Curb your enthusiasm. Yes, the economy is recovering, as everyone save the nihilists expected. However, the debate ought to be about the strength, not the fact, of the recovery. At the risk of gross oversimplification, the debate is this: do we follow the strong recovery model (the “V”) which holds that deep recessions are followed by strong recoveries, or the weak recovery model (the “U”) that holds that recessions caused by financial crises are followed by weak recoveries? I have long been in the latter camp. In fact, I describe my forecast as “reverse square root”, sort of a cross between a V and U (credit to George Soros for the term): an early cyclical rebound followed by muted growth. I’m still there.
Now, to the evidence. So far, the magnitude of growth does not validate the V. GDP fell more during the 2007-2009 recession than in either 1973-75 or 1981-82 and has recovered less. Assuming GDP grew 3% (annualised) in the first quarter, which is the consensus, then it will be up 2.8% (not annualised) in the nine months since the recession ended, compared to 3.8% after 1975 and 5.6% after 1982. Yes, employment is finally rising, but as The Economist notes, its performance is far worse than after other recessions.
Second, the composition of growth looks unsustainable. A disproportionate amount so far has come from inventories which are not a sustainable source of demand. Relative to expectations, final demand is a wash: consumption has been stronger but housing has been weaker. Our special report argued consumer spending cannot lead the recovery because wealth has been devastated and credit is tight. Contrary to that thesis, consumption has outgrown income in the past quarter, saving has declined, and the trade deficit has widened, though only a bit.
An important reason for caution is that much of the recovery we’ve seen so far is down to fiscal stimulus. It probably accounted for half of the estimated 3% growth in the first quarter. Its contribution will turn negative by the third quarter. We need a virtuous cycle of incomes and spending underway by then, which means stronger job creation than we’ve seen so far. I still think it will happen. The economy is highly unlikely to dip back into recession; 3% growth seems a safe bet. But I don’t yet see the makings of the 5%-plus growth that would characterize a V, though I’d love to be wrong.
