Republican cuts would cost 700,000 jobs

In the March 1, 2009 article "Republican cuts would cost 700,000 jobs: Report," Zachary Roth reports that Mark Zandi, a prominent economic forecaster, suggests that the budget cuts proposed by Republicans will slow economic growth and reduce the number of jobs. The logic is that a primary determinant of the number of jobs is the overall demand for newly produced goods and services, which economists refer to as aggregate demand (AD). And a key source of demand, especially in economic downturns and their recoveries, is government purchases. Less government spending translates into less aggregate demand and fewer jobs.

According to Roth:

A new report by a leading economic forecaster finds that budget cuts passed by the House of Representatives would cost 700,000 jobs over the next two years if enacted.

"The House Republicans' proposal would reduce 2011 real GDP growth by 0.5% and 2012 growth by 0.2%," according to the study, by Moody's Analytics chief economist Mark Zandi. "This would mean some 400,000 fewer jobs created by the end of 2011 and 700,000 fewer jobs by the end of 2012."

Zandi is no left-wing ideologue. He was on the economic team for Sen. John McCain's 2008 presidential campaign, and has advised members of both political parties. His findings point in the same direction as those of an even more pessimistic Goldman Sachs report, leaked last week, which concluded that the proposed cuts would reduce second- and third-quarter growth in 2010 by 1.5 to 2 percentage points.

Although the economy has been growing of late, it's not adding jobs fast enough to start significantly bringing down the unemployment rate, which stands at 9 percent. Writes Zandi: "Imposing additional government spending cuts before this has happened, as House Republicans want, would be taking an unnecessary chance with the recovery."

America already faces a jobs crisis, having lost around 8 million jobs since the start of the recession in late 2007.

Zandi argues that the government does need to cut spending--but that it should wait to do so until unemployment has come down further. "Significant government spending restraint is vital," he writes, "but given the economy's halting recovery, it would be counterproductive for that restraint to begin until the U.S. is creating enough jobs to lower the unemployment rate."

The House proposal cuts spending by around $60 billion from 2010 levels. The Senate and the Obama administration will weigh in before any cuts become law.

Consumer confidence improves slightly in November

In the November 24, 2009 article "Consumer confidence improves slightly in November," Associated Press retail writer Anne D'Innocenzio explains that economists look to consumers to reviving the lagging U.S. economy because their purchases account for about 70% of overall demand for newly produced goods and services:

NEW YORK – Americans' confidence in the economy improved slightly in November from October, but shoppers remain gloomy heading into the traditional start of the holiday shopping season amid a weak job market, according to a monthly survey.

The Conference Board, based in New York, said Tuesday that its Consumer Confidence Index edged up to 49.5, up from a revised reading of 48.7 in October. Economists surveyed by Thomson Reuters expected a reading of 47.7.

The index, which hit a historic low of 25.3 in February, had enjoyed a three-month climb from March through May, fueled by signs that the economy might be stabilizing. The road has been bumpier since June as rising unemployment has taken a toll on consumers. A reading above 90 means the economy is on solid footing. Above 100 signals strong growth.

One component of the Conference Board's confidence gauge that measures consumers' assessment of the current economy fell slightly to 21.0, compared with 21.1 in October. The other that measures shoppers' outlook over the next six months increased slightly to 68.5 from 67.0 in October.

"Income expectations remain very pessimistic and consumers are entering the holiday season in a very frugal mood," said Lynn Franco, director of The Conference Board Consumer Research Center in a statement.

Economists watch consumer sentiment because spending on goods and services for consumers accounts for about 70 percent of U.S. economic activity by federal measures.

While the reading doesn't always predict short-term spending, it does serve as a barometer of spending levels over time, especially for big-ticket items.

Retail sales showed some signs of life in September and October, with major merchants collectively posting two consecutive monthly gains in sales in more than a year, according to the International Council of Shopping Centers-Goldman Sachs Index.

That followed more than a year of declines as shoppers shut their wallets tight. But business still remains weak and shoppers are still focused on necessities like socks, coats and underwear.

Experts say depressed spending is likely to persist for several years amid stubbornly high unemployment. The unemployment rate is now at 10.2 percent, the highest in 26 years, and 15.7 million Americans out of work. Meanwhile, the housing market has showed signs of improvement, but overall the sector is still tepid.

A housing report announced Tuesday showed home prices improved for the fourth straight month in September, though only in 11 out of 20 major metropolitan areas.

