FROM THE OFFICE OF PUBLIC AFFAIRS

The outlook for the economy has changed considerably since we last met. Three months ago, activity was slowing but improvement in the second half of the year was widely anticipated. The Blue Chip consensus forecast of some 50 private-sector economists collected just after our last meeting expected real growth approaching 3 percent by the fourth quarter.

September 11 marks a watershed in the change of opinion. Not only did the terrorist attacks of that day exact an enormous human toll but they tipped further off balance an economy already treading a difficult course. By early October, Blue Chip forecasters sliced their real growth estimate for the second half of the year from a pre-attack, early September figure of approximately plus 2 percent annual rate to a negative 1 percent pace, a huge swing in just a month's time.

The attacks added significant stress to an already sluggish economy. For industries in difficulty before September 11, such as airlines and lodging, the assault no doubt hastened adjustments. As a result, it now seems that some decline in real GDP is quite likely.

Whether the ultimate drop is in fact deep enough, sufficiently widely dispersed, and of long enough duration to qualify as a recession will eventually be determined by the National Bureau of Economic Research (NBER), the official arbiter of business cycle dating. The NBER has recently noted that of the four coincident indicators on which the Bureau relies most heavily, so far only industrial production and business sales are clearly signaling recession and those are heavily influenced by the weakened manufacturing sector. Of the other two coincident measures, personal income continues to grow and employment has fallen by only 0.4 percent, much less than the 1.6 percent drop associated with the 1990-91 recession or the 3.0 percent decline of the 1981-82 period.

Employment detail shows, however, that weakness is becoming more pervasive. The private service-producing sector lost 117,000 jobs during the third quarter, the first such decline since 1991.

Other indicators of labor market activity suggest further deterioration is likely. Initial claims for state unemployment insurance benefits - a leading indicator of economic activity - hit a ten-and-a-half year high in the latest week. The state insured unemployment rate rose 0.2 percentage point from the September to the October employment survey week and at 2.8 percent is at the highest point since 1993. This increase represented the addition of a huge 378,000 workers to the state insured unemployment rolls since September and points to significant upward pressure on the more comprehensive national unemployment rate for October to be released at the end of this week. It should be kept in mind that because the September national labor market reading was taken early in the month, October's results will be the first to capture the effect of the attacks on employment.

While labor market data may still hold some bad news, it is also possible that some statistics may be exaggerating recent declines. The disruptive - and therefore temporary - effects of the attacks may be included on top of genuine economic weakness. For instance, retail sales fell by 2.4 percent in September - the largest monthly decline in a decade and a half. Yet, such a drop should hardly come as a surprise in a month when retail enterprises in many cities were shut down unexpectedly for at least a day - and those at airports for several days. In addition, there was a substantial "CNN effect," with consumers glued to their TV's rather than out shopping.

Developments in the consumer sector since September are somewhat more promising. Weekly chain store data indicate that the immediate post-attack free-fall appears to have been halted. In addition, estimates coming from the auto industry suggest that motor vehicle sales for October could be the strongest of the year. The lure of zero-percent financing has boosted results but the near-record sales pace many expect would certainly not be characteristic of a serious recession.

While it is easy to emphasize the negatives most immediately in our field of vision, a longer-term perspective helps explain why the consumer is not in full retreat.

• Despite a rise of 1 full percentage point over the past year, the unemployment rate remains below 5 percent and is still 0.6 percentage point lower than at the start of the 1990-91 recession.
• Consumer price inflation, near 5 percent at the start of the last recession, now stands at only 2-3/4 percent, an important factor in keeping personal income growing in real terms.
• Even the prolonged decline in the stock market has still left the S&P500 up at nearly a 14 percent annual rate since the end of 1994, allowing many households to feel their asset positions are relatively secure.
• Finally, a wave of mortgage refinancings in response to 6-1/2 percent mortgage interest rates has added cash to household budgets.

The position of the consumer sector is a positive for the economy. The monetary and fiscal stimulus already either in the pipeline or in preparation offer further support. But the possibility that risks may still lie ahead cannot be discounted.

Applications for mortgages for home purchase have been falling, pointing to the likelihood of reductions in residential construction. New orders for investment goods plunged in September, a sign that the investment cutbacks may continue into the next few months. And already-falling corporate profits have come under pressure from reduced pricing power and additional security costs.

That is the summary of recent economic developments and the near-term outlook.