Don't Bet on a Quick US Recovery

Whither the US economy? Every piece of good news suggesting that America's recession is about to end is followed by bad news suggesting otherwise. The Federal Reserve Board's current monetary policy reflects this ambiguity: it is neither lowering nor raising interest rates. Instead, it maintains a "neutral" stance. The meanderings of the stock market are a similar indication of uncertainty.

Much of the discussion of the US economy is of little help, for it is focused on the wrong question: when did the recession start and end? Recessions typically are defined by whether GDP has fallen . But what is of real concern is the gap between the economy's potential and its actual performance.

In these terms, the American economy's performance is likely to remain dismal. Increases in measured productivity mean that the economy's potential growth rate is now somewhere between 3.5-4% annually. (There have been changes in the way we correct for price changes, so that what we measure today as 4% actually represents what we used to measure as a substantially smaller number.)

Even when America grows at 0.5%, a gap of 3% in a $10 trillion economy means a loss of output of $300 billion--an enormous amount by any definition. The shortfall, in turn, implies rising unemployment. Given the huge gap, the US will have to grow in excess of its long run potential in order to get back to utilizing its resources fully. Even with the surprisingly strong growth numbers for the first quarter of the year, most forecasters see growth over 2002 as a whole falling short of its long run potential, and by a significant amount, implying that unemployment will rise.