experimental recession indexes, 46 Fannie Mae, 325, 359 Farber, Henry, 38 Federal banking supervisory agencies, 357–358 Federal Deposit Insurance Corporation (FDIC), 357, 359 Federal Home Loan Bank Board, 120 Federal Home Loan Mortgage Corporation (Freddie Mac), 325, 359 Federal Housing Administration (FHA) mortgage loans, 119–120 Federal National Mortgage Association, 120 Federal National Mortgage Corporation (Fannie Mae), 325, 359 Federal Open Market Committee (FOMC), 46, 279–280, 353 Federal Reserve as agent of recession, 349–351 bank loans and, 73–74 components of, 357 consumer durable goods spending and, 74 economic policy recommendations by, 353–355, 357, 359–360 forecasts of recessions and, 41, 46 inflation and, xxii, 11 monetary policy and, authority to conduct, 109 1937–38 recession and, 84 1948–49 recession and, 55–56, 73, 80–81, 338 1953–54 recession and, 89, 92–93, 98, 104, 109, 340

Federal Reserve (continued) 1957–58 recession and, 113, 119, 122–123, 127–128, 340 1960–61 recession and, 138, 140–141, 341 1969–70 recession and, 147, 161, 163–164, 168 1973–75 recession and, 175, 185, 188, 194 1980 recession and, 198, 212–213, 215, 219, 222, 344 1981–82 recession and, 225, 235–236, 241, 345 1990–91 recession and, 248–249 Treasury-Federal Reserve Accord and, 109, 340 2001 recession and, 279–280, 283, 293, 300, 347 2007–9 recession and, 326–328, 335, 349 Federal Reserve Bank of Philadelphia, 41 Federal Reserve Bank presidents, 47 Federal Reserve Governors, 47, 353 FHA mortgage loans, 119–120 Fiscal policy 1953–54 recession and, 106–107, 108 1973–75 recession and, 172 1990–91 recession and, 249–252 2001 recession and, 275–279, 277 2007–9 recession and, 305–310, 333, 348 Floating exchange rates, 174 Food prices, 257–259, 259 Freddie Mac, 325, 359 Frictional unemployment, 148 Friend, Irwin, 54 Full employment, 148–149, 152, 341, 343 Full Employment and Balanced Growth Act (1978), 149 GDP. See Gross domestic product; Real GDP GI bill, 86 GNP. See Gross national product Great Society initiatives, 147 Groshen, Erica, 37 Gross domestic product (GDP), 7–8, 89, 105–106. See also Real GDP 1990–91 recession and, 250–251, 251

INDEX

Gross domestic product (continued) 2001 recession and, 297–298, 299 2007–9 recession and, 330–332, 332 Gross national product (GNP) Korean War and, 89 1948–49 recession and, 76–77, 77 1953–54 recession and, 104, 105 1957–58 recession and, 125–127, 127 1960–61 recession and, 143–145, 144 1969–70 recession and, 165–167, 167 1973–75 recession and, 191–193, 192 1980 recession and, 216–217, 218 1981–82 recession and, 239–240, 240 1990–91 recession and, 267–268, 268 Hedge fund collapse, 280 Ho, Mun, 274–275 House price bubble, 314–316, 315, 333–334, 348 Household durable goods, backlog of, 52–54, 338. See also Consumer durable goods spending Household income, spending, and saving, 310–311, 312, 313–314 Households, 4 Housing backlog, 53 Housing starts 1948–49 recession and, 68–69, 70, 82–83 1953–54 recession and, 100–101, 101 1957–58 recession and, 118–120, 120 1960–61 recession and, 136–138, 137 1969–70 recession and, 158, 159 1973–75 recession and, 182–183, 183 1980 recession and, 208–210, 209 1981–82 recession and, 230–232, 231, 232 1990–91 recession and, 261, 262 2001 recession and, 290, 291 2007–9 recession and, 323–326, 324, 325, 334 Humphrey-Hawkins Act (1978), 149 Hurricane Hugo (1989), 243, 246, 269–270, 346, 349 Hurricane Katrina (2005), 316, 334, 349 Hurricane Rita (2005), 349 Hurricane Wilma (2005), 216 Hyperinflation, 63

