April 17, 2009
How Bad Is This Recession? And Why? -- Illustrated Version
The chapter documents the stylized facts that (1) recessions are longer and deeper when associated with financial crises, and (2) recessions are longer and deeper when the downturns are synchronized with recessions abroad. And those two points are why this otherwise reasonable -- and representative (but not from the IMF) -- prognostication from 15 months ago proved so wrong:
We know this for sure: It could be a lot worse, recessions used to last almost two years during the 1854-1919 period, and 1.5 years in the 1919-1945 period. Since WWII, the average recession lasted 10 months, and the last two recessions (1990-1991 and 2001) lasted only 8 months. With the support of a booming world economy, we could expect a short and shallow 2008 recession, IF it happens. If futures trading is correct, there's a 29% of NOT having a recession, so don't give up hope.
Source: a blog posting from January 2008.
Posted by Menzie Chinn at April 17, 2009 05:57 PMdigg this | reddit
The IMF's report seems to be based on the now defunct 'decoupling' theory ("With the support of a booming world economy..."). IMO such views were based an a fundamental misunderstanding of the true driver of growth in Asia - aggregate demand borrowed from other countries through currency policies. For a while, the dynamics were self supporting - the savings glut increased as income grew in high-saving areas, fostering reduced borrowing costs and supporting the asset bubbles and high consumption in the countries absorbing the savings glut. At the time, pundits were saying things like "Fannie and Freddie need cheap capital from China to support the housing boom."
Posted by: don at April 17, 2009 07:32 PM
don: You might be under the misapprehension that the last paragraph quoted is from the IMF. It's not. I've added an explicit indication to that effect (it's from a random post from the blogosphere).
Posted by: Menzie Chinn at April 17, 2009 08:15 PM
How Bad Is This Recession? And Why?
Negative real earnings growth for most people in the high wage countries (maybe other places too) and too much debt leading to wealth/income inequality and asset prices being too high.
Central bankers usually try to fix an economic problem with more debt and/or force an economy to become a net exporter.
"The chapter documents the stylized facts that (1) recessions are longer and deeper when associated with financial crises, and (2) recessions are longer and deeper when the downturns are synchronized with recessions abroad.
What happens when central bankers can't create any more debt (especially private debt) [see (1)] and no one wants to be a willing importer [see (2)]?
Posted by: Get Rid of the Fed at April 17, 2009 09:44 PM
t=0 @ Dec 07, the official start of the recession?...but the graph shows only 2 quarters? We are slightly more than 5q into this recession, yes? IMF is then 3q behind due to the prevalent use of abacuses in this not always technologically advanced world?
The graphs illustrate why it's called a dismal science.
One last dismal question before I just plain expire: the link was not clear about what counted as "government consumption", the least dismal of the graphs pictured...and I wondered if the assortment of "troubled asset reparations" was part of this tally...but if they are only looking at data as recent as June 08, that news would be news to them.
Posted by: calmo at April 17, 2009 11:30 PM
Decoupling may be discredited.
But China is grew by 5% (q/q) in the first quarter. While the will shrink (probably) by the same amount.
Posted by: bill j at April 18, 2009 03:03 AM
The now defunct "decoupling theory"?
US Q1 growth predicted -5%
China Q1 growth (JPM estimate) +5
Posted by: bill j at April 18, 2009 04:05 AM
Don has it exactly right about currency issues. Michael Pettis and Martin Wolf explain with unusual clarity here:
The Fed used artificially low interest rates to encourage indebtedness and consumption as domestic stimulus to offset the negative effects of trade/currency policies.
Posted by: Doc at the Radar Station at April 18, 2009 06:23 AM
Stocks inched higher Friday as better-than-expected earnings from Citigroup, General Electric and Google, helped stretch the recent advance to a sixth straight week.
The Dow Jones industrial average (INDU) added 6 points or less than 0.1%. The S&P 500 (SPX) index rose 4 points or 0.5%. Both ended at more than two-month highs.
The Nasdaq composite (COMP) gained 2 points or 0.2%, ending at a more than five-month high.
Stocks, as represented by the S&P 500, have gained 28.5% in the past six weeks, on bets that the economy is closer to stabilizing. The gains followed a selloff that left the S&P 500 at a 12 1/2 year low. A rash of better-than-expected profit reports has helped sentiment this week.
The six week run is the market's best since May 2007, said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.
Posted by: u at April 18, 2009 06:47 AM
Anso u thinks we are not merely going up that ski jump (providing much needed intra-day volatility too) on the giant slalom, but returning to the days of old: up, up and away.
Because the Martians have landed and they are so into empty McMansions just waiting...spurring the housing market, the leading indicator of any rebound in a recession in the past.
Ok, reports of the Martian landings greatly exaggerated...like that full disclosure of stress tests...it B the wounded consumer boomers who have decided to spend it all now rather than face the future a decade from now...so they are subletting their recreational homes to squatters, now employed as "house sitters" and "dog walkers"...reducing the UE stats and generally providing a last gasp of aggregate demand to a consumption profile that was, face it: too Picasso heavy and velvet Black Matador lite.
Posted by: calmo at April 18, 2009 08:02 AM
calmo: Good question. The WEO uses a statistical procedure based on peak output to date the recession beginnings. See footnote 5 in the chapter. Some sort of consistent categorization procedure was used because NBER does not provide recession dates for all countries, and the chapter is a cross-country analysis.
Posted by: Menzie Chinn at April 18, 2009 09:40 AM
US +1% -5%
China +11% +5%
Singapore +8% -19%
Posted by: Rajesh at April 18, 2009 10:42 AM
I think that what the graphs show is the increased role played by financialization in the past few years.
