The High-Flying U.S. Economy Begins to Drop:.

• Author: Polzin, Paul E.
• Position: United States, economic forecast

Will the Landing Be Hard or Soft?

Higher interest rates and other factors are causing the U.S. economy to slow from the unsustainable growth levels of the late 1990s. The major concern now is whether the economy will decelerate to a moderate growth rate (soft landing) or drop into a full-scale recession (hard landing).

In the most likely scenario, the Gross Domestic Product (GDP) growth rate will fall to about 1.8 percent in 2001, and then rebond to the sustainable 3.1 to 3.6 percent range in 2002 and thereafter. Inflation peaked at 3.4 percent in 2000, and is projected to decelerate to between 2.6 and 2.9 percent. In addition, interest rates are expected to drop from their current levels.

Chances of a Recession

One way to determine whether or not a recession will occur is to examine the recession index (Figure 1). The recession index - a composite of many economic indicators -- measures the probability of a recession during the next 12-month period. A 12-month time horizon is used because it takes about a year for most economic impacts to be felt in the economy. If projected beyond a year, these trends will be influenced by events that haven't happened yet.

The recent downturn in the recession index is clear. There is definitely an increased risk of a recession. In fact, the index is at its lowest point in a decade. But this graph also puts things into perspective. Recession seemed likely in 1995 and again in 1998, but did not materialize, providing some confidence in the Federal Reserve's counter-cyclical skills. [Editor's note: The latest data show the recession index turned upward in February 2001.]

The Federal Reserve has repeatedly decreased interest rates in early 2001, indicating that they take the economic slowdown very seriously. So maybe we will have a repeat of 1995's "soft landing," with slower growth but no recession. Let's hope these cuts were the right decision at the right time.

However, one might still ask, aren't there fundamental imbalances in the U.S. economy that will drive it into a recession? The most often cited examples are the 0 percent savings rate, the strong dollar and the mushrooming current account balance, as imports far exceed exports. The problem is that it requires 20-20 hindsight to differentiate between critical imbalances and self-correcting phenomenon. It wasn't too many years ago when we were worried about the ever-expanding national debt and the burden the interest payment would place on future...