The real answer is that no one knows, and I mean this very literally. Usually, the NBER (National Bureau of Economic Research) looks at four indicators to decide whether or not we are in a recession: unemployment, industrial production, trade and sales, and personal income. However, in this recession they have all pointed in different directions, so there was some controversy about whether we are even in a recession.

That said, here's some speculation. During the dot-com boom, there was wide expectation that computerization and networking would result in rapid productivity growth. Since productivity growth is the only way to increase production without either increasing labor or capitalization levels, this translated to an expectation of fast profit growth, and hence higher share prices. However, while it turns out to be true that productivity was growing very quickly, it did so by increasing how competitive markets became. This held down profit growth, and meant that productivity growth raised personal incomes instead of corporate profits. So a lot of business plans turned out to be wrong, and you had the stock market crash and a surge in unemployment in 2001. But that's last year's news.

Unemployment is apparently staying high currently because the Bush administration and Congress extended unemployment benefits to 52 weeks from 26 weeks. With longer benefits, people can spend longer looking for work, which keeps the unemployment levels high. (The tradeoff is that if you can search longer, you typically end up at a better job.) It's not all roses, though. It's not clear what effect the numerous reports of accounting fraud we've seen are going to have: it depends on how widespread the problem is and what reforms are undertaken to fix the problems we've seen. I think the simplest effective fix there will be to report stock options as compensation. I thought this was a bad idea before, because it's a good idea to align shareholder and manager interests. But I've changed my mind: it creates too strong a perverse incentive for the corporate officers to fudge the numbers to keep their options from going underwater. Better still -- though not one I expect -- would be for the stock exchanges that list a stock to hire the auditors, rather than the corporation.


 Yr/qtr    GDP  Unemploy.   S&P 500  Productivity  
-------  -----  ---------  --------  ------------
2000 01   5.3%       4.0%     0.29%    \t     0.0%  
2000 02   6.6%       4.0%    10.70%    \t     6.7%
2000 03   5.8%       4.1%   -14.69%    \t     1.6%
2000 04   4.2%       4.0%     5.85%    \t     2.3%
2001 01   3.6%       4.2%   -11.84%    \t    -0.1%
2001 02   1.8%       4.5%    -7.84%    \t     2.1%
2001 03   0.5%       4.8%    -0.97%    \t     1.1%
2001 04   0.7%       5.6%    -2.87%    \t     5.5%
2002 01   2.3%       5.6%     2.45%    \t     8.4%