Alan Blinder ’67 On the U.S. Economy

Alan S. Blinder ’67 is the Gordon S. Rentschler Memorial Professor of Economics. Vice chair of the Federal Reserve Board from 1994 to 1996, he is codirector of the Center for Economic Policy Studies and regularly teaches Economics 101, The National Economy.

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What is the near-term outlook for the U.S. economy? It has been said that one thing you should never try to predict is the future. And it has not escaped notice that, if you reverse the word “outlook,” you get “look out!” Both are good pieces of advice for would-be forecasters.

Predicting the course of the U.S. (or any other) economy has always been a hazardous occupation; the usual uncertainties are daunting, and precision is out of the question – except by luck. But these days we have, layered on top of the usual economic uncertainties, a host of extremely unusual, indeed unprecedented, geopolitical uncertainties – all of which make forecasting next to impossible. If you want me (or anyone else) to forecast the year 2002, you must first answer a few simple questions:

• Will there be more terrorist attacks on the United States and, if so, how severe?

• Will the Middle East powder keg blow, sending oil prices skyrocketing – either because the U.S. invades Iraq or because of the Israeli-Palestinian conflict?

• Will India and Pakistan go to war?

Of course, none of us can answer any of these questions. So let’s think about a conditional forecast, conditioned on a benign world – that is, on a “no” answer to each of the preceding questions. What then? In that case, I’m an optimist. I believe the economy will bounce back sharply – and soon. There are four main reasons why.

Confidence in the stock market has been shaken by the collapse of Enron and by a slowdown in mergers and acquisitions.

Getty Images.

First, the Federal Reserve cut interest rates aggressively throughout the year 2001. Although both markets and politicians are invariably impatient, economists have always emphasized that the Fed’s monetary policy works with a substantial time lag. According to standard statistical findings, its major impacts on the economy are not due until 2002 and into 2003.

Second, fiscal policy has also turned substantially stimulative over the past year, despite the failure of the so-called stimulus package in Congress. The 2001 and 2002 installments of President Bush’s 10-year tax-cutting program are now in effect. And Congress has opened the checkbook for higher spending on national defense, homeland security, and a few other things. The bad news is that the budget surplus has disappeared even faster than it appeared. (That is a problem that needs to be addressed before too long.) But the good news is that lower taxes and higher government spending are now pushing the economy uphill.

Third, as everyone has noticed, oil prices have fallen very substantially since late in 2000. To most American households, falling oil prices are a godsend; they augment the amount of money available for spending on other items, just as a tax cut does. And since most American businesses are users of oil rather than producers, falling oil prices reduce costs and boost profits. (Sorry, Texas!)

Finally, one of those boring things that only economists look at: U.S. businesses have been drawing down inventories at a truly remarkable rate. Once sales turn around, many firms will need to rebuild their inventory positions, and that will provide further impetus to demand. Indeed, the current rate of inventory accumulation is so negative (about minus 1.3 percent of GDP per year) that even moving up to zero will give the economy a big boost. The arithmetic is impressive. If inventory investment moves up from minus 1.3 percent of GDP to zero within two quarters, that would add 2.6 percentage points to the annualized growth rate over that half-year (e.g., take a 2 percent growth rate up to 4.6 percent).

In my judgment, these four positive factors should provide enough fuel to blow through the negatives and power the U.S. economy upward – if the rest of the world cooperates. But that’s a big if. If events in the Middle East send oil prices soaring, or if domestic terrorism shatters confidence in the U.S. once again, all bets are off.

This was originally published in the Feb. 27, 2002, issue of PAW.