371

Import tax surcharge, 174 Income, personal and individual, 189–191 Individual income, 189–191 Industrial bank loans. See Bank loans Industrial production index (IPI) 1948–49 recession and, 66–68, 68 1953–54 recession and, 99–100, 99 1957–58 recession and, 118, 119 1960–61 recession and, 134–136, 136 1969–70 recession and, 156, 157, 158 1973–75 recession and, 180–182, 181 1980 recession and, 206–208, 208 1981–82 recession and, 228–229, 229 1990–91 recession and, 259–260, 260 2001 recession and, 288, 289 2007–9 recession and, 322, 323, 334 Inflation accelerating, 62 core, 62 creeping, 63 excessive demand leading to, xxii Federal Reserve and, xxii, 11 1948–49 recession and, 54–56, 61–63, 337–338 1953–54 recession and, 90, 91, 97–99, 98 1957–58 recession and, 116–118, 117, 340 1960–61 recession and, 134, 135 1969–70 recession and, 147, 152–153, 154, 155–156, 351 1973–75 recession and, 170, 171, 179–180, 180, 194 1980 recession and, 197, 204–206, 205, 343–344 1981–82 recession and, 222–223, 223, 227–228, 228, 240–241, 344–345 1990–91 recession and, 256–259, 258, 259 tolerable, 63 2001 recession and, 273–274, 286–288, 287, 288, 299, 347 2007–9 recession and, 321–322, 321, 334, 348–349 zero, 62 Interest rates 1948–49 recession and, 71–74, 72 1953–54 recession and, 103–104, 104, 109

372

INDEX

Interest rates (continued) 1957–58 recession and, 122–124, 123, 124 1960–61 recession and, 138–142, 140, 141 1969–70 recession and, 161–164, 162 1973–75 recession and, 184–187, 186, 187 1980 recession and, 212–214, 213, 215 1981–82 recession and, 233–234, 235, 236 1990–91 recession and, 263–264, 265, 266 2001 recession and, 293, 294, 295 2007–9 recession and, 326–328, 328, 329 International economy, 172–174 International Monetary Fund, 15, 174 “Invisible hand” economic theory, 5 IPI. See Industrial production index Iranian Revolution (1979), 197 Iraq war, 305–310, 333, 352 Irrational economic and noneconomic behavior, 4–5 Job earnings, real weekly cyclical movements, 24–26, 26 economic indicator content, 24 Job growth, 273 Job losses, 15–16, 16, 17, 18, 37–38, 316. See also Unemployment Jobless recoveries, 35–38, 274 Jobs and Growth Tax Reconciliation Act (JGTRA) (2003), 307–308, 310 Johnson, Lyndon, 27, 146–147, 341, 351 Jorgenson, Dale, 274–275 Kennedy, John F., 146–147, 341 Kennedy, Robert, 146, 341 Keynes, John Maynard, 4–5 King, Martin Luther, Jr., 146, 341 Korean War, 78, 89–92, 104, 107, 129, 146, 339 Labor force participation rates (LFPR), 96, 273, 285, 304, 320 Labor productivity. See Productivity Labor unions, 130 Lending Practices Survey (LPS), 264–265, 293–294, 328–329

