ANN ARBOR—The Sept. 11 attacks may have sent an increasingly vulnerable American economy into its first recession in 10 years, but the slump should be short as economic recovery will get under way by next spring, say University of Michigan economists.

“The tragedy of the terrorist attacks proved to be one-too-many negative shocks, and the already fragile U.S. economic expansion succumbed,” says Saul H. Hymans, U-M professor of economics. “The Commerce Department has estimated a negative growth rate for the 3rd quarter of this year. It’s our judgment that the economy will register another decline in output in the 4th quarter and that this will eventually be deemed a recession. But we’re expecting it to be brief and shallow.”

In their annual two-year forecast of the national economy, Hymans and colleagues Joan P. Crary and Janet C. Wolfe point to two main reasons for their optimism—the Federal Reserve‘s expansionary monetary policy and the U.S. government’s expansionary budgetary policy, including tax cuts and increased spending.

“The Fed has already moved the key Federal Funds Rate down from 6.5 percent to 2 percent this year, and that’s a lot of expansionary monetary policy put into the economic system in a short period of time,” Hymans says. “Skeptics will say that it’s done precious little good so far, but expansionary monetary policy is not demand. It’s a stimulus to demand, and its effects on big-ticket purchases take time to get going. And when the demand for goods and services is already weakening, when confidence is sliding, the incentive to respond to lower interest rates weakens as well.”

The U-M economists say, however, that with an expansionary monetary policy already in place, coupled with the government’s fiscal stimulus of nearly $300 billion in tax cuts and increased federal spending over the next two years, economic activity will begin to pick up by mid-2002.

While their forecast calls for real Gross Domestic Product (GDP) growth of just 0.4 percent overall in 2002 (down from this year’s 1.1 percent and last year’s 4.1 percent), Hymans and colleagues say that the economy should expand much more rapidly by the end of next year and by 2.7 percent in 2003.

Consumer price inflation will remain in check, falling from this year’s rate of 2.9 percent to 1.7 percent in 2002, before edging back up to 3 percent in 2003, they say. The unemployment rate, on the other hand, continues to rise, from 4 percent in 2000 to 4.8 this year to 6.2 percent next year.

“As the rate of unemployment moves up, reduced wage pressures, along with lower energy and raw materials prices, slow the pace of inflation for next year,” Hymans says.

Interest rates, like inflation, will drop again next year before heading up in 2003, according to the forecast. The conventional mortgage rate is expected to fall from last year’s 8.1 percent to 6.9 percent this year and to 6.5 percent in 2002, before edging up to 7.1 percent in 2003. The Aaa corporate bond rate will decline from 7.6 percent in 2000 to 7 percent this year and to 6.7 percent in 2002, and then increase to 7.2 percent the year after. The rate for three-month Treasury bills will drop from last year’s 5.8 percent to 3.4 percent this year and to 1.7 percent next year, before moving back up to 3 percent in 2003.

The U-M forecast (which is based on the Michigan Quarterly Econometric Model of the U.S. Economy and compiled by the U-M Research Seminar in Quantitative Economics) also predicts that:

Real disposable income will rise by 3.7 percent this year, but only by 2.1 percent in 2002 and, due to higher inflation, by just 1.5 percent in 2003.

Annual sales of light vehicles will back off from last year’s record-setting mark of 17.2 million units to a still-strong 16.6 million this year, 15.4 million next year and then move back up to 16.2 million in 2003.

Private housing starts will remain at about 1.58 million units this year, fall to 1.51 million in 2002 and then bounce back to 1.59 million in 2003.

The federal budget surplus will drop sharply from nearly $200 billion in 2000 to $150 billion this year, before running a deficit of a little more than $60 billion in each of the next two years.

Saul H. HymansJoan P. CraryFederal Funds RateResearch Seminar in Quantitative Economics