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Last Updated:  Friday, 28 March, 2003, 22:25 GMT
US economy faces war jitters

By Steve Schifferes
BBC News Online, Washington

The uncertainty about the war could delay the US economic recovery.

Economists still have widely divergent views about the future course of the US economy, two years since the boom came to a end.

Shattered bridge in Iraq
Reconstruction could be expensive
Even the US central bank, the Federal Reserve, has hedged its bets, saying it cannot decide whether to make future interest rate cuts until the "geopolitical uncertainty" has lifted.

That uncertainty has deterred firms from investing in new projects which create jobs, according to Kevin Hassett, an economist at the American Enterprise Institute (AEI).

Mr Hassett points out that disturbances in the Middle East have often caused US recessions, because of the effect on oil prices.

It is going to take a lot of economic growth to fire up the labour market
Kevin Hassett, AEI economist
He argues that, if the outcome of the war becomes clear in the next few weeks, the US economy will recover relatively quickly - and points to rising stock markets as a sign that the markets have already priced in a victory.

But he admits that, given the degree of layoffs in manufacturing industry, "it is going to take a lot of economic growth to fire up the labour market".

New figures showed that the US economy grew at an annual rate of only 1.4% in the last quarter of 2002, a sharp drop from the 4% in the previous quarter, while unemployment has remained stubbornly high at about 6%, and consumer confidence is at a 10-year low.

Other uncertainties

Another AEI economist, Eric Engen, is less optimistic.

He points out that, comparison to the earlier Gulf War, both monetary and fiscal policy are already poised to stimulate the economy.

Interest rates are at a record low of 1.25%, compared to an average of 8.1% during the 1991 war, and the budget deficit is still lower than the 4.5% of GNP it was in 1991.

But despite a series of tax cuts, and proposals for more, Mr Engen was not sure whether enough was being doing to stimulate the economy.

The latest tax cut proposal is currently the subject of the fierce battle in the US Congress, with Democrats and some moderate Republicans saying that it should be reduced to help pay the cost of the war.

Deeper problems

It is proving a difficult judgement for Congress and economic policy-makers alike to determine how deep-seated the problems of the US economy will be after the war.

The former director of research at the Fed, Michael Prell, says there are still significant weaknesses which preceded the war.

These include the overhang from the stock market boom of the 1990s, which means that many households have seen a sharp drop in their wealth, and the collapse of business investment.

Mr Prell says that the Fed is considering whether to make a dramatic new intervention in the economy, to try and lower long-term interest rates (which determine mortgage rates, for example) by direct purchase of government long-term bonds.

Currently the central bank only sets short-term interest rates, which indirectly influence other longer-term rates.

This would parallel the effort by Japan's central bank, where interest rates are nearly zero and the economy has been in long-term recession.

But Mr Prell said the US economy was not yet threatened with the deflation that has crippled Japan, with the prices of assets like stocks and land falling for many years.

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