The Standard & Poor's/Case-Shiller home price index, which tracks prices in 20 major metropolitan markets, rose 0.3 percent in September.

The Conference Board's confidence survey, which is based on a representative sample of 5,000 U.S households, showed that shoppers' assessement of the job market remains weak. The cutoff for the preliminary results wsa Nov. 17. Those claiming jobs are "hard to get" increased to 49.8 percent from 49.4 percent, while those claiming jobs are "plentiful" decreased to 3.2 percent from 3.5 percent.

Consumers' short-term outlook improved slightly in November, but that's because those expecting conditions to worsen decreased to 15.1 percent from 18.2 percent, Franco said. The percentage of consumers expecting an improvement in business conditions over the next six months decreased slightly to 20.0 percent from 20.8 percent.

Those anticipating more jobs in the months ahead declined to 15.2 percent from 16.8 percent. But those expecting fewer jobs declined to 23.1 perent from 26.1 percent. The proportion of consumers expecting an increase in their incomes decreased to 10.0 percent from 10.7 percent.

Consumer Spending Likely To Rise In Q3, But Outlook Cloudy

In the September 17, 2009 article "Consumer Spending Likely To Rise In Q3, But Outlook Cloudy," Scott Stoddard reports that government macroeconomic stimulus policies have increased consumer spending and aggregate demand:

Gains in retail sales, home purchases and household wealth are bolstering views that consumer spending has stabilized after weighing on the economy for a year. But analysts warn that outlays could remain tepid for two years, making for a sluggish recovery.

Consumer spending, which accounts for about 70% of GDP, is set to rebound sharply in Q3 thanks mainly to government tax breaks and incentives, such as the Cash for Clunkers program that fueled auto sales. Experts say the economy could grow 3% or more in July-September after shrinking for four straight quarters.

But as federal stimulus spending wanes, the economy may struggle to maintain momentum as Americans are pressured by debt, tight credit and a weak labor market.

"The big concern for me is 2011," said Scott Brown, chief economist at Raymond James. "Hopefully, the private sector will be back on its feet and moving forward to offset the decreasing fiscal stimulus."

In a positive sign, household wealth rose by $2 trillion in Q2 to $53.1 trillion as stock values rebounded, the Federal Reserve said Thursday. It was the first gain since Q3 2007, when wealth peaked at $65.3 trillion.

"We're beginning to turn the tide," Richard DeKaser, chief economist at Woodley Park Research, said before the report. "But we have some ways to go before we completely recoup the losses of the last few years."

Housing starts and building permits also rose in August on strong demand for multifamily units, the Commerce Department said.

Adding to signs that the recession has ended, the Philadelphia Fed's index of business sentiment jumped 9.9 points in September to 14.1, a two-year high.

Economists caution, however, that the U.S. could experience a double-dip recession if unemployment and tight credit force consumers to curb spending.

Households trimmed debt at a 1.7% annual rate in Q2 while consumer credit plunged at a 6.5% rate, the Fed said, as Americans focused on paring debt and rebuilding savings.

The number of workers filing new claims for unemployment benefits dropped by 12,000 last week to 545,000, the lowest since early July, the Labor Department said Thursday.

But the number of people still on jobless rolls after an initial week of aid rose by 129,000 in the week ended Sept. 5 to 6.23 million, indicating that employers remain reluctant to hire. The jobless rate, already at a 26-year high of 9.7%, is expected to top 10%.

"We need to see income growth go back up and people need to feel more certain about their job prospects" before they feel confident enough to boost spending, said Mark Vitner, an economist at Wells Fargo Investments.

Big-ticket goods such as autos will probably bear the brunt of consumer cutbacks, analysts said.

A Bloomberg News survey on Thursday showed that almost a third of U.S. households plan to trim spending while 58% expect no change amid concern about the economy over the next six months. Just 8% of households plan to increase spending, the survey showed.

Vitner said that a double-dip recession was unlikely but that economic growth would likely taper off next year after the expiration of stimulus measures such as the $8,000 first-time homebuyer tax credit and Federal Reserve efforts to keep mortgage rates low.

"We're likely to see a relatively sluggish recovery," he said.

Sale of big-ticket items soar, bolstering economy

As explained in an earlier post that compares macroeconomic policy to the story of Goldilocks and the Three Bears, the key to managing the economy is influencing overall spending on newly produced goods and services. The largest component of this aggregate demand (AD) is consumption spending. According to the August 26, 2009 article "Sale of big-ticket items soar, bolstering economy," Associated Press business writer Alan Zibel reports that spending increased significantly in July, which may indicate that the current economic recession is close to an end:

Consumers and business spend big in July, sending home, equipment and car sales soaring

WASHINGTON (AP) -- Consumers and businesses went on a big-ticket spending spree in July, sending home, car and equipment sales soaring by the largest amount in years.

