Whither the US economy? Every piece of good news suggesting that America's recession is about to end is followed by bad news suggesting otherwise. The Federal Reserve Board's current monetary policy reflects this ambiguity: it is neither lowering nor raising interest rates. Instead, it maintains a "neutral" stance. The meanderings of the stock market are a similar indication of uncertainty.
Much of the discussion of the US economy is of little help, for it is focused on the wrong question: when did the recession start and end? Recessions typically are defined by whether GDP has fallen. But what is of real concern is the gap between the economy's potential and its actual performance.
In these terms, the US econ-omy's performance is likely to remain dismal. Increases in measured productivity mean that the economy's potential growth rate is now somewhere between 3.5percent and 4 percent annually. (There have been changes in the way we correct for price changes, so that what we measure today as 4 percent actually represents what we used to measure as a substantially smaller number.)
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Even when the US grows at 0.5 percent, a gap of 3 percent in a US$10 trillion economy means a loss of output of US$300 billion -- an enormous amount by any definition. The shortfall, in turn, implies rising unemployment. Given the huge gap, the US will have to grow in excess of its long run potential in order to get back to utilizing its resources fully.
Even with the surprisingly strong growth numbers for the first quarter of the year, most forecasters see growth over this year as a whole falling short of its long run potential, and by a significant amount, implying that unemployment will rise.
There is a simple interpretation of what has been happening to the US economy. The recession of last year combined an inventory downturn with an investment downturn. The first is now over; the second -- the result of over-investment in high technology and telecommunications, the sectors that were so important in the boom of the late 1990s -- may last considerably longer. There remains a considerable capacity overhang -- such as fiber optic lines that remain dark, having yet to see any light pass through them. Merely lowering interest rates did not, and will not, lead firms to invest more in these sectors.
The good news -- and the bad -- is that the pace of technological change in these sectors is sufficiently fast that much of the equipment may become obsolete well before it is worn out, or even used, enabling new investment to start faster than it otherwise would. Meanwhile, the US cannot expect much relief from exports, given the global economic slowdown, or from consumer spending. Typically, a rebound in consumption helps to re-invigorate the economy; but consumption has, almost miraculously, sustained the economy as investment has fallen, and thus there is little scope for a rebound.
The risks are mainly on the downside. There is a significant chance that with Americans' savings rate at dismally low levels -- sustained last year by car purchases and home refinancing -- consumer spending may moderate. Some of last year's sales, more-over, reflected purchases that would have been postponed until this year were it not for special offers inducing consumers to buy cars earlier than they otherwise would. Even Americans can consume only so many new cars.
On the contrary, a high level of indebtedness now afflicts US households. This sharp deterioration in the US fiscal position means that long-term interest rates have fallen little, even as short-term interest rates reached record lows. Rising unemployment adds to a sense of economic insecurity, and may further weaken consumption. Record levels of military expenditures are the only major source of expansion and while such expenditures may be necessary and do stimulate the economy in the short run, they do not enhance its long-term competitiveness and strength.
After initially believing that its economy was so strong that it would not only be unaffected by America's slowdown but also maintain robust growth, Europe has turned to looking to the US recovery to lift it out of its malaise. I think this is a risky strategy; if a strong US recovery is not around the corner, then Europe needs to act on its own, using the standard counter-cyclical tools of monetary and fiscal policy.
The threat today is not inflation, but unemployment. It is unemployment and economic insecurity that breed xenophobia and support for extreme rightist movements across the continent.
Unfortunately, Europe's hands are partially tied by a central bank that focuses on capping inflation, and a stability pact that, as customarily interpreted, limits the use of deficit spending as an economic stimulus. The challenge going forward will be to reinterpret these strictures. The prospect of sustained long-term growth and social justice requires that Europe's new institutions retain sufficient flexibility to reshape themselves as they confront new problems.
Joseph E. Stiglitz is a professor of economics and finance at Columbia University, the winner of the 2001 Nobel Prize in Economics and the author of Globalization and its Discontents.
Copyright: Project Syndicate
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