Charting the U.S. Economic Recovery: V, U or W?

Charting the U.S. Economic Recovery: V, U or W?

Overview: There are growing debates about the shape of the economic recovery, how long will it take to close the output gap and if the economy will grow above or below potential during the recovery. Some analysts expect policy measures and pent-up demand to drive a V-shaped recovery like the one witnessed after the 1981-82 recession. Others expect sluggish recovery in private demand and structural weaknesses in the economy to lead to a U-shaped recovery. Some analysts forecast that as impact of policy measures fade and inventory adjustments finish, growth might slow again if private demand remains weak, leading to a "double-dip" or a W-shaped recession.

Will Fundamentals Support a V-Shaped Recovery?
* Several economists expect the Zarnowitz rule, which says that deeper recessions are followed by steeper recoveries, to hold during this recovery. As economic variables plunged to record lows during late 2008/early 2009, a pent-up demand can boost growth even of these variables don't go back to their pre-boom levels in the near-term. Under this scenario, GDP growth will revive in H2 2009, posting above-potential growth (3%-5%) for some quarters with the economy slowly moving toward potential growth.
* Economists expect this pent-up demand to come from consumption, home prices, autos, industrial activity and investment. They assume the recession will have no impact on consumer behavior, bank-lending or excess capacity. Despite wealth erosion, households will consume as long as they have positive net worth, rising incomes and debt-restructuring/forgiveness opportunities. Firms low on headcount will begin hiring and investing immediately. Residential investment will rebound.
* Senior Economist James Glassman, JPMorgan: The economy might bounce back quickly growing 3%-4% in the coming quarters due to "pent-up" consumer demand as the equity rally will have positive wealth effects. Fed actions might prevent long periods of high unemployment. (via Bloomberg, August 14, 2009)
* Professor Alan Blinder, Princeton University: Lower potential growth going forward is based on the assumption of slower productivity growth, which might not be true. The economy will grow “closer, but not quite, to 3 percent” ahead. (via Bloomberg, August 14, 2009)
* Vice Chairman Laurence Meyer, Macroeconomic Advisers: There is no evidence that the structural unemployment rate has increased. The economy will grow 3.6% in 2010 and 3.9% in 2011 due to pent-up demand from stabilization in home prices. (via Bloomberg, August 14, 2009)
* Chief Economist Stephen Stanley, RBS: Since housing and auto sales are at “very depressed levels,” they will contribute to growth even if they don’t reach their pre-recession peaks. “There is a lot of pent-up demand [as] consumers are holding off on practically all of their discretionary purchases.” The economy might grow 2.9% in 2010, 4.4% in 2011 and 3.5% in 2012. (via Bloomberg, August 14, 2009)
* Michael Mussa, Senior Fellow, Peterson Institute for International Economics: Policy measures will counter economic shocks and the downturn and will lead to a vigorous recovery. The cyclical turning point will occur in mid-2009 with modest growth in summer 2009 and firm recovery in autumn 2009. Growth will be over 4% (Q4-over-Q4) in 2010. (April 8, 2009)


