OCTOBER 2002: US Economy still uncertain (The Economist) 

In the balance
> Oct 4th 2002 
> From The Economist Global Agenda

> In spite of a surprising drop in the unemployment rate, America's
>economic prospects remain uncertain. A bitter labour dispute and concern
>about war with Iraq mean policymakers are having to contend with an unusual
>degree of uncertainty
THE world's biggest economy has lost none of its capacity to surprise.
>At the end of a week of almost uniformly grim news, figures released on
>October 4th showed an unexpected drop in the unemployment rate, from 5.7%
>in August to 5.6% in September. This was the cue for sighs of relief all round.
Too much reliance on one set of data relating to one month is always a
>mistake, though. Given the uneven nature of America's current economic
>performance, it could be a dangerous one: both for investors and
>stockmarket traders”who often overreact both to good news and bad--and
>for policymakers trying to pick their way through a statistical minefield.
Not even the unemployment figures were unambiguously good. The jobless
>rate was down; but so, too, were payroll numbers, measuring the number of
>jobs in the economy. The discrepancy is easily explained--they come from
>two different sources, with unemployment measured by household surveys and
>the payroll numbers coming from business reporting. But the differences
>underline the difficulty of understanding what is happening to the economy
>at present.
S&P 500 recorded their worst quarterly falls since 1987. The number of
>short-term jobless claims--yet another unemployment measure--went up.
>Business confidence weakened again, according to a survey of chief
>executives. Durable goods orders fell slightly in August, and the rapid
>growth in car sales tailed off sharply. The list goes on.
Yet most economists still expect America to continue to grow at a modest
>pace over the next year or two. Both the Federal Reserve--America's
>central bank--and the International Monetary Fund share this assessment.
>But they both also agree that downside risks remain and, indeed, have grown
>in the past few months.
Uncertainty is now the biggest obstacle to economic momentum. There is now
>more uncertainty about a wide range of factors than six months ago. Some
>are obvious. A bitter labour dispute between dockers and their employers on
>the west coast has led to the temporary closure of 29 ports from San Diego
>to Vancouver. For now, the economic impact of the shutdown is negligible.
>The longer the ports stay shut, though, the greater the risk of economic
>disruption as factories struggle for supplies and exporters lose business.

> The prospect of a war with Iraq is also casting a shadow over the economic
>outlook. Optimists see a brief conflict with only a temporary spike in oil
>prices. But it doesn't take a particularly fervid imagination to come up
>with a scenario involving a long and costly occupation of Iraq accompanied
>by a prolonged rise in oil prices. Not knowing can make businesses more
>likely to postpone investment decisions, and individuals more likely to
>delay big purchases.
As yet, though, American consumers--the mainstay of the economy through
>last year's downturn and since--have been oddly reluctant to abandon
>their addiction to shopping. (The volatility in car sales has more to do
>with special low- and zero-interest deals which might have changed the
>pattern of purchases.) Retail sales figures for September, due out on
>October 11th, will show whether consumers are starting to lose heart.
Some economists think a consumer slowdown is inevitable at some point.
>They foresee a sharp slowdown in the housing market, which has underpinned
>much recent consumer spending as people refinance their mortgages to
>benefit from lower interest rates and use some of the equity to buy goods.
>These same economists tend to be those most worried about the D-word:
In fact, deflation is on the minds of many economists and policymakers as
>they watch Japan struggle to grapple with the worst period of deflation
>seen in any industrialised country since the great depression of the 1930s.
>Could it happen in America? And if so, what should the policy response be?
Opinion is divided about the extent of the risk to the American economy,
>but few economists are prepared to rule deflation out altogether. With
>interest rates already at a 40-year low, and at 1.75% not that far off
>zero, the Fed is understandably cautious about using the remaining shots in
>its locker unless or until it needs to do so, in the hope of achieving
>maximum impact if more interest-rate cuts are needed. It decided against a
>cut at its last meeting, on September 24th.
But should the Fed act more pre-emptively at this point? There is a school
>of thought that says if there is any risk, however slight, of deflation,
>policymakers should treat it as the central risk. Since inflation is so
>low, erring on the side of caution would carry few risks: if the central
>bank were to end up cutting interest rates by too much and fuelling modest
>inflation in the attempt to avoid deflation--well, no great harm would
>have been done. Central banks know how to combat any rise in inflation that
>might result from a monetary loosening. And they know that it is easier to
>deal with inflation than deflation.
Judging the balance of risks is always difficult, since policymakers have
>to act with insufficient and imperfect information. The Fed might also, in
>this case, face a further dilemma. Suppose it did think some pre-emptive
>action was desirable, and decided to cut interest rates aggressively to
>ward off deflation. The markets--and other economic actors--might wonder
>whether the Fed knew something they didn't, and panic. They might not
>understand the subtle difference between seeing deflation as the principal
>risk and deciding that any risk, however slight, warranted pre-emptive
>action. Even choosing the least bad option then becomes almost impossible.

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