The sales, detailed in two government reports Wednesday, confirmed a subtle but marked shift in confidence about the economy. New home sales jumped almost 10 percent from June, while orders for long-lasting goods like appliances, planes and computers rose nearly 5 percent in July, the third increase in the past four months.

"It looks like we've hit bottom and we're now slowly trying to dig our way out," said Nigel Gault, chief U.S. economist at IHS Global Insight.

Still, it remains unclear whether the growth can be sustained. Though the increases in housing sales and manufacturing last month were dramatic, they came from extraordinarily low levels and were fueled by temporary government programs like Cash for Clunkers and tax credits for home sales.

Most economists now agree the recession that began in December 2007 has ended or is ending. Some say the economy is poised to grow strongly in the July-September quarter, but will probably show weaker growth after government stimulus spending tapers off.

Sales of new homes surged to a seasonally adjusted pace of 433,000 in July from 395,000 in June, the Commerce Department said, providing another sign the housing market is bouncing back from the historic bottom reached early this year. Driven by falling prices, the fourth-straight monthly increase was greater than expected. Sales haven't risen so dramatically since February 2005.

While sales are still off nearly 70 percent from the frenzied peak four years ago, they are still up more than 30 percent from the bottom in January -- a big relief after a long and painful decline.

"We can stop worrying about the housing market and start playing closer attention to other issues, such as when credit will start flowing more freely," Joel Naroff, chief economist at Naroff Economic Advisors, wrote in a note to clients.

The improved outlook could help further boost the economy. As home sales rise, builders will gradually need to hire more workers to pour foundations and pave roads, reversing the trend that saw 1.4 million industry jobs shed since the recession began.

"These are crucial elements of a sustainable recovery," David Resler, chief economist at Nomura Securities, wrote in a research note.

Construction job losses have slowed recently, with 76,000 lost in July, about half January's level.

Much like Cash for Clunkers, homebuyers are rushing to take advantage of a federal tax credit that covers 10 percent of the home price, or up to $8,000, for first-time owners. Home sales must be completed by the end of November for buyers to qualify.

And there are many deals to be had: The median sales price of $210,100 was 11.5 percent lower than levels a year ago, but still up from March's low of $205,100.

Builders and real estate agents fear that the end of the tax credit could reverse the upward trend. Sen. Johnny Isakson, R-Ga., has introduced legislation to extend it for another year, raise it to $15,000 and make it available to all buyers.

If that doesn't happen, Isakson said in an interview, "the little improvement we have from awful to terrible will go away and it will go back to awful again."

Some builders are already seeing sales dip.

At A.F. Sterling Homes in Tucson, Ariz., sales fell in July because the builder said it couldn't guarantee the homes could be finished in time to qualify, said Randy Agron, the company's vice president.

"The real estate market is really a fragile thing," he said. "It's not the right time to take (the tax credit) away."

There were 271,000 new homes for sale at the end of July, down more than 3 percent from May. At the current sales pace, that represents 7.5 months of supply, which means builders have scaled back construction to the point where supply and demand are coming into balance.

A similar trend is happening in other industries across the economy.

Orders for transportation equipment, including cars, car parts and airplanes rose more than 18 percent, helping to drive the durable goods data.

A huge jump in aircraft orders accounted for most of that gain. Also, auto production improved last month as General Motors and Chrysler reopened many plants that were shut in May and June while the companies restructured and emerged from bankruptcy protection.

The Economic Lesson of Goldilocks and the Three Bears: Overall Spending Should Not Be Too Large or Too Small

One of the most significant determinants of a country's economic well-being is overall spending on newly produced goods and services, which economists call aggregate demand (AD). Overall spending needs to be large enough to keep unemployment low, yet small enough to keep inflation low. Aggregate demand should not be too large or too small. Like the porridge, chair, and bed in the story of Goldilocks and the Three Bears, an economy's overall spending needs to be "just right."

Insufficient overall spending causes economic recessions and depressions. As aggregate demand declines, businesses sell fewer goods and services. Inventories of unsold products increase, leading to fewer factory orders for newly produced goods. Businesses lay off workers as production and sales decline. The unemployment rate increases as more workers become unemployed. The rate of economic growth, which is measured as the percentage change in output, decreases.