Will Sluggish Private Demand Lead to a U or W Shaped Recovery?
* Many economists believe that structural constraints to private demand will lead to a sluggish U-shaped recovery.These include: 1) slower credit growth; 2) lower household consumption/higher savings (due to jobless recovery, slower wealth and income growth, deleveraging, subdued home prices and higher taxes); 3) high government debt monetization raising real rates; 4) labor market woes (high structural unemployment, aging population); 4) low possibility of export-led growth due to global recession; 5) high taxes, greater regulation, more protectionism; 6) deleveraging in financial and corporate sector; 7) impact of slower capex, innovation and aging population on total factor productivity.
* Other economists expect policy measures and inventories to temporarily boost growth but believe the economy will fall back into slower growth in late 2010/early 2011 due to fading impact of fiscal stimulus, sluggish private demand, higher commodity prices during recovery, high government debt, less room for fiscal/monetary stimulus, lower credit growth and early withdrawal of stimulus measures. This might lead to a double-dip or a W-shaped recession.
* Under these scenarios, growth is forecast to remain below-potential for some quarters/years at around 1%-2% and it might take several years to close the output gap. The economy grew 3.4% during 1929-2008 and 2.8% during 1997-2008. Some of these economists see the risk of potential growth rate also declining.
* Dr. Roubini: "We are in a deep U-shaped recession [which is] three times longer than the previous two and five times deeper–in terms of cumulative GDP contraction–than the previous two. [A recovery will only begin in 2010] and will be weak given the debt overhang in the household sector, the financial system and the corporate sector...[There is] also a massive releveraging of the public sector with unsustainable fiscal deficits and public debt accumulation...[There will be] a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%...[T]here is a risk of a double-dip W-shaped recession toward the end of 2010 due to the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing." (May 19, 2009)
* Rischard Berner, managing director, co-head of global economics and Chief U.S. Economist and David Greenlaw, managing director and chief U.S. fixed income economist, Morgan Stanley: "The recovery likely will be bumpy, with surges in output followed by slower growth. Longer term, the recovery will be relatively slow, as financial and economic headwinds are only gradually giving way to tailwinds...Yet the recovery will be sustainable... Neither a ‘W' nor a double-dip are the most likely outcome." (August 13, 2009)
* CEO Mohammad El Erian, PIMCO: Excessive regulation, higher taxation, lower consumption and existence of zombie institutions will constrain the growth of potential output to a "new normal" of 2% or below with an eventual inflationary bias down the road. (May 12, 2009)
* Professor Martin Feldstein, Harvard University: "[T]here is a risk the economy may experience a double-dip contraction." The economy could flatten out or be positive in Q3 2009 and contract again in Q4 2009 as the stimulus' impact wears off and companies finish rebuilding inventories. "There isn’t going to be enough to sustain a really solid recovery." (via The Big Picture, WSJ, July 21, 2009)
* Economists Jan Hatzius and Ed McKelvey, Goldman Sachs: Growth will be below trend in 2010 due to fading stimulus impact, rising savings, tight lending conditions and excess capacity in housing and the rest of the economy. Another shock, such as early withdrawal of stimulus, might pose risk of a double-dip. (July 31, 2009, Report: A Stronger Economy in the Near Term, But)
* Economists Drew T. Matus et al, BoA/Merrill Lynch: A 'square-root' type of recovery looks likely as boost from fiscal stimulus will be muted by constraints on consumer spending. The economy will settle to a new trend growth of 2.5%. (In the Report 'The Shape of Things to Come', May 21, 2009)
* IMF: Financial turmoil characterized by banking crisis are associated with severe and longer downturns with larger impact on growth. The U.S. will grow 0.8% in 2010 (below potential) with a sluggish recovery. Growth will turn sustainably positive only in Q2 2010. Potential output will be weak in the medium term due to higher financing costs. (IMF 2009 Article IV, July 2009)
* Professor Kenneth Rogoff, Harvard University: "[The] next five to seven years won't be like the boom years before the financial crisis. With housing prices likely to be soft for years, credit much tougher to come by [and] unemployment stubbornly high, consumers are likely to remain cautious." Taxes will have to be raised to finance debt and entitlements. (via Washington Post, August 13, 2009)
* Gary Shilling: "The recession will extend into early 2010. Only by then fiscal stimulus will stabilize [consumption and] global financial woes [and] excess home inventories may be absorbed." GDP is forecast to grow 2% in the next decade with growth coming from government spending while growth of consumption, investment and trade will slow. Consumption's share in GDP will fall to 66.5% in 2018 from 71% in 2008 while share of other components in GDP will increase, especially that of government spending. (Via Investors Insight, August 10, 2009)
* Douglas Holtz-Easin, Brookings: Despite better economic data, consumers will take longer to recover as they re-build their wealth, pay higher taxes and face high unemployment and inflation. (via Washington Post, August 13, 2009)
* Congressional Budget Office (CBO): "Many factors will temper the strength of the recovery: the loss of household wealth, the fragility of financial institutions, persistently weak growth in the rest of the world, a surplus of housing units on the market and low utilization of manufac­turing capacity... Even if the economy returns to positive growth in 2009, the loss in output, income and employment during the recession and the next few years will be huge.... The gap in output (7% in 2009-10) will not close until 2013 due to large shortfalls in output over the next few years." (May 21, 2009)
* Bridgewater Associates: "Government actions...are not sufficiently directed at the root problem of excessive indebtedness to produce permanent healing." Labor cost cutting by companies will undermine demand and keep up the pressure on banks because of loan losses. (via Thoughts from the Frontline's May 15, 2009, Issue)