SYNOPSIS: Any upcoming American recession is due to unluckly monetary management. So take it easy.
When Lucy tells Charlie Brown that this time she really is going to let him kick that football, you know what's going to happen. When Wile E. Coyote insists that this time he really is going to catch the Road Runner, you know what's going to happen. And when Japanese officials tell you that this time their nation really is on the road to self-sustaining recovery . . .
A new clutch of indicators confirms that, sure enough, Japan's economy is stalling yet again. Business confidence has gone flat, consumer spending is falling, unemployment is rising, deflation is accelerating. And the Nikkei stock index, which was over 20,000 earlier this year, is now oscillating around 14,000.
For Japan, it's the same old story. But with the U.S. economy going through its roughest patch in years, with panicky analysts and self-interested politicians declaring that the sky is falling, maybe it's worth explaining why our story remains very different.
You see, the general rule — the rule to which Japan is the great exception — is that recessions are not a serious problem for large, modern economies. It's not that the forces that cause recessions have been abolished — though every long expansion brings foolish proclamations of the end of business cycles. Rather, the point is that recessionary tendencies can usually be effectively treated with cheap, over-the-counter medication: cut interest rates a couple of percentage points, provide plenty of liquidity, and call me in the morning.
Or more accurately, call me in six months — or maybe as much as a year. Experience suggests that the Fed can almost always persuade consumers and businesses to spend more by cutting interest rates, but that there's a longish lag between the rate cut and the spending increase. And that's why we're still vulnerable to recessions: now and then the Fed gets behind the curve, failing to recognize a weakening economy until it's too late to prevent a slump. That's what happened in 1990; it may be what's happening now.
Specifically, it's now pretty clear that the Fed went an interest rate hike too far — that while it was right to raise rates in late 1999 and early 2000 to cool off a red-hot economy, that last half-percentage-point increase in May was overkill. Of course, I'm talking with the benefit of hindsight; it seemed like a good idea at the time.
The Fed can and almost surely will reverse that rate hike sometime soon, but the favorable effects of that reversal on spending will take time to materialize. Meanwhile the economy will slow, and could shrink for a couple of quarters, which is the technical definition of a recession. But it should be only a temporary setback — which brings us to the difference between ourselves and Japan.
In Japan, the sky really is falling. Because the interest rate is already very close to zero (it isn't quite zero, because of the Bank of Japan's foolish decision to raise rates back in August — but don't get me started), the slowdown is a sign that the nation's basic economic policies aren't working, and that it is long past time to do something radical. By contrast, our slowdown is just one of those things that happen now and then; it doesn't indicate any fundamental flaws in our economic policy, any need to do anything except cut interest rates.
So what should we be afraid of? The nightmare scenario, which cannot be completely ruled out, is that we will turn out to be more like Japan than we think — that we have just gone through our own version of the infamous "bubble economy," and that we are about to find out that this time cutting interest rates won't do the trick. But at this point that scenario isn't very plausible.
What worries me is not the recession that we may or may not be about to experience; it is the way that our politicians are likely to react to that slowdown. Will they use a mild, easily treated ailment as an excuse to force expensive, dangerous quack remedies down the nation's throat? I am, of course, talking about tax cuts — which won't cure the short-term slowdown, and will undermine our long-run fiscal health.
We don't need to fear a recession; if it does happen, it's something that the Fed can easily cure. What we do need to fear is fear itself: the all-too- likely prospect that the threat of recession will panic us into doing things we will regret for years to come.
Originally published in The New York Times, 12.27.00