FROM THE OFFICE OF PUBLIC AFFAIRS

Three months ago, a strong rebound in the economy in the first quarter seemed unlikely. The economy appeared to be moving gradually onto a recovery path but most forecasts projected a sluggish first half of this year. A payback from the auto-related surge in consumer spending in the fourth quarter was thought to be a virtual certainty, and final sales were expected to contract. Most forecasts postponed robust growth until mid-year.

Instead, the economy appears to be sprinting out of the tenth post-World War II recession. The Bureau of Economic Analysis reported last week that real GDP grew at a 5.8 percent annual rate in the first quarter - a marked improvement over growth of less than 1 percent expected by the consensus forecast at the beginning of the year. A slowdown in the rate of inventory liquidation added 3 percentage points to real growth. But consumption and residential investment - sectors thought last year to have little room for further gains - also contributed another 3 percentage points to growth. A further lift was provided by Federal defense spending and by spending of State and local governments. Offsetting part of the strength in this broadly favorable report were a fifth straight decline in business fixed investment and a surge in imports.

Few forecasters are now looking for the economy to sag again in the immediate future, and it appears that the recession is behind us. Barring unusual events, the past recession will have been alone among those in the postwar history to result in only one quarter of real GDP decline and that loss will amount to a narrow 0.3 percent - far less than the 2.2 percent average.

This leaves us with the question: Why was this downturn less severe than others? Certainly macroeconomic policy made an important contribution. The Federal Reserve began to ease monetary policy two months before the NBER-designated recession began and continued to lower short-term rates throughout the summer and fall. The President signed his tax cut package into law in June, putting $40 billion back into consumer pockets in the second half of 2001 and lowering future marginal tax rates. Thus, both monetary and fiscal policies were well timed to cushion the depth and shorten the duration of the recession.

Good policy timing is only one part of the answer, however. The efficiency of our capital markets also played an important role in limiting the depth and apparent duration of the recession. For example, as the economy weakened in 2001, long term bond yields and mortgage interest rates fell, especially after September 11^th, to near record lows. This set off a wave of mortgage refinancing which, by some estimates, put close to $80 billion in homeowners' pockets. The flexibility of our labor markets was also essential, especially the extent to which employers could better match hours worked with the demand for final output. Even though the 1.9-percentage point rise in unemployment in 2001 was less than in any previous downturn, the Administration is very concerned about the rise in unemployment that did occur. That is why it was important in March for the Congress to pass and for the President to sign legislation that provides incentives for firms to invest, which should give the economy a boost needed to bring down the unemployment rate later in the year.

Economists will evaluate the relative contributions of these factors on improved economic performance for some time. But the aggregate effect of all these contributions can be clearly seen in the behavior of productivity. Productivity typically declines in recessions. Yet growth of nonfarm productivity of labor over the four quarters of last year was a very respectable 2.0 percent, capped by a 5.2 percent jump in the fourth quarter. An even larger gain is likely in the first quarter. Output in the nonfarm sector surged at a 6-1/2 percent annual rate, while workhours appear to have declined, suggesting the likelihood that productivity growth will exceed 6-1/2 percent.

Looking ahead, it seems unlikely that we will repeat the first-quarter GDP surge in the coming months. Instead, like most private forecasters, we expect a more moderate, but sustainable rate of GDP growth. Inventory rebuilding is likely to contribute less to overall growth, while business investment is likely to contribute more. Although fixed business investment fell in the first quarter, there has been a decided slowing in the investment downdraft. Even more encouraging are the recent survey results from the National Association for Business Economics, showing that 48 percent of respondents expect capital spending in their own companies to be rising over the next 12 months, and only 18 percent expect capital budgets to shrink. As the expansion gains steam, we expect the unemployment rate to fall.

On the inflation front, we are looking for a continued favorable performance in the near future - one of the benefits of strong productivity growth. Of course, we have recently been reminded that oil price increases can have an effect on the economy, but the consensus is that all but the most severe shocks would not be large enough to derail activity. Overall the fundamentals in the economy appear to be very sound and set the stage for continued expansion.