Livingston Survey, 41 Long Term Capital Management hedge fund collapse, 280 Macroeconomic forecasting, 41 Marketplace and conditions, 352–353 McNees, Stephen, 46 Mitchell, Wesley Clair, 84 Monetary policy, 279–280, 339–340. See also Federal Reserve Morgenthau, Henry, 84 Multifactor productivity, 12 National Bureau of Economic Research, Inc. (NBER), 7–8, 13–14, 35, 41, 249 National Credit Union Administration (NCUA), 357, 359 National defense spending 1948–49 recession and, 77–78, 79, 80, 339 1953–54 recession and, 89, 90, 104–106, 106, 108, 339 1969–70 recession and, 342 1990–91 recession and, 250–251, 252, 345 2001 recession and, 346 2007–9 recession and, 309, 309 National income and product accounts (NIPAs), 106–107, 251–252, 275, 305 National Industrial Recovery Act (NIRA), 83 National Labor Relations Act (1935), 83 National Research Council (NRC), 27 National Union Share Insurance Fund, 357 Natural disasters 243, 246, 269–270, See also specific type New Deal, 83–85 New Economic Policy, 170, 174, 189 New housing construction. See Housing starts Nixon, Richard, 170, 188, 194, 342, 351, 356 Nordhaus, William, 10 North Atlantic Treaty Alliance (NATO), 78

INDEX

Office of Business Economics, 74, 76, 98 Office of Federal Enterprise Oversight, 314 Office of Thrift Supervision (OTS), 357, 359 Oil embargo (1973), 170, 179, 191, 342–343 Omnibus Budget Reconciliation Act (1990), 250 Omnibus Budget Reconciliation Act (OBRA) (1993), 276, 277 Organization of Petroleum Exporting Countries (OPEC), 62, 197, 257 Pay Advisory Committee, 199 Pay Board, 171–172 Permanent job losses, 37–38. See also Unemployment Personal income, 189–191 Pollution and safety guidelines for cars, 191 Ponzi scheme, 333 Population changes, 83 Potter, Simon, 37 Poverty cyclical movements, 28, 29, 30 data measuring, 14 defining, 27 economic indicator content, 15, 26–28 President, U.S. xxii, 349, 351–352, 355–356, 360. See also specific name Price Advisory Committee, 199 Price Commission, 171–172 Price controls, 108, 170–172, 193–194, 199–200, 339, 342, 355–356 Productivity 1969–70 recession and, 155–156 1973–75 recession and, 170–172, 342 1980 recession and, 196–197 2001 recession and, 274–275 residual, 12 Proprietors’ income cyclical movements, 35, 36, 37 economic indicator content, 34–35 Psychological predilections of individuals and businesses, 5–6 Public Employment Program, 176 Purchasing power, 57

373

Quality of information individuals and businesses possess, 5–6 Reagan, Ronald, 245, 249, 345, 351–352 Real GDP cyclical movements, 30–31, 31, 32 declines in, 41 economic indicator content, 30 1957–58 recession and, 111 1990–91 recession and, 245, 246 2007–9 recession and, 303, 334 Real-time data xxiv-xxv, 17. See also specific type Receipts of federal government, 276–277, 277, 306–308, 308. See also Surplus, federal Recession, economic. See also specific year agents of, 349–353, 354 analysis of, xxiii–xxv, 360 assessment of, 337 beginning and end of eleven (1945– 2009), 8, 9, 13 business cycles and, 3–9, 7, 11 categories of, 10 Congress, U.S. and, 352 defining, 6 designating beginning and end of, more transparency in, 360 failure to forecast, xxi–xii, 41, 46–48 Federal Reserve and, 349–351 forecasting, 41, 46, 353, 359 frequency of (since early 1980s), 10–12 general, 14 gross domestic product and, 7–8 impact of eleven (1945–2009), 12–15 impact of, xxi jobless recoveries from recent, 35–38 marketplace and, 352–353 particular, 14 President, U.S. and, 351–352 preventing, 360 severity of, xxi, 12–15 as stage in business cycle, 6, 7 themes of, 349–353 Recessions (in chronological order) 1937–38 recession, 84 1948–49 recession

