Did 9/11 Delay an Economic Day of Reckoning?

After almost ten years, it's interesting to read this interview of Jack Beebe, the former director of research for the Federal Reserve Bank of San Francisco, conducted by bank staff writer Suzanne Slade at the end of 2001. Slade started off asking Beebe if any previous recessions were similar to the one in 2001:

Jack [Beebe] explained that only one twentieth-century recession serves as a comparison for the current economic period, and that was in the late 1920s. "It was the end of a very long period of productivity enhancement because of the invention of the electric motor, which was followed by mass production of automobiles and other goods," Jack explained. Automobiles led to a land boom throughout the U.S., and stock prices started rising dramatically in the late 1920s until the famous stock market crash of 1929.

Similarly, the 1990s boom arose from technology that began in 1955 with the invention of the transistor, leading to the extraordinary technological advances of the 1990s.

Beebe went on to draw the contrasts that modern economists often do when they bring up the Great Depression, e.g., the existence of automatic stabilizers such as unemployment insurance that didn't exist in 1929. Slade then asked Beebe about the economic effects of 9/11, and after mentioning the negative short-term impact on sectors such as tourism, he noted the stimulative effect of military spending:

Wartime spending, though, is always a stimulus to the economy. "I'd much rather see us spending on infrastructure and schools," Jack said, but he noted that, while some military spending results in money spent abroad, all the munitions and supplies come from here. "So that's economic stimulation all the way through the next couple of years," he explained.

Recall that the Fed Funds Rate was at 3.5% at the beginning of September, 2001. It was cut by 50 bps after 9/11, and was down to 1.75% by the following January (before declining to 1% in July of 2003; see this Fed Funds Rate Chart), so 9/11 accelerated the Fed's easing process early last decade. These lower rates lead to more mortgage equity withdrawals. For an estimate of what economic growth would have looked like in the beginning of the last decade without those mortgage equity withdrawals, take a look at John Mauldin's "Economic Blue Screen of Death" chart below.




(Click chart to expand)

In addition to the acceleration of the Fed rate cuts, which increased mortgage equity withdrawals, 9/11 lead to a surge in military spending for the wars in Afghanistan and Iraq (the buildup for which started in late 2002). Munitions manufacturers weren't the only beneficiaries of this spending. Civilian airliners, for example, were chartered to fly troops to their staging areas in Kuwait. Returning troops flush with tax-free combat pay (often including tax-free, five-figure reenlistment bonuses) bought up trucks and SUVs at auto dealers near their state-side bases, and flat screen TVs from their local Wal-Marts (NYSE:WMT).

What would the U.S. economy have looked like in the first few years of this century without the accelerated interest rate cuts and military spending spurred by 9/11? Perhaps something like it has looked over the last few years (albeit, without a similarly acute crisis in the financial system).

Al Qaeda meant to sabotage the U.S. economy with its attack on the World Trade Center, and 9/11 did wound the economy in the short term (e.g., its impact on tourism that Beebe mentions in the interview), but without the rate cuts and military spending that followed, we might have been in for our longest post-WWII recession at the beginning of the last decade, on the heels of our longest economic expansion (see the NBER data). Instead, the recession that started in December of 2007, and (officially) ended in July of 2009, ended up being our longest post-WWII recession. So perhaps the larger economic effect of 9/11 was to delay the record recession that would have otherwise followed the record economic expansion of the 1990s.