FROM THE OFFICE OF PUBLIC AFFAIRS

A great deal has happened in the three months since we last met. In late November, the National Bureau of Economic Research (NBER) officially confirmed that the economy was in recession. More recently, however, we have begun to get increasingly strong signals of a likely bottoming out. A sense of incipient recovery is emerging in surveys of both consumers and businesses.

The improved tone to recent economic data is a welcome development after the initial post-September 11 readings. More than 800,000 jobs were lost in October and November, the steepest two-month drop since the early 1980s both in volume and percentage terms. New orders for nondefense capital goods excluding aircraft, a leading indicator of business investment spending, plunged by 10 percent in September. That was the sharpest fall since 1989 and a further blow to the already-fragile investment sector. The impact of the attacks appeared likely to throw the economy seriously off course.

Instead, the economy regained its footing rather smoothly and appears poised to resume growth in the current quarter. Fourth-quarter real GDP estimates will be released by the Commerce Department tomorrow. The latest consensus forecast predicts that real GDP will have contracted by an annual rate in the neighborhood of 1-1/4 percent. Should this prediction come to pass and growth resumes in the first quarter as expected, the entire GDP loss during the latest recession will have been a mere 0.6 percent. This would be much less than the average decline of 2.2 percent associated with the previous nine post-World War II recessions and would be matched only by the contraction of 1970 as the mildest on record.

The source of this relatively modest decline can be found in the behavior of households. Benefiting from tax cuts, low mortgage and auto finance rates, the lift to real incomes from falling energy prices, and a competitive pricing environment generally, both personal consumption and residential investment have outperformed typical recession patterns.

• Real personal consumption expenditures seem quite likely to have gone throughout the entire recession without turning negative on a quarterly basis and in the fourth quarter are expected to have increased by a rapid 4 to 5 percent annual rate. That consumption does not decline in a recession is not typical but also not unprecedented. It also occurred in 1970. Still, this strength is surprising after the spending boom of the late 1990s led to the widespread assessment that consumption had little room for further growth.
• Also atypical for a recession has been continued growth in residential investment, which in the past has always fallen early in a downturn. While a decline is likely in the fourth quarter, the overall strength has been another important pillar supporting real GDP.
• The burst in consumption in the fourth quarter, along with a possible increase in investment in equipment for the first time in more than a year, could propel real final sales forward at a fairly healthy pace in tomorrow's GDP report. More than offsetting that growth, however, is an expected record rate of inventory liquidation - a vital pre-requisite for a revival in production. Thus, even a negative headline GDP number would obscure a healthy composition of developments - strong demand and lean inventories - that set the stage for recovery. While it is too soon to declare the recession over, positive signs are becoming more abundant.
• Initial claims for unemployment insurance benefits have fallen by about 20 percent on a four-week average basis from a peak in late October to the lowest point since the beginning of September. In 1991, the economy was 3-1/2 months into recovery before such a drop was achieved.
• Consumer attitudes have risen back to levels of last January.
• The average factory workweek jumped four-tenths of an hour in December and overtime hours rose two-tenths, likely signaling an imminent need for additional workers.
• New orders for nondefense capital goods have risen in each of the latest two months and high-tech categories, such as computers, are beginning to grow.
• The Conference Board's composite index of leading indicators, which includes the statistics cited above, has now risen three months in a row - including a gain in December which was the strongest in nearly 6 years.
• And finally, a survey by the National Association for Business Economics (NABE) noted that demand revived at businesses of most of its members in the fourth quarter. Surveys of purchasing managers are similarly upbeat.

Despite reasonably compelling evidence that an economic rebound is near, less certainty can be attached to its likely profile and strength. Most current forecasts place real growth for the year following the GDP trough in the 2-1/2 to 3-percent range. While this is substantially less than the 5-1/2 percent averaged in the first year of growth following other post-war downturns, a conservative estimate may be warranted.

• A portion of consumption and residential investment was surely pulled forward by the recent favorable interest rates and auto incentives, perhaps limiting scope for further large gains.
• In addition, business willingness to expand both payrolls and investment is likely to hinge heavily on the restoration of corporate profits. In the current environment of little pricing power, that may prove a difficult challenge.