374

INDEX

Recessions (in chronological order) 1948–49 recession (continued) backlog of household durable goods, housing, and business capital needs and, 52–54, 338 bank loans and, 71–74 beginning of, 52, 337 consumer durable goods spending and, 74–76, 75, 82 consumer price index and, 63–65, 65 deflation and, 61–63 earnings of manufacturing workers and, 69–71, 71 economic indicator overview and, 57–59 economic policy assessment and, 80–83 economy before 1948 and, 52, 83–86 economy during 1948 and, 56–57 employment and, 59–60, 60, 80 end of, 52, 337 events leading to, 337–339 Federal Reserve and, 55–56, 73, 80–81, 338 gross national product and, 76–77, 77 housing starts and, 68–69, 70, 82–83 industrial production index and, 66–68, 68 inflation and, 54–56, 61–63, 337–338 interest rates and, 71–74, 72 national defense spending and, 77–78, 79, 80, 339 surplus and, 338 unemployment and, 60–61, 62 wholesale price index and, 65–66, 67 1953–54 recession bank loans and, 103–104 beginning of, 89, 339 consumer price index and, 91, 108 deflation and, 97–99 earnings of manufacturing workers and, 102–103, 102 economic indicators overview, 93–94 economic policy assessment and, 107–109 employment and, 94–95, 95 end of, 89, 339 events leading to, 339–340

Recessions (in chronological order) 1953–54 recession (continued) Federal Reserve and, 89, 92–93, 98, 104, 109, 340 fiscal policy and, 106–107, 108 gross national product and, 104, 105 housing starts and, 100–101, 101 industrial price index and, 99–100, 99 inflation and, 90, 91, 97–99, 98 interest rates and, 103–104, 104, 109 Korean War and, 89–92 monetary policy and, 339–340 national defense spending and, 89, 90, 104–106, 106, 108, 339 unemployment and, 96–97, 97, 339 1957–58 recession bank loans and, 122–124 beginning of, 111, 340 consumer durable goods spending and, 125, 126 consumer price index and, 111, 116–118, 117, 124 deflation and, 116–118 earnings of manufacturing workers and, 120–122, 121 economic indicators overview and, 111–113, 112 economic policy assessment and, 127–128 employment and, 113–115, 114 end of, 111, 141, 340 events leading to, 340 Federal Reserve and, 113, 119, 122–123, 127–128, 340 gross national product and, 125–127, 127 housing starts and, 118–120, 120 industrial production index and, 118, 119 inflation and, 116–118, 117, 340 interest rates and, 122–124, 123, 124 real gross domestic product and, 111 unemployment and, 111, 115–116, 115 1960–61 recession bank loans and, 138–142 beginning of, 129, 341

INDEX

Recessions (in chronological order) 1960–61 recession (continued) consumer durable goods spending and, 142–143, 143 consumer price index and, 134 deflation and, 134 earnings of manufacturing workers and, 138, 139 economic indicators overview and, 129–131 economic policy assessment and, 145 economy and, 129 employment and, 131–132, 132 end of, 129, 341 events leading to, 341 expansion before, 129, 130 Federal Reserve and, 138, 140–141, 341 gross national product and, 143–145, 144 housing starts and, 136–138, 137 industrial production index and, 134–136, 136 inflation and, 134, 135 interest rates and, 138–142, 140, 141 unemployment and, 133–134, 133 1969–70 recession bank loans and, 164 beginning of, 146, 150, 341 capacity utilization rate and, 156–158 consumer durable goods spending and, 164–165, 166 consumer price index and, 152–153, 154, 155 deflation and, 152–153, 155 earnings of manufacturing workers and, 158–159, 160, 161 economic indicators overview and, 149–150 economic policy assessment and, 167–169 employment and, 148, 150–151, 151 end of, 146, 341 events leading to, 341–342 expansion before, 146, 341–342 Federal Reserve and, 147, 161, 163–164, 168 gross national product and, 165–167, 167

