Economy proves newly resistant to old remedies
By William Neikirk
Washington Bureau / The Chicago Tribune
Published December 7, 2001
WASHINGTON -- Despite 10 interest rate cuts by the Federal Reserve and $40 billion in tax rebates by Congress, the American economy has been slow to respond to traditional government measures to spark a recovery.
The recession that began in March still has a firm grip on the economy. Unemployment is still rising, as government figures being unveiled Friday are expected to reflect. Business is reluctant to invest after overdoing it in the 1990s. Consumer buying has picked up, but largely in response to sharp price discounting by companies, not government policy.
In today's economy, many analysts say, the old remedies of stabilization don't seem to be working as well as in the past, complicating the efforts to stimulate the economy by President Bush, Fed Chairman Alan Greenspan and the 535 members of Congress.
Economists say the usual policy tools appear to have lost some of their edge as the economy has shifted, becoming more global even as a worldwide downturn is developing and threatening to make the U.S. recession deeper.
In addition, the economy's problems caused by the excesses of the longest-running boom in American history have proven hard to address with interest rate reductions and tax cuts. Not only is consumer debt high, but business has too much capacity to produce as a result of these excesses.
On top of that, the Sept. 11 terrorist attacks have dealt a major blow to consumer confidence, the very economic depressant that federal policymakers have been trying to overcome since the first of the year.
The longer the country goes without another act of terrorism, the better for confidence, analysts say, but each government alert about the threat of another attack reminds America's debt-ridden consumers of the danger.
"Once people get scared, the tools of economic policy become ineffective," said Paul Heise, economics professor at Lebanon Valley College in Annville, Pa.
The possibility of future terrorist attacks is cited as the major uncertainty in the forecasts of most economists these days.
Sooner or later, perhaps by early or mid-2002, the government's policies will begin to work, economists said. But there is greater awareness of the limitations of these policies than in the past. Some analysts fear the downturn could last all of next year.
Brian Wesbury, chief economist at Chicago-based Griffin, Kubik, Stephens & Thompson Inc., said the Fed is still powerful but has lost some of its ability to control the economy in the wake of many fundamental changes domestically and internationally.
The key problem is business overinvestment during the economic boom. This overbuilding was exacerbated by the Y2K problem at the turn of the century, but it became clear as 2000 drew to a close that American firms had too many goods and had overbuilt their productive capacity in the high-technology sector.
"The makeup of this recession is really quite different," said Conrad DeQuadros, economist for Bear Stearns in New York. "In 1990, we saw the consumer and housing sectors deteriorate in the recession. Now, this is mainly a business-led recession caused by overcapacity."
Businesses won't invest in response to lower interest rates unless there is an increased demand for their goods, said Heise. "If you invest, you invest because you think you are going to make a profit, no matter what the interest rate is."
Barry Bosworth, economist at the Brookings Institution in Washington, praised the Federal Reserve for its actions in stabilizing the economy, but he conceded that lower interest rates have their limits. "The boom was investment-driven, and now the recession is investment-driven," he said. "That is hard for monetary policy to get at."
Business cycle must run
There are no quick fixes, said Pierre Ellis, economist at Decision Economics in New York. To a large extent, he said, the business cycle may just have to run its course through the process of selling off a glut of inventories. Rehiring won't begin until these stocks are largely sold off, analysts said.
Tax cuts to induce business to invest have been proposed by both Democrats and Republicans, but just like interest rates, these work only marginally, economists said. Despite tax reductions, companies are not eager to make a lot of investment in a climate where consumer demand is uncertain, economists said.
Bosworth and other economists said the Federal Reserve has done a good job with its aggressive campaign of interest rate reductions. Without the Fed's actions, they said, the economy would be worse off and the recession might be deeper. Consumer spending would not have held up, Bosworth maintained, and the automobile companies would not have offered their zero-percent financing to move a glut of vehicles.
Personal debt grows
But Heise said the excesses of the 1990s not only caused overinvestment, but "people have spent themselves into debt thinking that the boom would go on forever. Now they have to pay down that debt." According to the Federal Reserve, consumer debt outstanding is about $1.6 trillion, compared with $1.3 trillion in 1998. Mortgage debt has jumped from $5 trillion in 1997 to $7 trillion.
Rather than the tax rebates that most Americans saved rather than spent, Heise said he favored doubling the minimum wage to stimulate the economy. "You can't sustain an economic boom without putting money in the hands of people who will spend it," he said.
James K. Galbraith, economics professor at the University of Texas, said higher debt levels reduce the effectiveness of lower interest rates to boost the economy. Consumers will be inclined to reduce their debt before stepping up spending, he said. Zero-percent financing on cars may increase car sales, he said, but "the sales will go away" once the incentives are gone.
Galbraith said he sees the recession deepening and believes that, rather than cut taxes, Congress should pass a revenue sharing program of up to $300 billion to prevent state and local governments from making major cutbacks in their programs.
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