Comments By Dr. Gerald Simons and Dr. Doug White


Dr. Gerald Simons

The direct expenditure of fixing the Millennium Bug will initially appear to help GDP, because of the extra expenditures in the economy, but the long term effect over the next few years is essentially the opposite of what Reagan-era supply siders were recommending -- a decrease in aggregate supply in the economy, resulting in higher product prices, lower corporate profits, and decreases in employment and production. The overall impact from this on the US economy will likely be relatively small -- the Federal Reserve Bank estimates that the Y2K bug will cost the US private sector more than $50 billion to fix, causing a GDP decrease of one tenth of a percentage point over the next two years.

As Dr. White indicates below probably the largest impact will come from uncertainty in the economy, unfortunately at the same time that we are experiencing a general downturn due to what started out as the Asian economic crisis. Investor uncertainty will surely result in declines on Wall Street -- economist Ed Yardeni (a well respected Wall Street forecaster) -- is very bearish about Y2K, believing that we may well have a recession because of it comparable to that in 1973-74 (see The Economist, Sept. 19, 1998, http://www.economist.com/editorial/justforyou/19-9-98survey/index_survey.html). This would lead to declines in consumer confidence, resulting in diminished consumer spending, and declines in profit forecasts, leading to cutbacks in business spending, production, and employment (in addition to those due to the costs of fixing the Y2K bug).

In the absence of any additional problems (eg. worsening situation in the Gulf leading to large gasoline price increases), I think the possibility of a recession due entirely or mainly to Y2K is small, and that rather we will experience a worsening of the global slowdown that we are beginning to feel now.

Dr. Doug White

  1. The amount of expenditure on correction of the Y2K problem in business
  2. The overreaction of investors to the Y2K problem
Issue one is fairly complex since it would appear the expenditure is very large all over the world. Supply side economists would argue that the expenditures of corporate America will "trickle" down to consumers and this increased expenditure by corporations will fuel the economy. I have never believed this theory works and several South American countries had severe problems after trying to implement this. The other side is that prices will be driven up by the increased costs to corporations and this increase may fuel a recession in the economy and perhaps the world. I hope that Dr. Gerald Simons will add some comments for us on this matter. He is a leading economist often seen on the evening news.

Issue two is more speculative since it is not clear what investors will do. A great many people seem to feel that there is some imminent collapse of the banking system but I haven't seen any technical evidence of this happening. Likewise, most of the horrible prophecy should prove to be juse paranoia but investors may react whether any real effects are felt or not. Panic on Wall Street could drive investors out of the market which might cause a wild stock market for a while. In my observation of the last few years investors usually jump back in when the price is right, particularly since gigantic mutual funds (which behave in a much more stable fashion than individual investors) represent a large portion of individuals holdings these days.

So, in the end, what is the answer to your question? I wish I knew, if I did I would get rich playing the market :). I think it will be a trying time for investment bankers and a nervous time for the FED and the World Bank. My best advice, play it conservative for a while and see what happens.




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