Academic journal article National Institute Economic Review

Commentary: The Economic Situation

Academic journal article National Institute Economic Review

Commentary: The Economic Situation

Article excerpt


The normal air of uncertainty which surrounds economic forecasts and policy analysis is, of course, greatly compounded by the aftermath of the New York air raid. It is widely believed that the business disruption to which it gave rise led to a fall in United States output in the third quarter of 2001. It is generally thought that the disruption is continuing into the fourth quarter, leading to a further output fall and meeting the widely-used definition of a recession.

That there has been this short-term disruption is no great surprise; the question is whether the raid has substantially affected prospects for the United States and world economies in the longer term, after the direct effect of the disruption has passed. Looking back to the period before the raid, there was concern that consumer confidence would suffer; it is widely recognised that a rise in the saving rate of US households, from its current (2001 March-August average) level of 1.9 per cent of disposable income to its average for the decade 1991- 2000 of 5.3 per cent of disposable income, would exert a contractionary influence on the US economy unless matched by an increase in borrowing elsewhere in the economy. If the adjustment happened rapidly it would be likely to lead to a sharp fall in output. There is no past experience to indicate whether, given recent events, this is likely. At the same time the United States has enjoyed a high level of fixed capital formation. In 2001 Q2 this took up 16.4 per cent o f GDP, while the average value for the decade 1991-2000 was only 15.8 per cent of GDP. If the proportion of GDP devoted to fixed capital formation were to fall below its long-run average the contractionary pressures in the United States would be augmented. There are some fears that, even before 11 September, a downswing of this form was starting to emerge and there is a risk that it could prove difficult to halt by means of interest rate reductions.

The concern about rising savings rates also applies in the United Kingdom. Here the household savings ratio is also low by historical standards and a sharp recovery would exert a very depressing influence on the economy. Of the other major economies, Japan is extremely weak and likely to remain so, and the continental European economies are also performing sluggishly. These domestic influences interact with the weak state of world trade. World trade in goods has been falling for much of this year; it usually grows by about 6-7 per cent per annum. This fall is a consequence of domestic weakness being particularly concentrated in electrical and electronic investment goods, which are disproportionately involved in international trade. This is a result of excess capacity in the industries which use such goods as capital equipment.

There are at present no figures which give a useful guide to the economic consequences of the New York raid. The data which cover the period immediately after the attack will give little guidance even into the medium term, and it will not be until data appear for the fourth quarter that it is possible to start to form an impression of the economic effects of the raid.

There are a number of influences which may strengthen or weaken economic activity over and above the downward pressures on consumption and investment described above. Business transactions costs may rise, or people may learn how to do business more efficiently and with less travel. Weaker oil prices may offset the influence of the high prices of the last two years. Firms may increase inventory levels to protect themselves from transport disruption, raising demand in the short term but keeping extra capital tied up in stocks in the longer term.

However, it is not so far clear that beyond the immediate disruption, the New York raid has led to a marked worsening of economic prospects except for some particular industries such as airlines. Stock markets may not be good predictors of economic movements but they do provide an indication of the level of business confidence. …

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