Look out for blips

The stock market is going gangbusters this morning (Dow up 160 points at last check), but NYT columnist Paul Krugman warns that all the bullish talk could lead the U.S. back to 1937, when the Roosevelt administration declared that the Great Depression was over, and that it was time for the economy to throw away its crutches. Specifically, federal spending was cut, the money supply was tightened, and, well, you can see by the above graph what happened.

As you read the economic news, it will be important to remember, first of all, that blips -- occasional good numbers, signifying nothing -- are common even when the economy is, in fact, mired in a prolonged slump. In early 2002, for example, initial reports showed the economy growing at a 5.8 percent annual rate. But the unemployment rate kept rising for another year. And in early 1996 preliminary reports showed the Japanese economy growing at an annual rate of more than 12 percent, leading to triumphant proclamations that "the economy has finally entered a phase of self-propelled recovery." In fact, Japan was only halfway through its lost decade.

Such blips are often, in part, statistical illusions. But even more important, they're usually caused by an "inventory bounce." When the economy slumps, companies typically find themselves with large stocks of unsold goods. To work off their excess inventories, they slash production; once the excess has been disposed of, they raise production again, which shows up as a burst of growth in G.D.P. Unfortunately, growth caused by an inventory bounce is a one-shot affair unless underlying sources of demand, such as consumer spending and long-term investment, pick up.