Thursday, June 11, 2009

RIP the recession, May 2008–March 2009?

Could it really be over already?

Just two weeks ago, I’d have laughed incredulously at this question. Now, it’s looking as though the answer may well be yes.

But a quick summary of the background:

In the third quarter of 2008, GDP shrank by 0.7%. In Q4, it shrank by 1.6% and in Q1 of this year an agonising 1.9% – and recent figures on Q1 construction output suggest that this could be revised to as much as 2.2%. Ouch, ouch, ouch. Nobody has imagined that the current quarter would be as bad as Q1, but surely we couldn’t just pull out of that sort of nosedive so quickly?

After all, an IMF analysis in April found that “recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak.”

So what grounds for optimism are there?

Exhibit 1: the OECD’s latest round-up of leading economic indicators suggests “a reduced pace of deterioration in most of the OECD economies with stronger signals of a possible trough in Canada, France, Italy and the United Kingdom”.

Exhibit 2 is the purchasing managers’ index for the UK service sector, which recorded growth in activity in April – for the first time in a year.

Exhibit 3 is industrial output – including manufacturing – which also rose in April.

Exhibit 4 is most interesting of all: the National Institute of Economic and Social Research produces estimates of monthly GDP. When you add these up, they tend to tally pretty well with the official quarterly figures, when they later come out. And these monthly numbers have been looking fascinating lately:

For most of last year and January-March this year, the NIESR recorded GDP falls. But April’s figure was +0.2% and May’s was 0.1%. We still have to see what happens in June before we can get a Q2 figure, but it’s looking good.

This, if right, is stunning. How could we possibly have such a quick end to such a steep recession (see chart below)? A couple of things may help to explain:

Exhibit 5: The IMF study mentioned above finds “evidence of a bounce-back effect: output growth during the first year of recovery is significantly and positively related to the severity of the preceding recession”. This makes some sense in light of the really ferocious running down of inventories since about last autumn, meaning a brutal halt to factory production – the faster this process, the sooner it stops and even reverses.

The IMF also argues that “expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries” and that “both fiscal and monetary expansions undertaken during the recession are associated with stronger recoveries”. Which brings me to…

Exhibit 6: the Bank of England’s February inflation report (table 2) looked at economic stimuli at early stages of the 1970s, 80s, 90s and current recessions: “interest rates have been cut more significantly than at the early stage of previous UK recessions… fiscal policy and the exchange rate are also more supportive of activity than at the early stage of these previous recessions. And oil prices have fallen significantly, boosting households’ spending power”.

Let’s not go wild, though. One swallow doesn’t put a spring in the economy’s step. Even if the current quarter turns out to have stable GDP – or even a little growth – there’s still a chance of things turning down again later on, as in the kind of double-dip we had in the 1970s (see chart below). And even if growth does resume properly, unemployment is still very likely to keep rising for some time to come.

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