The Daily Interview: Steering Clear of the R Word

As the year began, the consensus of many economists was that the economy would revive in the third quarter. But as growth remained stagnant, earnings continued to disappoint and the stock market kept tumbling, economists began pointing to the fourth quarter. Now some are saying they don't expect the economy to improve until 2002.

Martin Regalia
Chief Economist,
U.S. Chamber of Commerce
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Martin Regalia, chief economist at the U.S. Chamber of Commerce, still believes that gross domestic product growth will begin to pick up, albeit modestly, in the second half of the year. He also believes the economy hasn't fallen into a recession for two main reasons. One, consumer spending has remained strong, and two, GDP growth rates have remained positive only because they're coming down off of such a robust growth rate of 5% to 6% last year.

There's still a chance that second-quarter GDP figures could indicate a recession, Regalia says. Nonetheless, he's forecasting second-quarter GDP growth of 1.5%. Here's why Regalia remains cautiously optimistic.

TSC: Do you believe that there might still be a recovery in the second half of this year, and, if so, what kind of GDP growth rates do you foresee for the next few quarters?

Regalia: We're forecasting a little bit of a pickup in the second quarter, very modestly over the first quarter -- perhaps 1.5%. And then we're looking at growth of about 2.5% in the third quarter and then closer to 3% in the fourth quarter and the potential rate of 3.5% in the early part of 2002. I am not sure the growth rates or corporate profits are going to be high enough to push the stock market significantly higher until the tail end of this year. By November or December, if the economy does, indeed, show signs of picking up, the market will firm up because of it.

TSC: You've said that we have avoided a recession. What has kept the economy out of one?

Regalia: Consumers, plain and simple. Consumption accounts for two-thirds of the economy. We have seen investment in business equipment declining, but in terms of GDP, that's a relatively small component. To date, we have been really lucky. We've seen a confluence of events that has weakened the economy, but not all sectors of the economy. Now we're down to where we have got one stalwart left: consumption. If consumption goes, then, clearly, the economy tips into a recession because we don't have anywhere near the strength anyplace else.

Despite what they've read in the press, people have looked at their paychecks, and their paychecks are going up -- modestly, but they're going up. While a few more people are unemployed now, we still have a very low unemployment rate of 4.4%, up four-tenths of 1% from 3.9%. At the same time, the other 95.6% of the labor force that is employed has generally seen their real wages go up. Income growth has continued.

A number of broad market indices have declined 15% to 20%. The Wilshire 5000 is off about 18%. That qualifies as a correction, not as a collapse.

Finally, if you look at the other assets that people own -- and probably as many or more people own this asset as they do stock -- it's their home. And home prices have been going up while interest rates have been going down, so people have been able to capitalize that appreciation in their house through second mortgages or cash-out refinancings. All of this has helped to offset the decline in the stock market.

So when you look at consumers, there's a reason to expect that consumption would slow from the 5% to 6% rate it had been at the end of last year. While it's not very strong, it's still growing, and perhaps the fact that it slowed from such a strong rate last year is what has kept us out of a recession. The inventory run-off in the first quarter took three percentage points of growth out of the economy. Our average growth rate over the past 20 or 30 years has barely been 2% to 3%. Over the past nine months, we've had what, in normal times, would have been a period of declining growth, and therefore, a recession.

TSC: While consumers may have continued to spend, inventories have, nonetheless, been a problem. When do you expect inventory levels, and therefore production, to rise again?

Regalia: We've seen a big inventory correction in the fourth quarter of last year and the first quarter of this year, and that took a lot of growth out of GDP. But it also means that the inventory-to-sales ratios are relatively lean, and what that means is you don't have to have more cutbacks in manufacturing.

So when you look at growth across the board, you see modest consumption growth and some modest stabilization in the industrial production sector. Housing starts, while not at their highs of the first quarter, are still reasonably strong and historically in very good shape. Again, people are spending and don't seem to be losing their confidence at the rate that they were. This all averages out to slow, anemic growth -- yet still growth.

We've probably got one more quarter of dicey nail-biting left with the second-quarter GDP figure due out in late August. This number is really worrying me. I think it's going to be really, really close. Once we get through that, I think we'll see modestly better numbers as we go forward.

TSC: Have there been any other leading economic figures that give you an idea what the second-quarter GDP figure might be?

Regalia: Yes, there has been some data that have led us to our forecast of 1.5% GDP growth in the second quarter. And while there are some numbers that look good and others that look bad, altogether they seem to indicate a bottom. A few months ago, everything looked bad; we were in a free fall. The mixed signals and the confusion we are now seeing in the data is typical of an inflection point in the economy.

We have recently seen the weekly unemployment claims staying in the upper 400,000 range. The consumer confidence numbers fell from 140 to 109 but have since bounced back again, which gives us some indication of a bottom there. The market corrected tremendously, and then it came back 700 or 800 points and seems to be bouncing around in this new range on a weekly basis.

Industrial production declined in April and will probably decline again in May. But it didn't decline in April at anywhere near the rates it declined at in the fourth quarter and the first quarter. Interest rates are lower and inflation hasn't really picked up.

All of this would indicate a bottom.

TSC: What about the Federal Reserve rate cuts? Are these now taking effect, and how do you measure these?

Regalia: We've had just under six months of lower interest rates, and it usually takes six months for the rate cuts to take effect, so we are starting to see the effects of the cuts made back in January. We'll see the impact build, and I expect that the majority of the impact will be felt in the September through December period. It would be pretty anomalous if nine months to a year after the Fed cut rates as dramatically as they did and after the tax cut, that the economy would still be declining.

There's no one indicator out there in which the Fed cuts will manifest themselves. They'll surface in all kinds of ways throughout all the data: stronger consumer confidence, improved sales, housing starts picking up and industrial production becoming stronger.

TSC: So, in sum, you seem to be cautiously optimistic that we will see a gradual recovery begin in the second part of the year?

Regalia: Yes, with the "cautiously" in capitals and "optimistic" in lower case. I am cautiously optimistic that we are going to see another slow-growth quarter, and then things will pick up in the second half.

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