Samuelson: The Upside of Recession?

It's increasingly clear that much of our standard economic vocabulary needs revising, supplementing or at least explaining. The customary words we use don't, for one reason or another, fully convey what's actually happening in the real world. Let me illustrate with two basic economic terms: inflation and recession. There are also larger lessons.

Start with inflation. You may have noticed that last week's release of the March consumer price index—the government's main inflation indicator—inspired much optimism. INFLATION FEARS RELAX, headlined The Wall Street Journal. Stock prices jumped on the supposedly good news. But if you actually examined the CPI report, you found that prices in March rose at their highest rate since September 2005 and that, over the past three months, they've increased at a 4.7 percent annual rate. Doesn't sound like retreating inflation, does it?

What explains the discrepancy is "core inflation." That's the CPI minus food and energy prices. In March, core inflation did subside, prompting the upbeat spin. But you might wonder: we must pay for food, gasoline and electricity; why strip them out? The usual answer is: these prices jump around from month to month; they often reverse themselves (oil prices were high in the early 1980s, low in the late 1980s); core inflation better reflects the underlying trend. This is hardly wishful thinking. Since the early 1980s, the two indexes (the CPI and the core CPI) have recorded—despite many monthly differences—virtually identical increases.

But suppose that this relationship is now breaking down. We all know about oil. Prices are about $60 a barrel. They seem unlikely to return to $28, the 2000 level. The real surprise involves food prices. In the past three months, they've risen at a 7 percent annual rate. We may be seeing the first adverse effects of the ethanol boom. Corn is the main feed grain for poultry, beef and pork. Corn is also the main raw material for ethanol, an alternate fuel for gasoline. Competition for grain has pushed up corn prices to about $3.50 or more a bushel, almost double a typical level. High feed prices have discouraged meat producers from expanding. The resulting tight meat supplies raise retail prices.

"Poultry is the best example," says economist Tom Jackson of Global Insight. "In the past 40 years, we almost never have year-to-year decreases in production. In the past few months, we've seen production go down." In March, the decline was 4 percent from a year earlier.

So the government's lavish subsidies for corn-based ethanol are worsening inflation, perhaps permanently. Coupled with precarious global oil supplies—posing a constant threat of higher energy prices—that may make core inflation a less useful indicator. Ups and downs may no longer cancel each other. Inevitably, these developments also pose policy questions. Considering ethanol's tiny contribution to our motor-fuel supply (about 4 percent), is the program worthwhile? Or is it just a giveaway to corn farmers?

Now switch to recession. Since 1982, there have been only two (1990-91 and 2001). That's good. In the previous 13 years, there had been four (1969, 1973-75, 1980 and 1981-82). Almost everyone dreads another one. We've been conditioned to think of recessions as automatically undesirable. The labeling is simplistic.

Hardly anyone likes what happens in a recession. Unemployment rises, production falls; profits weaken; the stock market retreats. But the obvious drawbacks blind us to collateral benefits. Downturns check inflation—it's harder to increase wages and prices—and low inflation has proved critical to long-term prosperity. Downturns also punish and deter wasteful speculation. When people begin to believe that an economic boom won't ever end, they start to take foolish risks. Partly, that explains the high-tech and stock bubbles of the late 1990s and, possibly, the recent housing bubble.

Some sort of a recession might also reduce the gargantuan U.S. trade deficit, $836 billion in 2006 (just counting goods). Almost everyone believes that the U.S. and world economies would be healthier if Americans consumed less, imported less, saved more and exported more. The corollary is that Europe, Japan, China and the rest of Asia would rely more on domestic spending—their own citizens buying more—and less on exports.

Ideally, this massive switch would occur silently and smoothly. Realistically, the transition might not be so placid. A slowdown in Americans' appetite for imports (cars, computers, clothes) would involve weaker overall consumer spending, about 70 percent of the U.S. economy. Such a slowdown might also be needed to persuade other countries to stimulate their domestic spending.

Almost no one wishes for a recession, but the consequences might not be all bad. The larger lessons here involve perceptions. Our regular vocabulary often fails to describe the complexities of a changing economy. We must be alert to new possibilities. Things are not always what they seem.