Or, the Landing Ahead May be Soft
Subject Recession, slowing economy
Topic Fiscal Policy
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 economy descend gradually 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? Bruce Steinberg, chief economist at Merrill Lynch & Co., argues forecasts of a hard landing or recession are wrong because they fail to recognize the profound changes that the economy has undergone. Changes that Steinberg argues make the U.S. economy if not recession-proof at least much more resilient to the economic shocks that we've experienced. Steinberg sees only a lowering of the growth rate as the likely outcome.

Steinberg thinks that the wealth effect is overrated as a determinant of consumer spending. Consumer spending in the 1990s increased in accordance with increases in consumer incomes without consideration of stock prices. The drop in stock prices that has recently been recorded should not appreciably dampen consumer spending as long as household income remains strong. Although some economists worry that consumer debt and the drop in household savings will depress consumer spending, Steinberg argues that they fail to recognize the impact of capital gains or profits earned on the sale of real estate. Incorporating these gains results in a savings rate of 10 percent and makes servicing consumer debt less of a problem.

A slowdown in the economy will cause capital spending to decrease. Even a fifty percent reduction in capital spending will result in spending that is greater than average and greater than the growth rate for the rest of the economy. Firms will continue to invest in capital equipment because they want to stay competitive.

While some economists worry that the rise in unit labor costs will lead to increased inflation, Steinberg argues that this is not likely to occur. Unit labor costs have been rising at a rate of 4 percent for the past four years. They have, however, been offset by productivity increases with resultant stable prices. With little or no inflationary pressure, the Fed would not be afraid to cut interest rates should a recession materialize.

(Updated January 1, 2001)

1. In the past, business firms responded to falling profits by cutting capital spending considerably. Steinberg argues that the rules of the new economy preclude that from happening. According to Steinberg, business firms that cut capital spending become uncompetitive and die. Explain how changes in capital spending affect aggregate demand and long run aggregate supply.
2. Steinberg believes that actions by the Fed can prevent recession. Do you agree or disagree? Explain.
3. Some economists argue that a rise in unit labor costs lead to increases in prices while Steinberg argues that this is not necessarily so. What is Steinberg's argument?
Source Steven Pearlstein, "The Landing Ahead: Hard or Soft?," The Washington Post, December 10, 2000.

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