375

Recessions (in chronological order) 1969–70 recession (continued) housing starts and, 158, 159 industrial production index and, 156, 157, 158 inflation and, 147, 152–153, 154, 155–156, 351 interest rates and, 161–164, 162 national defense spending and, 342 productivity and, 155–156 tax increases and, 147, 341 unemployment and, 146, 149, 152, 153, 341 unit labor costs and, 155–156 Vietnam War and, 147 1973–75 recession bank loans and, 187–188 beginning of, 170, 342 capacity utilization rate and, 181–182 consumer durable goods spending and, 188–191, 189 consumer price index and, 179–180, 180 deflation and, 179–180 dollar and, value of, 172–174, 342 earnings of manufacturing workers and, 184, 185 economic indicators overview and, 175–176 economic policy assessment and, 170–174, 171, 193–194 economic weaknesses emerging before, 343 employment, 176, 177 end of, 170, 342 events leading to, 342–343 Federal Reserve and, 175, 185, 188, 194 fiscal policy and, 172 gross national product and, 191–193, 192 housing starts and, 182–183, 183 import tax surcharge and, 174 industrial production index and, 180–182, 181 inflation and, 170, 171, 179–180, 180, 194 interest rates and, 184–187, 186, 187

376

INDEX

Recessions (in chronological order) 1973–75 recession (continued) international economy and, 172–174 irrational behavior leading to, 4–5 oil embargo and, 170, 179, 191, 342–343 personal income and, 189–191 price and wage controls and, 170–172, 342 Social Security taxes and, 189–191 unemployment and, 170, 171, 176–178, 178 1980 recession bank loans and, 214–215 beginning of, 196, 223, 343 capacity utilization rate and, 207 consumer durable goods spending and, 215–216, 217 consumer price index and, 204–206, 205 deflation and, 204–206 dollar and, value of, 198 earnings of manufacturing workers and, 210–212, 211 economic indicators overview and, 200–201 economic policy assessment and, 217–220 employment, 201–202, 202 end of, 196, 233, 343 events leading to, 343–344 exchange rates and, 198 Federal Reserve and, 198, 212–213, 215, 219, 222, 344 forecasts of, 198–199 gross national product and, 216–217, 218 housing starts and, 208–210, 209 industrial production index and, 206–208, 208 inflation and, 197, 204–206, 205, 343–344 interest rates and, 212–214, 213, 214 Iranian Revolution and, 197 irrational behavior leading to, 4–5 1981–82 recession and, 222–223, 223 productivity and, 196–197 unemployment and, 202–204, 203, 343–344

Recessions (in chronological order) 1980 recession (continued) voluntary price and wage standards and, 199–200 1981–82 recession bank loans and, 235–237, 237 beginning of, 222, 344 capacity utilization rate and, 230 consumer durable goods spending and, 237–238, 238 consumer price index and, 222–223, 223, 227–228, 228 deflation and, 227–228 earnings of manufacturing workers and, 232–233, 233, 234 economic indicators overview and, 224–225 economic policy assessment and, 239–241 Economic Recovery Tax Act and, 223–224 employment and, 225–226, 226 end of, 222, 344 events leading to, 344–345 expansion before, 222, 239, 240, 344 Federal Reserve and, 225, 235–236, 241, 345 gross national product and, 239–240, 240 housing starts and, 230–232, 231, 232 industrial production index and, 228–229, 229 inflation and, 222–223, 223, 227– 228, 228, 240–241, 344–345 interest rates and, 233–234, 235, 236 irrational behavior leading to, 4–5 1980 recession and, 222–223, 223 unemployment and, 226–227, 227 1990–91 recession bank loans and, 264–265 beginning of, 243, 345 capacity utilization rate and, 260–261 consumer durable goods spending and, 265–267, 267 consumer price index and, 256–259, 258, 259 deficit and, federal, 251–252, 253, 345

INDEX

Recessions (in chronological order) 1990–91 recession (continued) deflation and, 256–259 deregulation and, 245, 270 dollar and, value of, 244, 270, 346 earnings of manufacturing workers and, 261–263, 263, 264 economic indicators overview and, 252–254, 268–269 economic policy assessment and, 268–270 employment and, 254, 255 end of, 243, 345 events leading to, 345–346 expansion after, 243 Federal Reserve and, 248–249 fiscal policy and, 249–252 gross domestic product and, 250–251, 251 gross national product and, 267–268, 268 housing starts and, 261, 262 industrial production index and, 259–260, 260 inflation and, 256–259, 258, 259 interest rates and, 263–264, 265, 266 international events and, 243 national defense spending and, 250–251, 252, 345 natural disasters and, 243, 246, 269–270 real GDP and, 245, 246 regulation by federal government and, 244–245, 246 savings and loan associations failures, 247, 345 Soviet Union breakup and, 243, 269–270 stock market crash (1987) and, 243, 247–249, 345 tax cuts and, 249–250, 251, 269, 345 unemployment and, 255–256, 256 2001 recession bank loans and, 293–295 beginning of, 272, 346 budget shifts and, 276, 277 capacity utilization rate and, 288–290

