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The Not Yet Recession
Subject Economic Growth
Topic Fiscal Policy
Key Words Recession, Unemployment, Interest Rates, Trade Deficit, Economic Growth
News Story

Economic growth this past quarter was a modest 2 percent. The increase in gross domestic product (GDP) extended the current expansion to a full 10 years - the longest period of expansion on record. Despite widespread concerns that a recession was looming, economic activity actually accelerated in the first quarter of 2001 compared with the last quarter of 2000. The growth in GDP was twice the rate that forecasters had predicted, and was the result of continuing strength in consumer spending.

In spite of increases in unemployment, many announcements of layoffs, and decreases in business and consumer confidence, consumer spending increased 3.1 percent in the quarter, compared with 2.8 percent for the last quarter. The increases in consumer spending were led by consumer durables such as cars, appliances and furniture. Government spending was up 4 percent and the U.S. trade deficit decreased, adding 1.38 percent to the overall decrease in GDP.

Business investment declined 11.5 percent as businesses cut inventories and cancelled planned expansions. The value of inventories fell this quarter for the first time since 1991, just after the recession had ended. Analysts believe that most of the production cuts required to reduce inventories have already been made, and are predicting an increase in economic growth in the second half of this year.

There is a great deal of uncertainty about what these changes mean for the next few months and how the Federal Reserve will react. The Fed has cut interest rates by one-half percent four times this year. Some argue that increased consumer spending and stronger economic growth will make the Fed less likely to cut interest rates further. Others point out that the interest rate cuts were in part a response to decreased business investment and current data indicate continued decreases. Consumer confidence, according to latest polls, has slipped, and whether consumer spending will continue to increase is problematic. This uncertainty may push the Fed to continue rate cutting although in a less aggressive manner.

(Updated June 1, 2001)

Questions
1.

The last three recessions were initiated by a drop in consumer spending and followed by a decrease in business spending.
a. How important is consumer spending in GDP?
b. Why does business investment typically follow consumer spending?
c. How does business investment respond to interest rate decreases?

2. One closely-watched index of the course of the economy is business inventories.
a. What typically happens to sales and inventories during a recession?
b. What happens to sales and inventories during a recovery?
3. What reasons are offered for an expected increase in production during the second half of the year?
Source John M. Berry, "Economy Beats Expectations," The Washington Post, April 28, 2001.

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