Excessive overall spending causes inflation, which is a general increase in the price level. During periods of inflation, the prices of most goods and services are rising. Inflation is similar to the rising prices of scalped tickets to a popular concert or sporting event. If a society tries to buy more goods and services than the economy is able to produce, the prices of most things will increase.

If society wishes to manage the natural fluctuations in economic activity, called business cycles, it needs to alter overall spending on newly produced goods and services. Thus, there can be a role for government in managing the economy when the consumption and investment actions of households and businesses fail to provide socially desirable outcomes.

When low unemployment and increasing inflation suggest the productive capacity of the economy is unable to meet the demand for goods and services, the appropriate policy is to discourage spending through contractionary monetary policy (higher interest rates, fewer bank loans, and a smaller money supply), and contractionary fiscal policy (higher taxes and reduced government purchases).

However, when unemployment is relatively high and economic growth is small (such as in the current recession), the appropriate policies to pursue are expansionary monetary policy (lower interest rates, more bank loans, and a larger money supply) and expansionary fiscal policy (lower taxes and increased government purchases).

In the current U.S. economy, monetary policy has been largely ineffective. Interest rates are about as low as they can go. (The federal funds rate is 0.25%. It is almost zero.) Because of the financial crisis, banks are reluctant to lend money. Tax cuts have been largely ineffective as well. Studies show most recipients have used the additional funds to pay down debt rather than increase purchases. So that leaves increased government spending as the most viable way to increase the aggregate demand for newly produced goods and services.

Thus, the economic justification for government spending programs to stimulate the economy is that they can increase aggregate demand when consumers and businesses and unwilling to do so.

If one's primary concern is economic recovery, then the spending should be done as quickly as possible on projects that employ workers in the production of new goods and services. However, there is a tradeoff between projects that can be done quickly, and those that provide the greatest long-term benefit. This has led to criticism of U.S. government stimulus spending. Projects that can be done quickly are criticized for lacking long-term benefit. Spending for more worthy projects is criticized because it is not helping the economy quickly enough. This is why defenders of stimulus programs argue we need to give them more time. Much of the spending was designed to help over the period of several years, not a few months.

CLICK HERE to read the story of Goldilocks and the Three Bears.

How did we avert a second Great Depression? The answer, basically, is Big Government.

In his August 10, 2009 op-ed column "Averting the Worst" Paul Krugman explains how government spending has prevented the economic decline from being worse. Recessions and depressions are caused by insufficient overall spending on newly produced goods and services. The collapse of housing prices and the resultant reluctance of banks to extend new loans reduced the demand for new products, leading to reduced purchases and increases in unemployment. Without the government spending, aggregate demand would have fallen even further, making the economic decline much deeper. According to Krugman:

So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.

Just to be clear: the economic situation remains terrible, indeed worse than almost anyone thought possible not long ago. The nation has lost 6.7 million jobs since the recession began. Once you take into account the need to find employment for a growing working-age population, we’re probably around nine million jobs short of where we should be.

And the job market still hasn’t turned around — that slight dip in the measured unemployment rate last month was probably a statistical fluke. We haven’t yet reached the point at which things are actually improving; for now, all we have to celebrate are indications that things are getting worse more slowly.

For all that, however, the latest flurry of economic reports suggests that the economy has backed up several paces from the edge of the abyss.

A few months ago the possibility of falling into the abyss seemed all too real. The financial panic of late 2008 was as severe, in some ways, as the banking panic of the early 1930s, and for a while key economic indicators — world trade, world industrial production, even stock prices — were falling as fast as or faster than they did in 1929-30.

But in the 1930s the trend lines just kept heading down. This time, the plunge appears to be ending after just one terrible year.

So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government.

Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.) Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

All of this has helped support the economy in its time of need, in a way that didn’t happen back in 1930, when federal spending was a much smaller percentage of G.D.P. And yes, this means that budget deficits — which are a bad thing in normal times — are actually a good thing right now.

In addition to having this “automatic” stabilizing effect, the government has stepped in to rescue the financial sector. You can argue (and I would) that the bailouts of financial firms could and should have been handled better, that taxpayers have paid too much and received too little. Yet it’s possible to be dissatisfied, even angry, about the way the financial bailouts have worked while acknowledging that without these bailouts things would have been much worse.

The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

Last and probably least, but by no means trivial, have been the deliberate efforts of the government to pump up the economy. From the beginning, I argued that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow over time — and that the stimulus has played a significant role in pulling the economy out of its free fall.