377

Recessions (in chronological order) 2001 recession (continued) consumer durable goods spending and, 296–297, 297 consumer price index and, 279, 286–288, 287, 288 deficit and, federal, 347 deflation and, 286–288 earnings of manufacturing workers and, 290–292, 292 economic indicators overview and, 282–283 economic policy assessment and, 298–300 employment and, 283–285, 284, 303–304 end of, 272, 346 events leading to, 346–348 expansion before, 272–275, 273, 298–300, 299, 347 expenditures of federal government and, 276–279, 277, 278 Federal Reserve and, 279–280, 283, 293, 300, 347 fiscal policy and, 275–279, 277 gross domestic product and, 297–298, 299 housing starts and, 290, 291 industrial production index and, 288, 289 inflation and, 273–274, 286–288, 287, 288, 299, 347 interest rates and, 293, 294, 295 irrational behavior leading to, 5 job growth and, 273 monetary policy and, 279–280 national defense spending and, 346 productivity and, 274–275 receipts of federal government and, 276–277, 277 stock market bubbles and, 280–281, 282, 347 stock market speculation and, 281, 347 telecommunications company bubbles and, 280–283, 347 unemployment and, 273, 285–286, 286, 304, 347

378

INDEX

Recessions (in chronological order) (continued) 2007–9 recession bank loans and, 328–329 beginning of, 303, 348 capacity utilization rate and, 322–323 consumer durable goods spending and, 329–330, 331, 335 consumer price index and, 304–305, 315, 315, 321–322, 321 deficits and, 306, 307 deflation and, 321–322 earnings of manufacturing workers and, 326, 327, 334 economic indicators overview and, 317–318 economic policy assessment and, 332–335 employment and, 303–304, 318–319, 319, 334, 349 events leading to, 348–349 expansion before, 303–305, 304, 334–335, 348 expenditures of federal government and, 309–310, 309 Federal Reserve and, 326–328, 335, 349 fiscal policy and, 305–310, 333, 348 gross domestic product and, 330–332, 332 house price bubble and, 314–316, 315, 333–334, 348 household income, spending, and saving and, 310–311, 312, 313–314 housing starts and, 323–326, 324, 325, 334 Hurricane Katrina and, 316, 334, 349 industrial production index and, 322, 323, 334 inflation and, 321–322, 321, 334, 348–349 interest rates and, 326–328, 328, 329 irrational behavior leading to, 5 national defense spending and, 309, 309 real GDP and, 303, 334

Recessions (in chronological order) 2007–9 recession (continued) receipts of federal government and, 306–308, 308 tepid economic growth and, 334–335 unemployment and, 304, 319–321, 320, 334, 348 wars and, 305–310 wealth effect and, 330 Recovery, economic, 6, 7, 35–38, 274 Reemployment, 36–41, 42–43, 44–45 Regulation, 244–245, 246. See also specific legislation Residual productivity, 12 Revenue and Expenditure Control Act (1968), 147 Roosevelt, Franklin, 27, 83–84, 173 Russia’s devaluation, 280 San Francisco Bay Area earthquake (1989), 246, 269–270, 346 Savings and Loan (S&L) Associations failures, 247, 345 Second New Deal, 83 Shiller, Robert, 4 Shreft, Stacey, 36–37 Singh, Aarti, 36–37 Smith, Adam, 5 Social Security Act (1935), 83 Social Security taxes, 189–191 Social upheaval, 146, 341 Soviet Union breakup, 243, 269–270 Sputnik launching (1957), 129 Stiroh, Kevin, 12, 274–275 Stock, James, 11, 46 Stock market bubbles, 280–281, 282, 347 crash (1987), 243, 247–249, 345 speculation, 281, 347 Structural unemployment, 148 Surplus, federal 1948–49 recession and, 338 shift from deficit and, 276, 277, 289–290, 299–300 terminology, 252, 305–306 Survey of Professional Forecasters, 41 Survey of Terms of Business Lending (STBL), 295

