2001 Recession: Its Causes, Impact, and What Ended It
Y2K, 9/11, and Beyond
The 2001 recession was an 8-month economic downturn that began in March and lasted through November. While the economy recovered in the fourth quarter of that year, the impact lingered and the national unemployment rate continued to climb—reaching 6% in June 2003.
Y2K a Cause
The Y2K scare was a significant contributor to the 2001 recession. Y2K stands for the Year 2000. Experts falsely warned businesses of a Year 2000 software problem. They said the operating code had to be able to understand the difference between 2000 and 1900. Many fields within that code only had spaces for two digits, not the four needed to differentiate between the two dates.
Fears were that the world would come to a halt when the year 2000 arrived because computers would believe it was 1900 again. Many companies and individuals bought new computer systems to make sure their software was Y2K compliant.
This drove an economic boom in computer and software sales. As a result, the stock price of many high-tech companies started to increase. Investors began buying stock in any high-tech company, whether it was showing profits or not. The exuberance for dot-com companies became irrational.
The boom led to a bust in dot-com businesses. It had become apparent in January 2000 that computer orders were going to decline. Companies had just bought all the equipment they would need for a few years. As a result, the stock market dropped in March 2000. As stock prices declined, so did the value of the dot-com companies and many went bankrupt.
The Federal Reserve ignored the markets. It raised the fed funds rate three times, climbing to 6.5% in May 2000. The Fed kept interest rates high when the economy needed low rates for cheap credit.
Next Came 9/11
The 9/11 attack worsened the downturn. The New York Stock Exchange closed for four trading days after the attacks. That was the first time since the Great Depression. The stock market reopened on September 17, 2001. The Dow Jones Industrial Average fell 7.13%, closing at 8,920.70. The 617.78-point loss was the Dow's worst one-day drop at that time.
Tax Cuts Introduced
The Bush administration helped to end the recession with expansionary fiscal policy. Immediately upon entering office in January, President George W. Bush began working with Congress to cut taxes.
On June 7, 2001, Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001. It gave income tax relief to families retroactive to January. That covered them for the entire 2001 tax year. The administration believed they would spend the extra money and boost economic growth.
EGTTRA lowered the maximum tax rate from 39.6% to 35%. It reduced the 36% rate to 33%, the 31% rate to 28%, and the 28% rate to 25%. It reduced some of the 15% tax rate to 10%. It also expanded the Earned Income Tax Credit.
EGTTRA also doubled the standard deduction. It raised the threshold for the 15% tax bracket for married couples. It doubled the child tax credit from $500 to $1,000.
Consumer Demand Picked Up
These cuts gave taxpayers more money to spend. This increase in demand would boost the economy and lift it out of recession. Some of its other provisions benefited retirement savings and estate taxes. Those measures wouldn't help the recession. They might promote saving instead of spending.
The second cause for the end of the recession was the War in Afghanistan. In its first year, Congress appropriated $29.3 billion in emergency funding for the war. President Bush launched the war to find and bring to justice Osama bin Laden. He led the al-Qaida terrorist group responsible for the 9/11 attacks.
The third reason the recession ended was the Federal Reserve's expansionary monetary policy. It began lowering rates in January 2001. The fed funds rate history reveals how the Fed steadily lowered them about one-half point each month. By December 2001, the rate was 1.75%. Lower interest rates made homes, education, and auto purchases less expensive.
What Actually Happened
Although the recession ended in November 2001, the threats of war drove the Dow down for another year. It hit bottom on October 9, 2002, when it closed at 7,286.27. That was a 37.8% decline from its peak. No one knew for sure if the bull market had returned until the Dow hit a higher low on March 11, 2003. It closed at 7,524.06.
The tax cuts were phased in through 2009, too slowly to boost the economy. Economic growth was 1% in 2001. It increased to 1.8% in 2002 and 2.8% in 2003. To solve this, Congress passed the Jobs And Growth Tax Relief Reconciliation Act in 2003. Its goal was to speed up the tax cuts and give breaks to businesses.
Second, many people saved their rebates instead of spending them. Tax cuts went to everyone, regardless of income. Those with higher incomes are more likely to invest rather than spend any tax cuts.
Stage Set for 2008 Financial Crisis
The response to the 2001 recession set the stage for the 2008 financial crisis. The Fed continued lowering interest rates through 2003. That forced banks to earn less revenue. They looked for other sources, such as mortgage-backed securities and other derivatives. When the Fed began raising rates in 2004, many mortgage-holders had trouble paying the higher rates.
In the long run, the Bush tax cuts hurt the economy by dramatically decreasing government revenues. That increased each year’s annual deficit, and thereby the U.S. debt. Congress fought against President Barack Obama's jobs bill because it was more concerned about the debt. Instead, it forced a 10% spending cut with sequestration. That contractionary fiscal policy made it harder to recover from the Great Recession.
The trade wars and continued tax cuts under President Donald Trump have resulted in record-setting debt and sow the seeds for another recession in 2020.