Sunday, April 5, 2009

Anticipation...what is still true

Still true after this week...
It is still an out look for growth, more than continued recession.
It is still an economy that seems to have its worst times behind it.
It is still true that revisions keep making the past seem worse.
But it is still true that the past is worse than today.
And that is the good part that is still true - despite all the bad news.

As to recovery, it is still true that most economists expect a weak recovery.
But it is still true that such an outlook is poorly grounded in economic history and logic.

Something new?
One question is this: do we think that this cycle is driven by the usual cyclical forces or do we think that some structural change has rendered the economy different, making the last two recoveries so feeble and impacting this one as well? If so what are those new forces?
Maybe not...
I don't think any such new set of forces exists to justify current pessimism on growth. I think instead that the last two recessions were very different slow-motion recessions that we can understand in a conventional framework of analysis. It is not so much that they were less destructive, because they did a lot of damage in the labor market but much of that damage was done in the name of 'recovery'. These two recent recessions are a good example of what economists warn of when they talk about the cost of being 'out of equilibrium' and debate about getting adjustment over quickly or not. The recessions in 1990 and 2001 were not severe in terms of the peak to rough declines in GDP or the intra-recession job loss. But the recessions were stretched out in another way. Even though the formal recession periods themselves were not so long or severe the recovery periods were the Post War period. Because the recession did not have the cleansing sharp drop in activity, the forces to build momentum in recovery consolidated more slowly, effectively pushing some of the disequilibria -no longer called 'recession' - into the recovery period.

Stylized Factoid:
In recessions, where the cleansing power of the recession is strong, recession ends clearly and it marshals the forces of recovery more quickly.

The wrong precedents
In the last two recessions, economic growth in the first four quarters of recovery posted growth rates of only 2% to 3%. In the previous recoveries since 1957 first year growth in a recovery ranged from 6.1% to 9.5% with the exception of the 'weak' recovery of 4.5% growth in the 1970 recovery period. These recovery periods are in no way similar to the ones of the past two cycles and neither were their respective recessions similar.

Job growth as a cycle discriminator...
One main difference we can identify is the loss of jobs. In the typical recession job loss is severe declining by 2% to 4% to a cycle low that comes right near the end of recession in a compressed period of 12 months or less ( yes, even tough some recessions last longer, severe job losses are back-loaded). In the 1990 recession jobs did fall nearly 2% to their trough but it took them 17 months to make that 'small' drop and the low point came well into recovery. In 2001 the cycle's drop for jobs was only about 1% and that took about 17 months to reach its low point as well. GDP began to grow in both of those periods before the job drop played out causing the NBER to say that the recession had ended and leaving us with these weak-looking recoveries after recessions that were less than brutal. That does not make them a new paradigm.

What job growth says Vs what economists forecast
Not surprisingly, the weakest recessions with the greatest, fastest job loss, spawned recoveries with the strongest and most vigorous job gains. This recession is the worst in post war history its job losses are the worst even in percentage terms. So accordingly we should expect job growth in the recovery period to be much improved compared tot eh last two recoveries along with income growth and GDP growth. Yet that is not the consensus view in this cycle.


The bleak view
To be in the low profile-slow growth camp for recovery you need a reason. Many are pointing to a weak stock market or impaired consumer balance sheet or weak home prices or sagging foreign growth or some other long run factor as the likely retardant - but those just do not cut it. Those factors will eventually come into play determining the sustainability of growth after recovery is achieved. But recovery itself is about the business cycle itself and its peculiar dynamics of jobs lost; jobs gained, of income lost; income gained and, of confidence lost; confidence regained. Those forces are classic and they are beginning to turn up, as should the economy in a more traditional fashion. These cyclical forces overpower any of the structural issues named above. Structural issues will become more important after the forces of recovery are spent. At that time the economy will find a more hostile environment. I think economists are wrong to put these sorts of issues ahead of the power of the known business cycle with forces which promise to be so strong and which history has shown are coiled for action.

Recession/recovery in this cycle
It is still true that recessions with the worst job growth are followed by recoveries with the best job growth. That job growth puts income growth back on track quicker and helps to fuel strong GDP growth in recovery. So why look for weak recovery in this cycle? I think a lot about recession is misunderstood. And this time there is a political dynamic. We have a new president who wants a more interventionist government. To get that you need an economy that is floundering not one set for a strong recovery. We also have some special financial sector problems that have encouraged a bleaker view of economic prospects. To be sure special actions to bolster the financial sector were needed and will continue to be needed, but with them the prospect for a strong 'normal' recovery is improved.

Optimism defended
For me it is the sheer cycle force of recession that dominates all other trends. Models don't predict recession period results well or track their dynamics well. So don't expect macro simulations to produce results. But you can still see that there are clear patterns of behavior common to most cycles. I still think cycle-forces, not structural forces, are what are driving this recession. Cyclical forces drove oil prices higher, and turned the consumer over. Lehman's failure had widespread shock impact for about four months, adding to the slide. But the economy is beginning to mend itself. The initial shock from Lehman has passed and oil prices have largely unwound their gains. When the economy turns the corner it will be on two wheels and growth will ramp up as it has in the past cycles at the end of severe recessions. Everything we know about business cycle dynamics points to such a result. Even in 1982 with all sorts of banking sector problems the economy was able to muster a strong recovery as traditional recovery forces overpowered banking sector weakness. Now with mark to market rules neutered, the banks have an opportunity to reset sights on longer term goals as they did in 1982 and 1983. That will be important in getting lending going in recovery. It may also help banks to participate in the PPIP and remove some of their questionable assets from their balance sheets. With the backstopping of the Fed and Treasury the recovery path still looks even more likely --- and more likely to be solid.

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