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Gloom in the Forecast
Subject Recession
Topic Fiscal Policy
Key Words Recession, Interest Rates, Investment, GDP, Economic Growth
News Story

Although most economists are predicting a mild recession with recovery in the second-quarter of 2002, Joseph Stiglitz, Nobel-prize winning economist, believes that this recession can be, "the worst recession in twenty years." Furthermore, Stiglitz argues, the proposed stimulus package will do little to improve the economic climate and could even exacerbate the problem. A prolonged U.S. recession could trigger a world-wide recession, further aggravating U.S. problems.

Reported economic data tell a gloomy tale. The October increase in unemployment was the largest monthly increase in two decades. Current GDP is estimated to be below potential GDP by $350 billion and consumer confidence is at its lowest level in seven years.

Professor Stiglitz believes that the Federal Reserve's approach to stimulating the economy by reducing interest rates is not very effective. Monetary policy is more effective in moderating expansions, he argues, than in reversing a downturn. The Fed has just initiated its 10th rate cut without any perceptible change in the economy's direction.

President Bush's tax cut proposal was supposed to induce consumer spending. Stiglitz claims that the President's initiative was also ineffective because, "the $300 and $600 checks sent to millions of Americans were put largely into savings accounts." Stiglitz believes that the new stimulus package Congress is currently debating will not produce the desired result. The House proposal, relying principally on tax cuts for corporations and upper-income households will not produce either increased investment or spending according to Stiglitz and the Senate Republican bill would be even worse.

Stiglitz proposes a program that he argues would have a bigger impact. Increased funding for America's unemployment insurance program, he argues, would put needed dollars in the hands of people who would spend it. He also proposes temporary investment tax credits to stimulate business spending. Another key element of his proposal is a revenue-sharing program that would provide needed cash to states and enable them to continue to provide vitally needed public services. These three elements of his stimulus package would, according to Stiglitz, prevent a serious recession with global implications.

(Updated December 1, 2001)

Questions
1. Define potential GDP. Prof. Stiglitz calls the difference between potential and current GDP, "an enormous waste of resources." Explain.
2. Stiglitz points to implementation lags as a problem for monetary policy. Explain this statement. What is an implementation lag? Are there other relevant lags that impede the performance of monetary policy?
3. Consumer confidence plays a large role in determining the depth of the recession. How does consumer confidence impact aggregate demand? Real GDP? The aggregate price level?
Source Joseph Stiglitz, "A Boost That Goes Nowhere," The Washington Post, November 11, 2001.

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