So the new economy gives way to the new recession.

That's the term Frank Badillo, a senior retail economist at PricewaterhouseCoopers, has pinned on the current economic downturn. Even though the upcoming holiday season is expected to be the worst since the early 1990s recession, it won't be nearly as bad. The difference? Slowing growth hasn't been coupled with inflation, keeping the economy out of negative growth territory.

Nevertheless, retailers are in for a rough holiday season, he says, one that can't be saved by any tax rebate. Badillo recently chatted with

TheStreet.com

on the state of retailing. For more on the upcoming holidays and why he sees more store closings and bankruptcies looming, read on. (This interview has been edited for length and clarity.)

TheStreet.com:

So what happened to that second-half recovery?

Frank Badillo:

What we've actually been expecting -- at least on the consumer side -- was for the second half to be weaker than the first half. What we've been seeing happening is that business has of course led this economic downturn, but the impacts on the consumer have been lagging. We've been expecting that those lagging impacts are going to be worse in the second half. Our forecast for the fourth-quarter Christmas period is for 2.5% growth in what we call core retail sales, which exclude autos and gasoline. And that would be significantly weaker than the approximately 4.5% growth we saw in the same quarter a year ago.

TheStreet.com:

All throughout the first half of the year economists were chirping that lower interest rates would be a boon for retailers. Now few economists mention those lower rates in the context of consumer spending. Have you seen evidence that lower borrowing costs have supported the consumer?

Frank Badillo:

It is actually having an impact. When you drill down within retailing you see the different sectors being affected very differently. If you look at the home goods sector -- the home improvement stores, the furniture, the

consumer electronics stores -- they had some weakness earlier in the year, saw some negative growth. But since then we've seen interest rates fall and mortgage refinancing start to pick up, and with that, in particular, the home improvement sector, we've seen some pickup in recent months. We've actually seen a couple of good months in a row. We haven't seen that, yet, in the other home goods sector -- furniture and consumer electronics.

"Our forecast for the fourth-quarter Christmas period is for 2.5% growth in what we call core retail sales ... that would be significantly weaker than the approximately 4.5% growth we saw in the same quarter a year ago."

But what I think is what's going to happen is the effect of the lower interest rates, and the fact they are sustaining the housing market, is going to help keep those sectors from getting even worse, and we may see them firm up and get a little better in the second half. So of all the retail sectors, they will probably do a little better than others because of that continuing strength in the housing market. But it's not the same for some of the other retail sectors.

The apparel sector is probably going to be the worst hit of all the retail sectors. If you look at overall apparel demand, it was still relatively strong to the end of last year. But what is happening is that comparisons to a year ago are difficult comparisons. And that is going to mean some very weak growth for the apparel retailers through the end of the year. In particular, the department stores -- I think they are already seeing negative growth, which is what we expected, and that should continue. The other apparel retailers should see flat to maybe very slight positive growth. But that's the best it's going to get there.

And if you look at the third broad area -- what we call food, drug and mass retailing -- I think they're also going to see some of the lag effects hit home in the second half.

TheStreet.com:

How does the tax rebate play into all of this?

Frank Badillo:

Some individual retailers have tried to capitalize on it, and it may make some difference on an individual basis here and there. But overall across retailing, I don't think it's going to have a significant impact. I think a lot of people are going to end up saving it. Some are going to spend, but it's a temporary tax cut, not a long-term thing. A lot of people don't see this as something that will increase their spending ability in the long run. Particularly, with being a little more cautious in a down period, they are more likely to put it aside for what may yet come.

"There are some of the pains that you get in a recession, but it has some very different qualities at the same time. And that lack of inflation -- and, in fact, deflation in retailing -- is one of those significant differences."

TheStreet.com:

Do you think the upcoming holiday season will be the worst in a decade, as some are now predicting?

Frank Badillo:

The 2.5% I'm predicting would be the slowest growth since 1991, the last recession. In dollar terms, nominal growth would be similar. But there is a significant difference between 2.5% growth this year vs. 2.5% growth in 1991. The difference is that in '91 we had inflation in retail channels. It was running between 4% and 4.5%. When you adjust for that inflation, it actually meant negative real growth for retailing. And negative real growth is of course what we define a recession by.

Currently, in retail we've got deflation. Prices have been falling at an average rate of nearly 1% in these retail channels, so it makes for a very different environment. That 2.5% growth this year would translate into positive real growth, which does not meet the definition of a recession. That's one of the reasons I've taken to calling this downturn that we are going through a new recession. There are some of the pains that you get in a recession, but it has some very different qualities at the same time. And that lack of inflation -- and, in fact, deflation in retailing -- is one of those significant differences.

TheStreet.com:

Thus far, retailers haven't been forced to announce massive layoffs, as has occurred in many other sectors. Do you see this on the horizon?

Frank Badillo:

What I think we'll see is more store closings. This should accelerate store closings, consolidation and some bankruptcies. Maybe it will wait until after the holidays, but maybe we'll see some before. There was a very significant expansion in the last few years, in terms of opening new stores and expanding square footage. In the high tide of that booming economy, it lifted all those stores, but now that the tide has receded, it will leave a number of those stores on the rocks.

"It looks like the whole inventory-correction process is happening a lot faster across a lot of businesses than it usually does during a downturn."

TheStreet.com:

How well do you think retailers have adapted to the slowing economy? Have they reduced inventories to appropriate levels?

Frank Badillo:

I recently looked at some of the inventory data from the government, and it was clear that apparel was probably the worst. They really let inventories build up through the end of last year, and that was one of the reasons why a lot of apparel retailers have been reporting bad results this year. It looks like that inventory-correction process is under way, and they may be getting in better shape. It looks like the whole inventory-correction process is happening a lot faster across a lot of businesses than it usually does during a downturn. Which is a good thing, because if they get it corrected and in good shape before consumer spending plummets too much, then that might set up a good environment for a rebound next year in the economy.

TheStreet.com:

When do you see a turnaround of the level that many economists were predicting for the second half?

Frank Badillo:

Our expectation has been that sometime in 2002 the rebound will occur, maybe as soon as the first quarter. Comparisons get a lot easier at that point. But it's still a very dicey time for the economy, and we are still seeing some layoff announcements. A lot of this will depend on what happens in business investment. If we're bottoming out there, and business and manufacturers are cutting those inventories and getting in shape for a rebound, then it may happen in the year. If there is more correction that needs to happen there, then the weakness may lag further into 2002.