Explore BrainMass

reasons for the 2001 recession

When will America's longest running economic expansion in history come to an end? One way to predict is to look at what happened in the past. The usual causes include:
Ineptness of policy-makers
Bad luck - oil shocks and war
Happily, none of these culprits are afoot in the U.S. today. Policy-makers have learned the mistakes of the past. A Harvard economist noted: "When we look at the mistakes of the 1920s and 1930s, they were clearly amateurish. It's hard to imagine that happening again - we understand the business cycle better."
The fact that consumer confidence is now sky high used to mean that the end was near. A Yale economist touted the soaring stock market just days before it collapsed in 1929. In 1968, the Commerce Department dropped the title, "Business Cycle Developments" from a monthly publication, assuming the business cycle was dead.
Fat chance. Virtually every economic expansion following World War II followed the same script: inflation went up, the Fed cracked down, and the economy fell into a recession. The longer growth lasted, the more likely business cost pressures built up. Falling unemployment forced wages to go up. These were passed on to consumers in the form of higher prices. Blooey! Recession.
The boom of the 1990s was different:
Internet shopping caught on a recent comparative shopping survey, found a London Fog trench coat went for $225 in the store bubt cost $89.95 on the Net. Likewise, a dose of Viagra at the corner drug store cost $57.69 and $45.60 on the Web. That sort of competitive pricing keeps inflation down.
Productivity - output per worker hour - soared. Since 1995, thanks in part to computers and a massive capital-spending boom, productivity grew at an annual rate of 3 percent versus the usual 1.5 percent.
The expansion and diversification of capital markets created trillions of dollars of new wealth that was spread widely among the public. Capital funds were allocated more efficiently.
Manufacturers were better able to manage inventories. In the past, in anticipation of growing demand, manufacturers stockpiled stuff. If demand fell, production dropped to work off excess inventories. This accelerated the downward spiral. New techniques such as just-in-time inventory management systems and more sophisticated market-monitoring trimmed inventories.
This is the first major expansion fueled not by the government, but by private-sector spending. Government spending causes inflation, while in this boom, the opposite happened - budget deficits shrank and turned into surpluses. The government was no longer crowding out private business in the capital markets.
There are storm clouds ready to rain on this parade.
Tight labor markets are forcing employers to begin to compete for workers by hiking wages.
The stock market euphoria. The S&P 500-stock index was trading at 31 times earnings, double the average rate of the past 40 years. Yahoo! was trading at a P/E ratio of 735. Those kinds of multiples had not happened since the 1920s. Nearly half of American households own shares of corporations either directly or through pension plans of one sort or another. So if the bust comes, it will affect many people.
The trade deficit resulted from Americans' insatiable desire for more overseas things. This is accompanied by a growing dependence on foreign capital to finance American business. A plunge in the value of a dollar would touch off a stampede to pull out of the American market. That's exactly what burst the Asia bubble of the 1990s.
Will fiscal and monetary policy be able to cope? The Fed certainly has had a lot of practice lately - usually on the winning side. Sadly, the tools of economics are not yet sharp enough to perfectly predict what the outcome will be.
Source: Jacob Schlesinger and Nicholas Kulish, "The Usual Causes of Death - Inflation and Inept Policies - Aren't Afoot in America Yet," The Wall Street Journal, February 1, 2000, p. A1.

Very short answer questions:
1. Does this article describe the multiplier process as it worked in the past?
2. Do economic expansions depend on rising income?
3. Are there examples of people's forward-looking expectations in the article?
4. What would better inventory management do for GDP?
5. Are the authors correct that there were no signs of inflation? That there was no government ineptness?
6. What do you think caused the recession that was officially begun and ended in 2001, but that still caused net job losses throughout most of 2003? (Don't say 9-11. In 2001, the tragedy of September 11 had an adverse impact on the economy, but did not cause an economic downturn. See note above.)

Solution Preview

The article mentions that a "downward spiral" was created by the build up of excess inventory. This is directly related to the multiplier process. When consumers cut back, each dollar of spending creates a much larger overall decline, since businesse cut jobs in response to declining sales. Then, there are even fewer people with the funds to buy other goods.

Rising incomes are a key component to economic expansions. When people buy more goods, it creates jobs which then creates even more demand. Other factors are important as well, such as increasing productivity. But without rising incomes, an economic expansion is unlikely. An increasing population could have a similar ...

Solution Summary

Analysis of article discussing reasons for the 2001 recession.