By Neil Irwin
Washington Post Staff Writer
Tuesday, December 2, 2008
The U.S. economy entered a recession one year ago, a group of the nation's leading economists said yesterday, and new evidence that the downturn will be deep and prolonged sent the stock market plummeting.
The Dow Jones industrial average dropped 7.7 percent, or 680 points, on bleak economic reports, including one that showed that manufacturing activity in November was weaker than it had been since 1982. Investors plowed money into U.S. Treasury bonds, seen as safe havens in uncertain times.
Meanwhile, Federal Reserve Chairman Ben S. Bernanke indicated in a speech that he is inclined to keep cutting interest rates and using novel approaches to try to contain damage from the downturn. Treasury Secretary Henry M. Paulson Jr. said he is designing new programs to strengthen the financial system.
The pledges to take aggressive action come as the recession appears to be getting worse.
"Right now, we still seem to be in an accelerating downslope of this economic cycle," said Ethan Harris, head of U.S. economic research at Barclays Capital.
Economists with the nonprofit National Bureau of Economic Research announced yesterday that that cycle began in December 2007, long before the health of the financial system deteriorated this spring. The group's Business Cycle Dating Committee, made up of seven academic economists, determines when a recession begins and ends and is considered the arbiter of such things.
The committee defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators."
Assuming that the country is still in a recession -- the committee makes its announcements on a delayed basis, after examining definitive economic data -- the downturn will be the longest since at least the 1981-82 recession, which lasted 16 months. The current recession, at 12 months and counting, is already longer than the eight-month downturns the nation experienced in 1990-91 and 2001.
There is little doubt that the country is still in a recession, said economists not associated with the NBER. Economic data in recent months suggest that conditions are getting worse, not better.
Bernanke himself said yesterday that "economic activity appears to have downshifted further in the wake" of the deepening financial crisis in September and that "even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time."
Most economists have considered it a foregone conclusion that a recession has been underway for months but have debated when it began. Employers started shrinking their payrolls at the end of last year, and many other measures of economic activity worsened then. But gross domestic product grew in the first six months of the year, and job losses have accelerated since August.
The business-cycle committee, chaired by Stanford University economist Robert Hall, relied heavily on employment data in making its call. Job growth turned negative in December, but for the first several months of the year, the economy was declining only modestly by most measures. It was only after problems in financial markets intensified in September that economic conditions deteriorated significantly.
"It's similar to back in 2001, when the economy was declining for a while, but it was not until the 9/11 attacks that there was a freefall in activity," said Mark Vitner, a senior economist at Wachovia. "That caused a slowdown to become a recession. That's why the committee waits so long to make a call, so it has as much data as possible to work with."
The formal designation of a recession was not the only source of economic gloom yesterday. The Institute for Supply Management's survey showed that manufacturing activity was weaker in November than it had been since 1982, when the nation experienced its worst downturn since World War II. Similar surveys yesterday showed that the manufacturing slump has extended to Europe and China. In a separate report, construction spending in the United States fell 1.2 percent in October, the Commerce Department said, worse than expected.
On Wall Street, demand for U.S. Treasury bonds was so high that investors were willing to accept extraordinarily low interest rates. The yield on a 10-year bond was 2.73 percent -- a record low -- meaning investors were willing to lend the U.S. government money at that rate for a decade.
Losses on equity markets spread to Asia. Japan's benchmark Nikkei average fell more than 5 percent in early trading today.
Top economic policymakers said they would use all possible measures to combat the slump. Bernanke, speaking to the Greater Austin Chamber of Commerce, said it would be "feasible" for the Fed to continue cutting the short-term interest rate it controls but noted that it could not go much lower. The federal funds rate stands at 1 percent, and analysts widely expect it to be cut at the Fed's policymaking meeting in two weeks.
Because the Fed cannot lower rates below zero, Bernanke indicated that he would continue trying to stimulate the economy through other means -- particularly by expanding the bank's intervention in private markets. He said the Fed, for example, could buy long-term Treasury securities or debt issued by the mortgage-finance companies Fannie Mae and Freddie Mac.
Last week, the Fed announced that it would deploy $500 billion to buy mortgage securities backed by the two companies and $100 billion of their debt. Those moves have already helped lower mortgage rates, thus stimulating the economy.
Bernanke also said that the Fed "can provide backstop liquidity not only to financial institutions, but directly to certain financial markets," referring to a recent program that was launched to support the commercial-paper market.
The Fed is already, in effect, lending money directly to companies that fund their operations with commercial paper, a form of short-term debt. Last week, it announced a similar action to effectively lend money for credit cards, auto loans and other consumer debt.
"He's confirming what they've already been doing," said Harris, the Barclays economist, "which is a dramatic expansion of their balance sheet, and creating direct lending programs that circumvent the banking system."
Although Bernanke left the door open to further expansions of direct Fed lending, he also signaled that the central bank would be aggressive in removing such programs to prevent inflation. "To avoid inflation in the long run and allow short-term interest rates ultimately to return to normal levels, the Fed's balance sheet will have to be brought back to a more sustainable level," he said.
Fed policymakers will ensure that this is done in a timely way, he said. "However," he added, "that is an issue for the future; for now, the goal of policy must be to support financial markets and the economy."
In Washington, Paulson indicated that there could be new programs before he leaves office in seven weeks.
"We are actively engaged in developing additional programs to strengthen our financial system so that lending flows into our economy," the Treasury secretary said in a speech to the Fortune 500 Forum. "When these programs are ready for implementation, we will discuss them with the Congress and the next administration.