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Uncertainty Abounds
Subject Slowing economy
Topic Monetary Policy
Key Words Soft Landing, Productivity, Unemployment, Interest Rates
News Story

Is there more uncertainty about the winner of the Presidential election or the direction of the U.S. economy? Many people would say it's the economy. Over the past year, a soft landing had seemed to be the most probable outcome following predictable declines in employment growth and the stock market. But events in recent weeks indicate that the "landing" may not be so soft.

Gross Domestic Product (GDP) slowed considerably in the third quarter of this year. GDP growth was 2.7 percent compared with the 5.7 percent annual rate recorded in the spring. Even though a decline of 3 percent in the growth rate does not constitute a recession, most Americans will feel this decline, especially since it will likely be accompanied by a significant rise in unemployment. The economic news in the past few weeks has not been cause for optimism. First-time claims for unemployment benefits have jumped, predictions of operating profit growth for Standard & Poor's 500 companies have been lowered and the stock market has had many ups and downs.

There is some concern among analysts whether a credit crunch is developing. The flow of capital to newer and developing companies has slowed. Banks are also tightening their lending terms and have approximately $100 billion in syndicated loans that are classified as problematic. If bad economic news continues, banks may reduce their willingness to lend, and foreign investors may redeem their investments in U.S. stocks and bonds.

Labor costs rose at an adjusted annual rate of 2.5 percent for the third quarter. This was the largest increase since the second quarter of 1999 and raised fears of inflationary pressures. Since the Federal Reserve has given priority to containing inflation even if it means accepting stagnant levels of economic growth, additional interest rate hikes cannot be ruled out. Interest rate hikes could take a slight downturn into a recession. Whatever the type of ballot, most economists would predict a soft landing as the most likely outcome but we may need to recount the ballots.

(Updated December 1, 2000)

Questions
1.

What is meant by a "soft landing?" Compare the outcome of a soft landing with a recession. What happens to GDP and the price level under each scenario?

2. Suppose that there is a "liquidity crisis." What happens to aggregate demand if business firms find it difficult to borrow money? What happens to GDP?
3. Suppose that there is a decrease in aggregate demand and a decrease in aggregate supply due to a major oil price hike. What will happen to real GDP and the price level?
Source Steven Pearlstein, "Soft Landing or a Bumpy Slowdown?" The Washington Post, November 15, 2000.

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