Don't blink now, but the recession that was only officially recognized four months ago by the experts may already be over.

Dean Croushore
Federal Reserve Bank of Philadelphia
RecentMeet the Streets
George Nichols
Lehman Brothers'
Matt Zolin
First Albany Asset Management's
Hugh Johnson
Driehaus Capital Management's
Richard Driehaus
New York Knicks'
Kurt Thomas
Charles W. Mulford

According to a report issued last week by the Federal Reserve Bank of Philadelphia, the current recession, which began in March 2001 according to the National Bureau of Economic Research, may end this quarter.

Each quarter, the Philadelphia Fed surveys a group of 35 economists drawn from academia as well as the public and private sector for their projections for the economy. This latest time around, its respondents expected GDP growth of 1.4% this quarter and 3% for the whole year (the National Bureau of Economic Research, the official arbiter of business cycles, relies exclusively on academic economists).

If the Philadelphia Fed's survey proves correct, the American economy, which stayed only a hair's breadth away from recession in the fourth quarter of last year when GDP grew 0.2%, would improve markedly. But the economists predicted that unemployment could reach 6% this year and drop only slightly to 5.7% by the second quarter of 2003.

Dean Croushore, an economist and vice president with the Federal Reserve Bank of Philadelphia, explains what's behind the economists' optimistic outlook for this year, as well as their projection for annual equity returns of 7% and GDP growth of 3% over the next 10 years.

TSC: Summarizing this report, what exactly does it tell us about an economic recovery for this year, and why?

Croushore: The forecasters who we survey each quarter think that the economy will grow throughout 2002, starting fairly slowly at first, at about 1.4% in the first quarter, then picking up steam for the next couple of quarters. Things look pretty positive. The recession may be over.

The Philadelphia Fed's 10-Year Forecast
(annualized figures)
Real GDP Growth 3.0%
Productivity Growth 2.1
Stock Returns (S&P 500) 7.0
Bond Returns (10-Year) 5.5
Treasury Bill Returns (Three Month) 3.75
* Consensus of 35 economists surveyed by Federal Reserve Bank of Philadelphia, First Quarter 2002

TSC: Did the forecasters elaborate on why they see recovery, or do you have any other variables that you would point to, to make a case for a 2002 economic recovery?

Croushore: The forecasters always watch for a recession that lasts for a little while and then ends, and what they look for are signs in the incoming data that things have begun to turn around, and I think they are beginning to see those signs in a variety of ways. Even in the manufacturing sector, which has been down for quite a while. Consumption has also been holding up very well, and housing as well.

Given the data that we've seen in the last few months, I don't think it's surprising that we are seeing this recovery in their forecasts.

TSC: In terms of their 10-year forecast, have you any comment on the economists' expectation that stocks will return an annual average of 7% over the next few years?

Croushore: The forecasters' expectation for a 7% average annual return on the S&P 500 over the next 10 years is down a little bit from what they thought a year ago, and it's not as high as historical average returns for stocks. Returns on stocks going forward are going to be a little bit lower than what they've been over the past 100 years. But it's fairly consistent with the fact that the stock market has run up over the last decade or so. Despite the declines of the past several years, the stock market indices are still at fairly high levels.

TSC: How does their forecast for an average 3% annual GDP growth rate over the next decade compare with other periods?

Croushore: The real question that forecasters and economists throughout the country are struggling with is that many people thought that there was a "new economy" going on in the second half of the '90s in the sense that suddenly productivity growth was a lot stronger than it had been for the last decade-and-a-half, and we had faster real GDP growth.

The question everyone is asking themselves now is, was that a permanent change or was it just a temporary phenomenon that happened in the second half of the '90s? Economists in our survey are struggling with the same question, and I think uncertainty over this debate has taken some of the steam out of their projections. Maybe they don't think the underlying strength of the economy is quite as strong as before.

Still, 3% growth for the next 10 years is not bad. It certainly beats what we saw in the 1970s and the 1980s.

TSC: Why do the forecasters see a slowdown in GDP growth in the fourth quarter of this year, when the end of the year has historically been lifted by holiday and end-of-year sales?

Croushore: These forecasts and the data on GDP are all seasonally adjusted, so special factors like holiday shopping are smoothed out over the year, so that you are not misled into thinking that the fourth quarter is always stronger.

Now, part of what's happened in our forecast to lead the economists to predict slower growth in the fourth quarter is the fact that the recovery is coming so much sooner in the year than they expected. With such a strong upswing in the third quarter, that's taking a little bit of the steam out of the fourth quarter.

That's nothing to worry about. They certainly see a healthy economy going forward beginning in the second half of 2002 straight into 2003. Their overall prediction for growth in 2003 is 3.5%.

TSC: Why, then, don't they see quicker improvement in the unemployment rate?

Croushore: In many recoveries from recessions, though you will see positive GDP numbers, it takes a little bit of time for that to affect the labor market. Occasionally in recoveries, unemployment during a recovery will even continue to rise after the recovery has begun. That's reflected here a little bit.

It really isn't rising much. Only to 6% in the third quarter and the fourth quarter, so I think that's fairly consistent with past historical episodes. The only thing is, if the recovery should happen faster than they anticipate, then I would expect those unemployment numbers to be lower.

TSC: In sum, what does this report tell investors about the American economy and hopefully the stock market?

Croushore: Investors and everyone else in the American economy should be pleased that forecasters see an end to the recession most likely faster than we'd though three months ago, so that's good news. They do see about a one-third chance that the recession could continue this quarter and next quarter. We may not be completely out of the woods yet, and I would think a lot of the data bear watching because in what looks like a recovery, sometimes we get some backsliding.

But most of the signs are pretty optimistic.

TSC: Did they pinpoint when this recovery is likely to happen?

Croushore: Most likely, it's some time in the first quarter because we have growth of real GDP of 1.4% for the quarter, so we think it's pretty much over in the first quarter. And then we get up to 2.5% GDP growth in the second quarter, so by the second quarter it looks pretty strong.