INDEX

Tax cuts, 249–250, 251, 269, 308, 308, 310–311, 333, 345 Tax Equity and Fiscal Responsibility Act (TEFRA) (1982), 249–250, 251 Tax increases, 147, 341 Tax Reform Act (TRA) (1986), 250, 251 Telecommunications company bubbles, 280–283, 347 Temporary job losses, 37–38. See also Unemployment Third New Deal, 84 Thrifts, 357 Tolerable inflation, 63 Treasury-Federal Reserve Accord, 109, 340 Truman Doctrine, 78 Truman, Harry, 55, 82, 91–92, 108, 338–339, 356 Unemployment cyclical, 148 cyclical movements, 20, 21, 22, 24 economic indicator content, 17–20 estimates of, at full employment, 149 frictional, 148 insurance benefit payments income from, 22–23, 24, 25 before 1948, 84 1948–49 recession and, 60–61, 62 1953–54 recession and, 96–97, 97, 339 1957–58 recession and, 115–116, 115 1960–61 recession and, 133–134, 133 1969–70 recession and, 146, 149, 152, 153, 341 1973–75 recession and, 170, 171, 176–178, 178 1980 recession and, 202–204, 203, 343–344 1981–82 recession and, 226–227, 227 1990–91 recession and, 255–256, 256 structural, 148 2001 recession and, 273, 285–286, 286, 347 2007–9 recession and, 304, 319–321, 320, 334, 348 types of, 148 Unemployment insurance (UI), 22–23, 24, 25

379

Unit labor cost (ULC), 155–156 U.S. Bureau of the Census, 27–28 U.S. Bureau of Economic Analysis, 30, 34, 106 U.S. Bureau of Labor Statistics, 15, 24, 61, 155 U.S. Congress, 349, 352, 356–357, 360 U.S. Department of Agriculture, 27 U.S. Department of Commerce, 34, 74, 76, 98 U.S. Department of Housing and Urban Development, 314 U.S. Department of Labor, 15, 22, 24, 59, 61, 155 U.S. Department of Treasury, 106, 174 U.S. Office of Management and Budget, 106 U.S. President xxii, 349, 351–352, 355–356, 360. See also specific name Veterans Administration mortgage loans, 86, 119–120 Vietnam War, 146–147, 164, 167, 193, 351 Volatility of U.S. economy, 12 Wage controls, 108, 170–172, 193–194, 199–200, 339, 342, 355–356 Wars, 305–310, 333. See also specific name Wasser, Solidelle, 316 Watson, Mark, 11, 46 Wealth effect, 296, 330 Weller, Christian, 315–316 Wholesale price index (WPI), 65–66, 67 Workers. See also Earnings of manufacturing workers displaced, 38–41, 42–43, 44–45 earnings of reemployed, relative, 40–41, 44–45 Works Progress Administration, 83 World Bank, 15 World War II, 52, 57, 77–78, 81, 85, 90, 337 Yellen, Janet, 273–274, 279–280 Zero inflation, 62

About the Author

Norman Frumkin, an economics writer in Washington, D.C., has a longstanding interest in macroeconomic analysis, forecasting, and policies, and in improving the quality of economic statistics. He has worked in the U.S. government, in industry, as an independent consultant, and has taught courses on understanding and using economic indicators. He is the author of Tracking America’s Economy, 4th ed. (M.E. Sharpe, 2004) and Guide to Economic Indicators, 4th ed. (M.E. Sharpe, 2006).

380