After the boom and bubble an American slowdown is a necessary corrective which will be hard to wish away

Almost the first economic article I wrote for the Financial Times was in response to queries about whether there would be a US recession. In fact there will always be a US recession on the horizon. Like most other market economies, it is prone to occasional dips; and the most one can do is to be prepared for them and then take action to prevent a downward spiral from developing.

The question of whether the US is already in a recession is largely one of semantics. If a recession is defined as a serious fall of output below trend then the US has been in recession since the last quarter of last year. If one wants to stick to the usual definition of two quarters of falling output, then we will not find out until the coming winter. Early indications suggest that there was no actual output fall in the first quarter.

What is however pretty clear is that major recessions are almost impossible to predict. This emerges just as clearly from modern work on complexity theory, expounded for instance by Paul Ormerod, as from the more orthodox study by empirical Christopher Dow (Major Recessions, OUP 1998).

Dow's book is mostly devoted to the UK; but it does have quite a lot to say about the US and the rest of the world as well. Looking at the last three international recessions in 1973-5, 1979-82 and 1989-93 he finds that in two cases out of three the forecasting performance of the highly esteemed Organisation for Economic Co-operation and development (OECD) was either poor or "a failure". Failures are particularly likely when the recession is due to a shift in confidence or the bursting of a financial bubble, the timing of which is almost unknowable. The same agnosticism applies to predicting the depth and length of any recession.

Gavyn Davies of Goldman Sachs cites a study showing that of 60 national recessions studied in the 1990s only two were predicted a year in advance. In two thirds of the cases they were not even expected in the April of the year in which they were actually happening.

The forecasting record this time round has if anything been worse. Among all the forecasters listed in Consensus Economics this February none was willing to predict a 2001 recession. As Davies says, it seems likely that "the herd-like tendencies of forecasters was being maintained" - or perhaps they were reacting to their wrong-headed recession predictions after the Asian crisis of 1998. More recently the fashion changed to a V-shaped recession with output recovering quickly by the end of this year. But following the gloom produced by the Federal Reserve's explanation of last week's interest rate cut there is no longer such confidence that it will all be quickly over. The upward blip in the latest consumer confidence indicator may be just the kind of temporary correction observed in most business cycle movements.

What can be said with more assurance is that the US needs a recession after a long and excessive boom. In saying this I am doing no more than following the implications of the mainstream analysis espoused for instance by Mervyn King, the Bank of England's deputy governor, and many other central bankers the world over. They have mostly accepted the view that there is something like a normal degree of resource utilisation or employment level above which we are likely to get not merely inflation but accelerating inflation. My main departure from this mainstream is that I do not think that this equilibrium rate -- and therefore the safety limits to the growth rate -- can be estimated even approximately. We do not know how far it has been changed either by labour market reforms or by the so-called revolution in Information Technology.

There are however a good many indications that the US was growing in the last few years at well above these safety limits. It was not merely the stock market: the pressure on the whole economy, including labour markets that had become too high. One indicator has been a recent tendency of some US costs and prices to creep up despite the downturn in activity.

There will always be those who will attribute such inflationary symptoms to special pressures. The fashionable scapegoat at present is a US energy shortage which either appears to come from nowhere or is the delayed reaction to many years of over-regulation. I am reminded of a previous period of upward creep in US inflation which was attributed to the failure of the anchovy harvest off the coast of South America. A more plausible explanation is the delayed action effect of the recent boom.

If we had press button control over the economy, then strictly speaking a recession would not be required. If the trend growth of US output is three per cent, then a few years of two per cent output growth would be sufficient to bring employment and activity back to a rate consistent with low and stable inflation. But such fine-tuning ability does not exist; and in practice a period of pretty depressed output has proved inescapable in the aftermath of a bubble.

There is another way of looking at the matter. In the words of Geoffrey Dicks of the Royal Bank of Scotland: "The US economy has over-invested in productive capacity, particularly in the high-tech sectors... and it will take time before the excess capacity is worked out of the system."

It is of course undesirable to have a secondary depression over and above the slowdown required to squeeze out inflation and reduce the investment overhang; but that is very difficult to achieve in practice. It is bad manners to say "I told you so"; but we would not have got to the present point if the Fed chairman, Alan Greenspan, had not put so much faith in the "New Economy" and its ability to suspend the normal generalisations about business cycles and the economy.

Sad to say, in the UK too there are also symptoms of excessive pressure on resources, although not on the American scale. These have not hitherto set off inflation because of various unexpected events such as the high level of sterling. But many telltale symptoms are there, including the widening of the UK balance of payments deficits and, even more, the emergence of labour shortages in so many areas such as teachers, nurses and doctors.

The market economist would say that these professionals are being paid below the market rate and as usual in such periods the government is trying to deal with the symptoms by ad hoc devices such as limited and selective pay increases, attempts to find cheap accommodation for new employees and appeals to the retired to come back to work. With luck the UK will not need an actual fall in output, but it will probably need a period of growth a good deal lower than the 2½ per cent annual rate still forecast by the Treasury for every year up to 2003.

It is more acceptable now than it used to be to say that the way to minimise recessions is to stop the excessive booms that precede them. This would have been the view of a whole range of economists from Friedrich Hayek to Christopher Dow. But I am not sure whether this is the ultimate in wisdom;, for there is something to be said for the alternative view of Schumpeter that expansionary bursts, followed by periods of "creative destruction", are part of the mechanism of capitalist growth. Anyone who could find a way of protecting the victims of recession without eliminating the corrective effects, would deserve a Nobel Prize several times over.

There is a sufficient degree of recession in the US pipeline to avoid having to advocate a deliberate and corrective slowdown. Exact rates of output performance and inflation or deflation are outside the control of central banks or other authorities. What they can do is to pursue sufficiently expansionary policies to maintain a normal four or five per cent per annum growth of nominal demand, while leaving the market to sort out the division between real growth and the price changes. A panic policy of "cheap money and plenty of it" would (except in Japan) either not work or stimulate a deceptive recovery leading to a greater downturn in later years.