Quarterly Update: The Economic Recovery in Historical Context

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1 Quarterly Update: The Economic Recovery in Historical Context Paul Swartz Analyst, International Economics August 16, 2010 How do the recent economic collapse and recovery match up with past cycles? This chart book provides a series of answers, plotting current indicators (in red) against the average of all post World War II recessions (in blue). To facilitate comparisons, the data are centered on the beginning of the recession (marked by 0 ). The dotted lines are composites representing the mildest and the most severe experiences in past cycles. Because the downturn has been compared to the Great Depression, the Appendix plots the recent trend lines against the 1930s. Six things to look for in this update: Growth has returned, but the recovery is by some measures the weakest of the postwar era. Payrolls, after a small blip upward, show worrying signs of stagnating. The number of jobs relative to the start of the recession is much lower than in any prior postwar recovery. Industrial capacity, which typically keeps expanding even during a recession, is now contracting. This is consistent with the concern expressed by many observers that U.S. corporations are accumulating cash surpluses on their balance sheets rather than investing in new plants and equipment. The Economic Stimulus Act of 2008, the Emergency Economic Stabilization Act of 2008 (TARP), and the American Recovery and Reinvestment Act of 2009, along with a contraction in revenues, produced a federal budget deficit far larger than anything experienced previously, either prewar or postwar. The budget deficit has shrunk slightly since the end of 2009, but still far exceeds 3 percent of GDP, the number many economists regard as the ceiling of a sustainable deficit. World trade is growing strongly, but remains well below past recession averages The collapse in home prices is more severe than anything experienced pre- or postwar.

2 Real GDP growth, which for a time was weaker than in any other postwar recession, has recovered thanks to the fiscal and monetary stimulus. Year-over-year growth has turned positive because of low prior-year output levels. Although growth has resumed, economic activity is still 1 percent below the level it was at the start of the recession. Relative to the beginning of the recession, output remains as low as it has been at this stage in any other postwar recession. The federal deficit has deteriorated far more rapidly than in any past recession due in part to the economic stimulus and declining tax receipts. Although the deficit has fallen in recent months, it has to improve much more to reach 3 percent of GDP, the approximate ceiling for a sustainable deficit.

3 The collapse in the dollar value of global trade remains far worse than in any other postwar recession. Although trade has started to grow again, it remains well below previous recession averages. World The increase trade growth in tends unemployment to slow as in the US economy percentage contracts. points since the Leading start indicators of the recession is suggest worse a than sharp in any other contraction postwar of recession. trade in the In absolute fourth quarter terms, the and early unemployment next year. rate was slightly Will the higher policy in makers respond by liberalizing trade or introducing new restrictions? The number of jobs in the economy relative to the number when the recession began is much lower than during any prior postwar recession.

4 Industrial production held up well when the recession began, but collapsed in the second half of Although a recovery is under way, industrial production remains worse than the postwar worst case. Production capacity in manufacturing, mining, and electric and gas utilities typically grows throughout the economic cycle, but at a slower rate after a recession begins. Capacity was growing slowly before this recession began. It has since started to contract, which is exceptional. Emissions in the United States have contracted faster in this recession than in any other post WWII case.

5 The Institute for Supply Management (ISM) survey offers a forwardlooking indicator of industrial production. A number above fifty in the ISM survey implies manufacturing growth, whereas a number below fifty implies contraction. Auto sales typically fall by 20 percent in a recession. This time around they fell by more than 40 percent. The Cash for Clunkers program helped boost sales and clear inventory, but after it ended, auto sales fell to their previous level. Typically by now auto sales would have returned to the level at which they started the recession, yet they remain well below that point. Consumer sentiment typically starts deteriorating before the recession begins, but turns around soon after. Despite some improvement, consumers remain relatively pessimistic.

6 The spread of investmentgrade debt a measure of the risk that high-quality corporate bonds will default typically rises during a recession. The rise during the current cycle was unprecedented. The credit markets recent improvement still leaves spreads at relatively high levels. The spread on BAA debt (the lowest investmentgrade rating) is an indicator of the risk that lowerquality companies will default. The rise in the BAA spread was also unprecedented. As the financial system has stabilized, spreads have fallen. However, they remain at relatively high levels. The collapse of the equity market in this cycle was more severe than in any other postwar experience. Although a strong rally has taken place since March 2009, the equity market is still well below its peak.

7 Appendix: The Current Recession Compared to the Prewar Average and the Great Depression The economic cycle framework can be used to compare the current cycle to prewar recessions and the Great Depression. The thick red line represents the current recession; the thin blue line, the postwar average; the thick green line, the Great Depression; and the thin gold line, the prewar average. Production in this cycle has collapsed relative to the postwar average, but is in line with the prewar average. The current collapse does not compare to that of the Great Depression. Although the labor market has deteriorated more than at any time since World War II, it is much healthier than during the Great Depression, and compares well with the typical prewar experience. The modern appetite for government activism explains this difference. The flip side is evident in the chart below, which shows larger budget deficits in the current cycle.

8 Government intervention is much less controversial than prior to World War II. Thus, government stimulus occurred faster than was the case during the Great Depression. U.S. trade the sum of exports and imports collapsed dramatically, but has started to grow again. The collapse in trade did not continue as it did during the Great Depression. Initially the equity market performance lined up with the Great Depression, but the rally broke that pattern.

9 The Great Depression and other prolonged slumps, such as that experienced more recently in Japan, tend to feature deflation. In this cycle, the U.S. economy flirted with deflation as demand for both goods and assets collapsed. But prices have begun to rise again. One area in which this downturn has been far worse than the Great Depression is real home prices.

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