I’ve commented earlier that many economic forecasts seem to assume reversion to the mean – here, meaning average economic growth over the last two decades. For a great example, go to the Wall Street Journal and admire the GDP growth rates projected for Q3 2009 through Q2 2010, marching happily up and to the right. (The numbers are 0.6%, 1.8%, 2.3%, and 2.8%.) This recession is different, however, and even if there is a mean to revert to after U.S. households decide how much they want to save, there’s no telling how long it will take.
For one perspective, the Carnegie Endowment for International Peace had a session at the end of April featuring a few IMF economists. Marco Terrones (link to PowerPoint at the bottom of the page) looked at the typical duration of a recession and the ensuing recovery. The duration of recovery is measured to the point at which the economy reaches its previous peak output (the output level when the recession began – December 2007 in our case). He looked at 122 recessions since 1960.
Terrones’s key point was that recessions last longer, and take longer to recover from, if they are linked to financial crises or if they are globally synchronized, for reasons that are probably evident to our readers: popping credit bubbles lead to an increase in the savings rate, dampening consumption; and globally synchronized recessions mean that no country can export its way back to growth. On average (slide 5), a recession that is both linked to a financial crisis and globally synchronized will last three quarters longer than normal (seven rather than four), and recovery, measured from the beginning of the recession, will take seven quarters longer than normal (fourteen rather than seven). (There is obviously some correlation there, since the longer the recession, the more ground needs to be made up.) Those are just averages, but projecting onto our experience that means recovery would start in Q4 2009, but we would not reach our peak (December 2007) output level until late 2011. Since the workforce will have grown by a few percent in the interim, unemployment would not reach December 2007 levels – if ever – for another year or two.
Seven quarters of contraction and seven of recovery to previous peak don’t seem that bad. Of course, this is still just an estimate based on data going back to 1960, and there is nothing in that time period like what the world is going through today.
This analysis is covered in greater detail in Chapter 3 of the IMF’s April World Economic Outlook.
By James Kwak
The Baseline Scenario 
For a variety of reasons it is extremely difficult to take any solace from a study of past recessions.
First, how does Mr. Terrones define “recession?”
Second, is the current economic situation a recession as Mr. Terrones defines it, or is it something all together different (i.e., a depression)?
Third, leaving definitions aside, were the economic reailties underlying those past crises sufficient to provide any confidence whatsoever that an adequate analogy can be made? Past performance is no guarantee of future results . . .
Fourth, will the brand new tools that the Federal Reserve has pulled out of its bag to address what seems to be a fairly unique set of circumstances create their own problems? That is, is the Fed inadvertently creating new, unseen risks in its efforts to mitigate the risks that it does see? That’s how the housing bubble was created in response to the bursting of the internet bubble. . .
The past recession data have no meaning except that which we impart to them.
Given the fall in global trade, how does import replacement compare to ‘Exporting out of recession.’ I would think the US is better positioned for that reason than say Germany or Japan.
I wouldn’t bet the farm on the past being particularly relevant to the future.
One problem in our interpretation, typically as economists, is that we understand ‘savings’ in a different context than consumers do. The fact is, there is not much real savings occuring. Rather, consumers are tapped out still, not taking on more debt, and refraining from purchasing durables. The whole notion of ‘deleveraging’ is also a buzzword. The fact is, many consumers cannot ‘de-leverage;’ they’re simply holding, deferring payments or making minimum payments on unsecured, non-clllateralized loans (aka revolving credit lines). So, how long?
Can you say…”J_U_B_I_L_E_E”?
Maybe so. However, part of the reason we find ourselves in this mess was that so many supposedly sophisticated people said, “This time it’s different.”
All the models at the mortgage places and all those who were packaging loans didn’t show any problems with the things until it was too late.
Comparing apples and oranges doesn’t work either. This is a whole ‘nuther anminal seems to me.
Past performance is still the best indicator of future performance. The unfortunate part is aksing the right question as to what is relevant from the past to today.
“This time its different” allows one to simply gamble without regard to past experience.
Did he define what he meant by a high fiscal response, especially with respect to a globally synchronized downturn?
