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Hard Landing Ahead
Subject Recession
Topic Employment, Unemployment, and Inflation, Monetary Policy, and Recession
Key Words Recession, Soft Landing, Unemployment, Interest Rates, Wealth Effect
News Story

There is a mounting body of evidence that the economy is slowing. Will the economic descent be gradual according to the master plan drafted by Alan Greenspan? Or, has the economy fallen so far so fast that a recessionary hard landing is inevitable? Stephen Roach, chief economist at Morgan Stanley Dean Witter, argues that the economy has stalled and that another shock, perhaps in the form of another decline in the stock market, could bring a recession both here and abroad.

As economic growth diminishes, people will find their incomes shrinking as overtime, bonuses, capital gains and possibly their jobs also dwindle. Decreases in income make it more problematic for consumers to service the credit card, home mortgage, margin and home equity debt that they accumulated in the 1990s. Decreased revenues lead firms to reduce their capital spending, causing further reductions in aggregate demand.

Unit labor costs will rise with as the economy slows, and businesses will attempt to pass these increases to their customers. These increases coupled with oil price hikes and rising health care costs, mean that there is a risk of significant inflation according to Roach. Since monetary policy acts with a significant lag, the Fed may find itself in a catch up mode, attempting to correct a problem that has already occurred.

(Updated January 1, 2001)

Questions
1. According to Stephen Roach, a decline in consumer confidence, a decline in capital spending and a reverse wealth effect could turn an economic slowdown into a recession. For each of these factors explain how aggregate demand will be affected and the impact this will have on real GDP and the price level.
2. Roach also argues that a substantial slowdown has already occurred and that the Fed is likely to be in a reactive rather than proactive mode. Why is there a lag in the implementation of monetary policy? What significance is this lag to the magnitude of the downturn?
3. Suppose that unit labor costs increase what impact will this have on the economy? Draw an aggregate demand/aggregate supply diagram to illustrate this impact.
Source Steven Pearlstein, "The Landing Ahead: Hard or Soft?" The Washington Post, December 10, 2000.

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