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Terrorists Shake Economic Forecast
GRAND RAPIDS — George Erickcek, senior regional analyst for the W.E. Upjohn Institute in Kalamazoo, says he’s “clueless” as to what impact last week’s terrorist attacks will have on the U.S. economy because “this has never happened before.”
Forecasters of economic activity depend upon the past to determine how things may respond, Erickcek said.
“Since there isn’t any historical framework that we can forecast on, I think it’s just a great unknown.”
When something strange and tragic happens, everyone’s natural reaction is to step back, he said. Many people are worried that consumers, who have been the sustaining force in the economy for the past year, will step back from the marketplace. And a consumer retreat would be a major blow to an already weakened economy.
“It’s pretty clear there is no upside in this,” said Richard DeKayser, chief economist for National City Bank. “The problem is we were in an economy that was just, perhaps, tentatively beginning to make a turn for the better.”
Tuesday’s events are likely to take a big toll on consumer confidence and, ultimately, consumer spending, DeKayser said.
In the six months following the August 1990 Iraqi invasion of Kuwait, the U.S. saw the sharpest decline ever in survey measures of consumer confidence, he observed.
“If that would repeat itself — and it’s a big ‘if’ — and we get something even approaching near half that magnitude in drop, in all likelihood consumers will feel more fretful, less confident about the future and will spend less,” he said. He thinks the country will see a decline in consumer confidence but not as severe as in 1990.
The business community began pulling away from the investment table last year. A consumer retreat would give businesses one more reason not to invest in new equipment, new plants, new computers, and new office furniture, Erickcek pointed out.
The three factors influencing business investment activity are the cost of money, the perception of the future and how much idle capacity exists or doesn’t exist. If consumers slow down, DeKayser said, there will be more idle capacity because there’s less demand for goods and services.
“Even if it’s not necessarily true that the outlook is dark, if it is perceived to darken, that’s what matters,” he stressed. “Even if we get a pretty substantial decline in interest rates, the dimmer economic outlook and excess capacity of capital equipment will contribute to further weakness in investment spending.”
Consumers can’t do it alone, Erickcek said. If businesses feel nervous and if they think the consumer is no longer present because of the attacks and the air of uncertainty that may prevail due to Tuesday’s tragedy, the third quarter could turn negative.
That could put the country on the road to a true recession.
Recession is a definite possibility now, acknowledged DeKayser, who said he had been in “the no-recession camp” up until a week ago. Though he’s still not predicting an outright recession, he’s predicting something “that’s going to feel an awful lot like one.”
On the other hand, in a couple of weeks the country could face a strong rebound possibly due to government action, or due to the American spirit and people’s desire to put the tragedy behind them, Erickcek noted.
“If the government responds in a way that brings confidence back to the citizens, that will have a major effect on the economy,” he added.
Erickcek thinks the Federal Reserve will respond fairly aggressively to keep the economy on track, making sure there is sufficient money available so that no one feels constraint regarding the money supply. The Fed also may lower interest rates more to try to encourage further investment.
More help in the form of lower interest rates may be on the way very soon, DeKayser suggested. He had anticipated another quarter-point easing of the interest rate by the Federal Reserve on Oct. 2. Now, he thinks the Feds will pare the federal funds rate by one-half a percentage point, and that they might not wait until October to do it.
DeKayser pointed out that the attacks impact both the stock and oil markets.
The potential impact on the stock market isn’t clear. His personal belief is that there will be a short-term sell off but no serious long-term consequences.
“Nonetheless, we’re looking at a stock market that’s already down 30 percent in the past year and further losses on top of that will adversely impact the economy through people’s wealth holdings,” he noted. “As holdings fall, people are less inclined to spend as well.”
The general feeling is that the stock market will go down further in the aftermath of the attacks. People could get really nervous and uncertain about the future or they could decide it’s a good time to buy.
The stock market was already close to what many people thought was the bottom, so it’s possible there could be a rally in terms of many investors thinking that prices won’t get any lower and now is the time to bargain hunt for stocks, Erickcek said. He said economists could build a case for either scenario.
Another impact of the attacks will be on oil markets, DeKayser said. If any retaliatory measures the U.S. is considering, or eventually undertakes, lead to the Middle East where there are key supply linkages for crude oil, there could be scarcity of oil and prices could rise.
Higher energy prices, in turn, drain consumers of discretionary income.
DeKayser has been preparing scenarios to try to quantify all the various impacts, and the most recent one he conducted has growth in GDP for the third and fourth quarters, as well as the first quarter of next year, at about 1 percent, which he said is not good.
A weakening of the U.S. dollar has both good and bad implications, he noted. A lower dollar generally is a bit of a worry because imports get more expensive and make the country’s inflationary environment worse.
On the other hand, domestic manufacturers have been fighting tooth and nail and losing the fight with foreign suppliers to gain market share. As a consequence, a cheaper dollar would help them recapture some of the market share they’ve lost over the past several years, he added.
Erickcek said what happens to the strength of the U.S. dollar will depend on the responsiveness of the U.S. economy.
“If our economy responds quicker than people believe, then I think that would only strengthen the dollar,” Erickcek said. “It would show that our economy could take a major blow and still keep on ticking.”
From a purely economic policy perspective, DeKayser thinks the government is doing all the right things.
“You can’t lose sight of the fact that just a few months ago we enacted a fairly aggressive fiscal stimulus package, which is still in the pipeline and that will go forth on schedule,” he added.
Judging from the statements he’s heard from government policy makers, he thinks the government ought to put greater emphasis on the “moving ahead, getting back to business” aspect if it wants to whip up confidence.
“I don’t think that we need either a new round of a capital gains tax cut or a temporary reduction in Social Security withholding taxes, which some leaders in Washington are proposing.
“Those measures would be perceived as temporary and when people perceive an action as temporary, they treat it that way. They don’t spend it; they save it. And that’s not going to help the economy.”