All in all, then, the government has played a crucial stabilizing role in this economic crisis. Ronald Reagan was wrong: sometimes the private sector is the problem, and government is the solution.

And aren’t you glad that right now the government is being run by people who don’t hate government?

We don’t know what the economic policies of a McCain-Palin administration would have been. We do know, however, what Republicans in opposition have been saying — and it boils down to demanding that the government stop standing in the way of a possible depression.

I’m not just talking about opposition to the stimulus. Leading Republicans want to do away with automatic stabilizers, too. Back in March, John Boehner, the House minority leader, declared that since families were suffering, "it’s time for government to tighten their belts and show the American people that we ‘get’ it." Fortunately, his advice was ignored.

I’m still very worried about the economy. There’s still, I fear, a substantial chance that unemployment will remain high for a very long time. But we appear to have averted the worst: utter catastrophe no longer seems likely.

And Big Government, run by people who understand its virtues, is the reason why.

The Leaner Baby Boomer Economy

The July 23, 2009 cover story "The Leaner Baby Boomer Economy" in BusinessWeek magazine emphasizes the importance of consumption (C) in overall spending on newly produced goods and services, which economists call aggregate demand (AD). The recession which began in late 2007 was caused by a decrease in aggregate demand as a result of the collapse of housing prices and insufficient regulation of financial markets that reduced loans.

The Leaner Baby Boomer Economy
The downturn is putting a crimp on baby boomers' free-spending ways, and the likes of Mercedes and Starwood Hotels are scrambling to keep up

By David Welch

Mercedes is the quintessential boomer brand. Drive down an American highway, and odds are good that the person piloting the Benz in the next lane was born between 1946 and 1962. And Mercedes-Benz (DAI) has prospered right along with America's huge postwar generation. Back in 1986, when the first baby boomers turned 40, Mercedes sold 99,000 cars in the U.S. In 2006, when those boomers hit 60, the automaker moved almost 250,000 vehicles, a fifth of its global total.

This year, Mercedes will sell a third fewer cars in America. In Montvale, N.J., Kristi Steinberg, who runs Benz's North American market research operation, has a nagging fear: that sales won't recover for a long time because boomers, history's wealthiest generation, are tapped out. "I don't know if anyone knows yet if this is a blip," she says, "or a defining moment like the Great Depression."

Executives such as Steinberg always knew boomers would curb their free-spending ways as they approached retirement. But not in their most nightmarish imaginings could they have predicted that an economic maelstrom would cripple the customers they have courted and counted on for 30 years.

FAITH IN RISING MARKETS
When 79 million people—nearly a third of Americans—start spending less and saving more, you know it won't be pretty. According to consulting firm McKinsey, boomers' conversion to thrift could stifle the economy's hoped-for rebound and knock U.S. growth down from the 3.2% it has averaged since 1965 to 2.4% over the next 30 years. "We would have gotten here in 5 or 10 years as boomers retire, but we pushed it up," says Michael Sinoway, managing director of consulting firm AlixPartners. "Now [companies] are scared things won't come back." And that's why everyone from Mercedes to Nordstrom (JWN) to designer Vera Wang are scrambling to remake themselves for the Incredible Shrinking Boomer Economy.

Not so long ago, boomers were never going to die. Filled with a self-confidence born of unprecedented prosperity, many thought rising markets would assure their future. If the economy faltered, well, it would rebound more strongly than ever, as it had so many times before. And so boomers spent—and borrowed—as if there were no tomorrow.

Meet Tim Woodhouse, 56. He owns Hood Sailmakers in Middletown, R.I., a business that helped finance a plush life. Woodhouse owns a boat, five Ducati motorcycles, and every few years treated himself to a new Porsche 911. He figured he'd retire when he felt like it. Then the markets crashed, the economy tanked, and suddenly Woodhouse felt a lot poorer. In April, with business slowing and his real estate holdings leaking value, Woodhouse hit the brakes. "I was scared," he says. "My net worth took a real hit." Woodhouse sold the Porsche and bought a Mini Cooper. The boat spends more time tied up these days than out on the water. He and his wife dine out less often, and they don't entertain at home much either.

Woodhouse and millions of boomers like him are doing what people normally do when they near retirement: They're living more frugally. Companies have long factored in this actuarial reality, gradually tweaking their products and marketing to appeal to the next generation. With boomers, however, many companies became complacent. It wasn't that they ignored younger consumers but that they counted on boomers to keep spending longer. And why not? Until recently boomers typically reached their spending peak at age 54, according to McKinsey. Contrast that with the previous generation—a thriftier bunch whose consumption typically peaked at 47.

