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Economic SYNOPSES short essays and reports on the economic issues of the day 2003 ■ Number 12 Waiting for the Investment Boom? It Might Be a While Kevin L. Kliesen ome economists believe that the 2001 recession ended the Federal Reserve’s measure of manufacturing capacity in the fourth quarter of 2001 (see the inside cover of and real GDP since 1955. Economic theory says that this publication). Since then, real business fixed growth of output (real GDP) will be commensurate with investment (BFI)—expenditures on structures and equipthe growth of capital inputs and, by extension, capacity. ment and software—has declined at a 2.2 percent annual From the first quarter of 1955 to the first quarter of 1994, rate. By contrast, in the first four quarters of the typical growth of manufacturing capacity (3.4 percent per year) recovery, real BFI increases a little more than 8 percent. was nearly identical to the growth of real GDP (3.3 percent One reason why growth of real BFI has remained weak per year). Since 1994, however, growth of manufacturing is that real GDP growth during the recovery has been weaker capacity (4.7 percent) has far outstripped growth of real than normal, which is probably related to the mildness of GDP (3.1 percent). the 2001 recession. Geopolitical uncertainties arising from It is possible that the sharp declines in the prices of the conflict with Iraq and tensions with North Korea may capital goods (particularly high-tech goods) in recent years be another reason why business investment spending has have become more or less permanent, inducing firms to been unusually weak. According to this argument, firms permanently alter the mix of their capital-labor inputs. If have been postponing plans for new capital projects until so, there might not be much of an overhang. But if an overthe risks become clearer. Indeed, in the policy statement hang does exist, we would expect to see relatively slow issued after the March 18 Federal Open Market Committee growth of real BFI until growth in output can create demand meeting, Fed policymakers said that, until these uncertainfor capital beyond the stock already in place. ■ ties abate, they will not be able to “usefully characterize” the risks to the outlook. Another explanation is that a recovery in business investment is being hampered by a capital “overhang.” Real GDP and Manufacturing Capacity According to this view, the economy’s actual capital 1994:Q1 = 100 stock currently exceeds its desired capital stock because 160.0 of the investment boom of the late 1990s, which was 140.0 perhaps exacerbated by the euphoria in the stock market. Some data support this argument: During 120.0 the record-long 1991-2001 expansion, real BFI 100.0 increased 113 percent and real GDP increased by about 39 percent. In contrast, during the 1961-69 80.0 expansion (the second-longest) real BFI increased 95 60.0 percent and real GDP increased by about 51 percent; Capacity 40.0 and in the 1982-90 expansion (the third-longest), real Real GDP BFI increased 42 percent and real GDP increased by 20.0 about 37 percent. 0.0 The strongest rates of business capital spending during the 1991-2001 expansion occurred toward its end. The accompanying chart shows this by plotting Ja n5 Ja 5 nJa 57 nJa 59 nJa 61 nJa 63 nJa 65 nJa 67 nJa 69 nJa 71 nJa 73 n Ja -75 nJa 77 n7 Ja 9 nJa 81 nJa 83 nJa 85 nJa 87 nJa 89 nJa 91 nJa 93 nJa 95 nJa 97 nJa 99 nJa 01 n03 S Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org