Why did GDP alone hold up? It may well have been the government reaction to Sept. 11, says Anirvan Banerji, managing editor at the Economic Cycle Research Institute. The alarming events provoked the Federal Reserve to lower interest rates sharply. As a consequence, Banerji said, auto companies could offer zero financing, and car sales drove GDP up in the fourth quarter (and consumers borrowed against their homes).
At the same time, government spending rose rapidly in the battle against terrorism. Both auto sales and government spending rose enough to account alone for the 1.7 percent gain of GDP in the fourth quarter, offsetting the sharp drop in capital spending.
Without the alarm set off by Sept. 11, Banerji said, it is possible that the economy might have slid into recession without provoking an adequate response from the Fed or fiscal stimulus from the White House and Congress.
What does this tell us about future growth? Some argue that with all the layoffs, business has positioned itself to improve profits and start investing again. But The Boom and the Bubble (Verso), a new book by Robert Brenner, a historian at the University of California at Los Angeles, raises some doubts. It is the best financial history of the period yet.
Brenner traces how the falling dollar from the mid-1980s to the early 1990s helped restore the profits of manufacturers by reducing export prices. He also shows how business' ability to keep wages down improved profits. With better profits, and more accommodative Federal Reserve policy, capital investment at last took off.
Even so, capital investment was soon generating a reduced return, and profitability began falling by 1997. But the rising stock market and low interest rates disguised the erosion because it allowed corporations to raise money and invest even without strong profit. In the meantime, consumers also borrowed in lavish amounts.
Now the dollar is high again. Wages have risen strongly for five years. Borrowing is at record levels. The stock market, even if it stops falling, is highly unlikely to rise at the pace of the 1990s.
Does this mean we are entering a period of slow growth or are on the verge of another recession? Financial conditions are not everything. A continuing fall in computer prices and new standardized products can offset any financial obstacles.
But the financial risks are high. And neither information technology nor free markets have eliminated the business cycle. The best guess is slow growth for a long time, and another recession cannot be ruled out.
There is thus ample room for more fiscal stimulus, ideally social programs for the poor who will spend the money. And the Fed should stay cautious about raising interest rates. We are not out of the woods yet.
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