Now many companies are scrambling to appeal to Generations X and Y. You can already see this thrust in the stores. Clothing designer Vera Wang is selling a casual line called Lavender aimed at twenty- and thirtysomethings. It's fashion, but not the pricey garments the company typically has sold. Meanwhile, says Wang, her namesake brand needs to get a lot less expensive. In one instance, Wang made a high-end dress using fabric that costs $5 a yard instead of $12 but used the fabric in several layers to give the garment a richer look. As a boomer herself, Wang, 60, feels her generation's pain. You don't have 30 years to reinvent yourself," she says.

Even as Mercedes continues to target boomers, it has quietly recruited 500 people aged 20 to 32 for a focus group it calls Generation Benz. Mercedes researchers are seeking their views on the economy, car ads, model designs, and more. The automaker sent 20 Generation Benzers into dealerships wearing flip-flops and other casual attire to see how much attention they received. Four of the 20 were ignored. The results, says Steve Cannon, vice-president for marketing, served as a wake-up call to Mercedes dealers "that we have to start paying a lot more attention to tomorrow's customers, especially if tomorrow is coming faster than we thought."

VALUE SHOPPING
Can younger consumers pick up the slack? Consider the demographics. Generation X, Americans born between 1964 and 1980, is generally estimated to be about two-thirds the size of the boomer cohort. And with boomers working longer, especially since the crash wiped out many retirement funds, it may take longer for Xers to move into their prime earning (and spending) years. And what about Generation Y, the 81 million-strong group born between 1981 and 1994? Right now, 14% are unemployed and will have their own hole to claw out of when the economy revives, according to Edward F. Stuart, who teaches economics at Northeastern Illinois University. In other words, companies will need boomers for years to come.

The trick will be finding a way to fulfill the needs and wants of a generation that is used to being catered to—but is now on a budget. Timothy Malefyt, an anthropologist who studies consumer trends for the ad agency BBDO New York (OMC), argues that boomers, having ridden a wave of technological change, are highly adaptable and well versed in problem-solving. (Or at least they see themselves as such.) Already, he says, they are making a virtue of value shopping, once viewed by this group as hopelessly déclassé. For many boomers it's no longer about keeping up with the Joneses, it's about outthinking them. "If you make boomers feel they've failed, you'll lose them," Malefyt says. "They want to feel they've outsmarted the system or their circumstances."

That's why some companies are coalescing around "cheap chic," a marketing conceit that has become synonymous with Target (TGT) but also has been tried by the likes of JetBlue, Ikea, and Mini. The latter is owned by BMW, another classic boomer brand. BMW didn't plan it this way, but the Mini is one solution for a company whose cars are becoming too pricey for many boomers. A fully loaded BMW 3 Series costs $40,000 plus change; a comparably equipped Mini: $25,000. The Mini, while a feat of engineering and retro style, can't compete with a BMW, which the company bills as "the ultimate driving machine." But the Mini possesses cheap chic in spades. In recent months, says BMW, fiftysomethings have been trading in their Bimmers and other luxury brands for Minis.

PAMPERING ON A BUDGET
Starwood Hotels & Resorts Worldwide (HOT) has embarked on a crash course in cheap chic—or what it prefers to call "style at a steal." The chain has long appealed to the boomer yen for luxury and pampering. Its high-end W, Sheraton, and Westin hotels offer spacious rooms, well-staffed front desks, valets, and extensive room service menus. So the polyester sheets and small-bar soap that typify the value hotel experience wouldn't do. Starwood's 40-year-old chief of specialty brands, Brian McGuinness, also knew boomers grew up challenging convention and still like to feel that they're on the cutting edge. But they also demand creature comforts. "They once drove Beetles and ended up in Bimmers," McGuinness says. "We wanted to strike that balance." Plus, don't tell them but boomers are getting older and presumably creakier. So edgy can't equal bare-bones minimalism.

After six months of research and brainstorming, Starwood came up with two cheap chic hotel chains: Aloft, named to echo the "urban cool" of loft apartments, and Element, a low-cost option aimed at people who prefer suites with every "element" of their daily lives—including spa-like bathrooms. Early last year the team mocked up an Aloft prototype and invited some boomer-age guests to stay. The mock hotel had an aggressive neon color palette, piped-in scents reminiscent of an Indian spice market, and garage band tunes on the sound system. To help bring the room rate down to the $150-to-$170 range, they cut out full-service restaurants, room service, and valets. The test subjects were fine with parking their own cars, and most said they'd rather explore and find their own restaurants than eat in their rooms. The garage music? Not so much. Starwood replaced it with contemporary rock and international music. The neon palette gave way to muted tones, and a mild citrus replaced the spice.