Also, will the effect of new regulations draw out the recovery time? These regulations are necessary and long overdue and will hopefully avert disasters like this in the future…but they will most likely come with a short-term cost.
I’m surprised Mr. Kwak (who I respect a great deal) is talking about recovery now. He gave us a Wall Street Journal link with forecasts. Here is another Wall Street Journal link with real unemployment numbers up to April of ’09. http://online.wsj.com/public/resources/documents/JOBSMAP09.html
A very good color coded map showing unemployment rates of the different states. You can look at your state and compare. Obviously Michigan and California are two of the worst. I would be so bold as to suggest that until this graph AT LEAST steadies, and better yet goes down, the use of the word recovery should only be used by those prepared to eat crow.
Don’t worry, I still count as a pessimist. My point was that expectations of a rapid recovery are unrealistic. You can put me in the “the economy has to stop contracting at some point but there’s no assurance that it will grow very much” crowd.
I can not speak for others but I have a new house with siding,roofing, etc. with 50 year waranty. I will not be buying anything for a long time.
Another party that has not taken–and, I predict, will not take until its too late–a long and slow recovery into consideration is the Obama administration. They are talking about cutting the deficit in half within a few years of this fiscal year’s end. Not bloody likely.
The demand for stimulus spending to bail out state budgets and so forth will be very high over the next couple of fiscal years. Unless taxes are increased substantially on all fronts, Obama’s spending initiatives for new programs will crush an already fragile federal budget. Will increased taxes spur economic growth? I doubt it.
But what do we hear out of the Obama administration? That’s it is pretty much business as usual. Good luck, to steal a line from Seinfeld, with all of that!
I admit that I thought you were going in a different direction with this at the start: “…even if there is a mean to revert to…”
Is there any chance we are seeing a far deeper and more fundamental change here – a challenge to the very concept that “growth” is a given? It would seem that a great deal of the “growth” of the last 30 years was not based on concrete production but rather on the artificial expansion of the financial sector and the bubbles it grew to feed itself?
I’m very curious (and certainly do not know) what does a world look like where the line is flat, where there is no growth?
This recession is very much different than any other, at least in the past 80 years. As the IMF report notes, it is globally synchronized and was caused, or at least set off, by a severe financial crisis.
In addition, there are fundamental economic imbalances, associated with the global trade and capital regimes, underlying this recession. Moving away from a world of huge surplus/debtor nations will be exceedingly complicated, both politically and economically. Moreover, many of the surplus nations (i.e. Germany and China) seem reluctant to do so, were the option to be on the table.
It is very difficult to determine from where an imminent and substantial recovery would, could, emerge. Certainly not the US, because (among other things):
1. it is running deficits on nearly every metric, be it the current account or the fiscal ledger,
2. the success of the PPIP is so very far from assured,
3. (while subprime resets are winding down) Alt-A and similar mortgage resets will hit their peak later this year (this coinciding with a rising default rate on PRIME mortgages),
4. consumption is likely to be depressed for a very long time, due to an increasing savings rate,
5. (as Paul Krugman recently noted) unemployment will put pressure on wages and on disposable income, exacerbating #4,
6. Equities seem to operating in some sort of la-la land (how can the DJ possibly go up 100+ points on a day containing a weak March housing report and with a GM bankruptcy imminent?!),
7. Most analysis seems to be ignoring the very real possibility that oil prices will rise. While demand is very low and inventories are very high, oil is nonetheless a commodity with an extremely political component. It is also prone to shock swings.
There are so many other problems that I did not mention. Simply put, the US is in for a world of hurt, lasting much longer than fourteen quarters. If the US starts showing strong growth sooner than that, be worried, not relieved.
The EU is fairing worse than the US. China is dependent on global trade. Japan, ha. India perhaps? Who will drive the recovery?
Indeed, the whole system is fundamentally misaligned, a unique situation indeed. This is only a cursory analysis.
I have a question. In order to begin a recovery we need to be building things and selling them. The last boom was basically funded by creating and selling our mortgage debt, with the incumbent inflation in house prices that many used as ATM’s to fund their spending. Exactly what is it we are going to be building and selling that will create wealth in our society?