Starwood has opened 25 Aloft hotels so far, and McGuinness says occupancy rates meet or exceed the average in most metro markets. Starwood won't say if the downturn prompted it to accelerate the rollout of its new hotel brands. But the company is opening two Aloft hotels each month, the fastest rate the industry has seen. David Loeb, a Robert W. Baird analyst who has been covering the hotel industry for years, says Aloft's ambience may be too hip and jarring for fiftysomethings. But he says if the chain finds the right balance, it might appeal to boomers and Generations X and Y. Starwood is advertising the new chains heavily online. "Boomers and Gen Y congregate in the same places on the Web," McGuinness says.

Starwood started changing its approach to boomers before the economy went south. Other companies are adjusting on the fly. OSI Restaurant Partners has watched its eateries lose boomer customers, whether middle-class types who frequented the company's Outback Steakhouse and Bonefish Grill restaurants or wealthier people who once dined on filet mignon at the more upscale Fleming's Prime Steakhouse & Wine Bar. OSI's chief operating officer, Paul E. Avery, reduced menu prices and offered smaller cuts of beef at Outback to maintain margins before retiring in early July. The company has gone on an ad blitz pushing the more modest portions for $9.99. This is obviously a tricky balancing act at Outback, where a big slab of meat was the chain's main attraction.

The good news, says Chief Branding Officer Jody Bilney, is that people who order the less expensive entrées typically end up buying dessert or more alcohol, so the average ticket is still about $19 per person. At Fleming's, OSI is offering more wines under $10 a glass and a fixed-price menu that caps everything but drinks as low as $36 a person. Before the downturn diners typically spent $60 apiece. OSI is responding to a recession but is prepared to run its business this way if boomers remain frugal over the long run. "If anyone tells you they know that the impact of the last 12 months is permanent or temporary, they're blowing smoke," Bilney says.

Nordstrom isn't waiting to find out. The purveyor of affordable fashion believes that its customers—many of them boomers—will be under pressure for years to come. So even as it starts building fewer full-price department stores, Nordstrom has tripled the pace for opening lower-priced Nordstrom Rack stores. It will open 13 in 2009 and nine next year. Rack stores offer Nordstrom's usual name brands but for 30% to 70% less than they fetch in the main stores. Nordstrom figures boomers still want fashion, but at a discount.

What many companies are attempting to do now has worked in the past. After the crash of 1929 few people could afford a Cadillac, so General Motors (GM) created a budget model to keep its luxury sales going. The 1934 LaSalle had art deco touches, including chrome portholes along the hood. To cut costs, GM stuck the car on an Oldsmobile chassis and gave it a smaller engine. The LaSalle's cheap chic was a hit with Depression-era drivers, and when the economy recovered, Cadillac again became a totem of material success. Of course, America was about to experience the greatest boom in history. That's unlikely to happen this time.

With David Kiley

The supply-side argument that tax cuts induce businesses to increase investment and create jobs.

A business does not need a tax cut to create a job. A rational business manager will hire a worker if that person generates more additional income than what he or she is paid in wages, salary, and benefits. Similarly, business investment will occur if the perceived future revenues exceed the expected costs.

Subsides can be used to increase private investment in factories or equipment. But they may be of no more benefit than similar expenditures by government entities. Any increases in physical capital can be of future benefit to the economy, whether in the form of government subsidies to private businesses or direct government purchases for public investment.

Factory workers do not lose their jobs because of the lack of a factory, as supply-side theorists might suggest. It is insufficient demand for their products that causes the job losses.

See also "Recessions & Depressions: Questions & Answers."

What causes recessions and depressions?

Recessions and depressions are caused by insufficient overall spending on newly produced goods and services. When there is insufficient aggregate demand (AD) for new products, stores sell fewer things, causing factories to produce less output and increasing unemployment. As workers lose their jobs, their incomes are reduced, leading to further decreases in overall spending and deepening the economic downturn.

The recession that began in December 2007 was caused by collapsing housing prices, the subprime mortgage crisis, and subsequent tightening of credit markets. In 2004 and 2005, the United States experienced unusually rapid increases in housing prices, sometimes referred to as a real estate bubble. Low interest rates and insufficiently regulated lending practices fueled these unsustainable price increases. Many people increased general purchases by borrowing against their homes (with unrealistically high values). Housing prices peaked in 2006 and the subsequent declines, sometimes called the bursting of the bubble, triggered home foreclosures, the subprime mortgage crisis and reductions in loans. Thus, real estate declines led to a decrease in the aggregate demand (AD) for newly produced goods and services.

See also "Recessions & Depressions: Questions & Answers."

Recessions & Depressions: Questions & Answers

A recession is a sustained decline in economic activity characterized by declines in national income, total output of goods and services, and employment.

A depression is an extremely severe recession.

Recessions and depressions occur when there is a prolonged decrease in overall spending on newly produced goods and services, which economists call aggregate demand (AD).

Gross domestic product (GDP) is the total value of new domestically produced final goods and services.

Aggregate Demand (AD) for Gross Domestic Product (GDP) = Consumption (mostly by households) + Investment (mostly by businesses) + Government Purchases (on newly produced goods and services) + Exports to foreign purchasers – Imports from foreign producers

AD (for newly produced U.S. goods & services) = C + I + G + X – M

Click on the questions below to link to the answers.

What is a recession and how does it differ from a depression?

What causes recessions and depressions?

Should the government do anything to prevent economic declines?

What types of government policies reduce the severity of recessions and reverse economic declines?

What about the supply-side argument that tax cuts induce businesses to increase investment and create jobs?

How Monetary Policy Affects the Economy

How Monetary Policy Affects the Economy

Monetary policy is conducted in the United States by the Federal Reserve System (the Fed), which is the U.S. central bank. A central bank is an institution that oversees the banking system and regulates the quantity of money in an economy. The Fed influences the economy by changing the money supply and interest rates to either increase or decrease aggregate demand (AD), which is overall spending on newly produced goods and services. When the Federal Reserve conducts monetary policy, it may increase or decrease the money supply depending on the condition of the economy.

Expansionary monetary policy occurs when the Federal Reserve System induces commercial banks to increase the amount of money they create through loans. Thus, expansionary monetary policy increases the money supply. If the economy needs stimulation (e.g., to fight unemployment), then the Fed usually conducts expansionary monetary policy to increase the money supply, reduce interest rates, and encourage more consumption and investment spending. Low interest rates encourage households and businesses to borrow money. If they use this borrowed money to increase spending on consumer products (C) and investment (I) in capital equipment, inventories, and structures, then aggregate demand increases. Aggregate demand is composed of consumption spending (C), investment spending (I), government purchases (G), and net exports (X-M).


AD = C + I + G + X - M


Contractionary monetary policy occurs when the Federal Reserve System induces commercial banks to decrease the amount of money they create through loans. Thus, contractionary monetary policy decreases the money supply. If the economy needs dampening (e.g., to fight inflation), then the Fed usually conducts contractionary monetary policy to decrease the money supply, increase interest rates, and discourage consumption and investment spending. High interest rates discourage households and businesses from borrowing money. If higher interest costs reduce spending on consumer products (C) and investment (I) in capital equipment, inventories, and structures, then aggregate demand decreases.

Strategies for Controlling Inflation

Strategies for Controlling Inflation

1. Break the cycle of expectations. This helps to control cost-push inflation.
2. Reduce the costs of production. This helps reduce cost-push inflation.
3. Reduce aggregate demand. This helps to control demand-pull inflation.

AD = C + I + G + X – M
where:
AD = aggregate demand
C = consumption
I = investment
G = government purchases
X – M = exports – imports = net exports = NE


Objective to help achieve low inflation
Fiscal policy
to achieve this objective
Monetary policy
to achieve this objective
Break the cycle of inflationary expectations.
Anything that convinces the public that the government is committed to reducing inflation.
Anything that convinces the public that the Federal Reserve System is committed to reducing inflation.
Decrease the costs of production.
Anything that reduces costs of production. Increasing the world supply of oil, for example, would reduce production costs for many industries.

Reduce aggregate demand.
Decrease government purchases or increase taxes. Since government purchases are a component of aggregate demand (and GDP), reduced government spending will reduce aggregate demand directly. Higher taxes leave workers and businesses with less disposable income. This leads to a reduction in consumption and investment spending, which are two of the components of aggregate demand.
Decrease the money supply to increase interest rates. Higher interest rates discourage borrowing. This causes a decrease in consumption and investment spending, which are two of the components of aggregate demand
Table 3. Using fiscal and monetary policies to achieve low inflation.