This recession seems to prove right that when the U.S. sneezes the rest of the world cathces a cold. My understanding is that since the late-80s, early 90s we have been experiencing a Second Era of Globalization, resembling the previous one. A gradual process of regionalization has been accompained by FTAs of a bilateral nature. Moreover, the U.S. and advanced economies' market have played a key role both in terms of trade and financial integration.
Decoupling is nevertheless gradually taking place between developed countries and emerging markets. I believe China's Q1 growth prediction of 5% depends on the partial convergence within the region and between China and other emerging markets. Data from a study (Kose 2009) shows that group-specific factors have been rising considerably through the past twenty years, from 17% to 31% for advanced economies and from 3% to 9% for emerging economies.
Furthermore, China still has considerable growth potentials, as embodied by its large domestic market. Investors are unlikely to pull out their money, for the sake of an established market presence, useful in the long run. I guess China has full potential to help preventing that this recession lasts for too long.
Posted by: GiuPu at April 18, 2009 10:51 AM
Interesting. As the graphs show government consumption is higher than during any other recession/depression, yet this recession is still roaring. And as Calmo points out the amount graphed is understated.
Menzie's earlier posting of the Brookings paper written by Phillip Swagel reveals that the Bush administration was attempting Keynesian pump priming for years before the recession - as was the FED - yet even with the Obama team increasing the Bush fiasco by four times, there still is no recovery.
Almost everyone now understands that excessively stimulated consumption, classical Keynesian pump priming, was actually the cause of our current problem, and also that, rather than helping, Paulson's "solutions" made things worse - now Geithner is Paulson on steroids.
Obviously Keynesian pump priming doesn't work, but what do the Keynesians say, "It just hasn't been enough," yet none actually know how much is enough.
In truth their answer is the same as when J.P. Morgan was asked how much money is enough. "Just a little bit more." Does that sound familiar?
But all of this is meaningless because the politicians love Keynsian pump priming. As Hayek has pointed out the Great Depression should have totally discredited this economic mistake but the politicians control the education establishment so they write the history. They propagandize the theory that gives them the academic cover to take more of our money and give it to their friends. The economics of freedom and liberty takes away political power and returns it to the people and this they will not abide.
Posted by: DickF at April 18, 2009 11:43 AM
The Chinese were taken by surprise. In the summer they were still seeking to slow their economy - raising interest rates, increasing capital ratios etc. - when unbeknownst to them the world was on the edge of collapse.
A combination of very high raw materials prices and the credit freeze after Lehmans.
They then went sharply in the other direction, between Jan-March 2009 their banks have lent as much as in the whole of 2008. Leaving out their massive reflation.
And their economy is recovering as a result.
De-coupling was a misnomer in the sense of a complete separation between the economies of the emerging markets and developed markets. But it did reveal a real thing - the increasing power of the emerging market economies and their ability to act independently of the crisis in the West. As indeed China is demonstrating today.
Posted by: bill j at April 18, 2009 01:54 PM
It would be interesting to see a chart of previous recessions; the runup in size of pre-recession finance industries as a % of GDP measured against recession employment hit. I bet employment drops are inversely correlated with the size of pre-recession finance industries.
Posted by: Phillip Huggan at April 18, 2009 02:25 PM
I think we need a better way to measure the contribution of finance to GDP. The point of finance is to deploy capital (e.g. convert savings into factories). When finance becomes a big part of the economy (siphoning off huge fees in the process), it's a distortion. It jacks-up transaction costs and diverts huge sums of money away from being productively deployed. An efficient finance system would maximize the deployment of capital for productive purposes at minimal cost consistent with maintaining stability.
Posted by: Patrick at April 18, 2009 03:02 PM
"when unbeknownst to them the world was on the edge of collapse."
I find it difficult to believe the Chinese - who are routinely described on these blogs as virtually omniscient and omnipotent - did not know something was coming.
Decoupling is, as stated, gradually taking place, but it's a very, very long way away, and it is unlikely to ever actually take place, at least not in the true sense of the word. Even very advanced economies like Europe and Japan are not decoupled from the U.S.
"But it did reveal a real thing - the increasing power of the emerging market economies and their ability to act independently of the crisis in the West. As indeed China is demonstrating today."
China is inflating an already large but not yet critical bubble that still has room to balloon. If the U.S. were in China's shoes and doing the same thing today, these blogs would be full of commenters promising today that the U.S. would pay dearly for this behavior down the road.
Posted by: PM at April 18, 2009 09:05 PM
Well its a moot point how far it could have been known. Obviously some people predicted it. And indeed it happened. So it could be argued as everything is knowable, then it was possible to know it.
But based on the behaviour of the Chinese authorities, its fair to say I think, that they didn't know it.
And of course it is possible to construct a scenario now, that the combination of the massive reflationary measures being taken, the revival in trade since February, the easing of credit and financial stress etc., the writing down of massive amounts of redundant capital, the restructuring of core industries i.e. GM/Ford etc. creates the conditions for a sharp rebound.
Posted by: bill j at April 19, 2009 02:57 AM
I found most interesting, that most of the statistical analysies involved in Chapter 3 of the IMF World Economic Outlook involves data post 1970. I find it ironic that that the failure of most recent econometric securitization models were due to their use of data sets too limited in duration... (They did not capture the global credit and banking crisies of 1872 and 1929).
I strongly recommend that Econobrowser readers check out Simon Johnson and James Kwak's article in May's The Atlantic -
The Quiet Coup.
Here you will find a more sobering discussion of the US economy and its financial system.
Posted by: MarkS at April 19, 2009 12:36 PM
Interesting charts. On the basis of correlation, one would conclude that government 'stimulus' consumption actually makes things worse. But even if you reject that and say "things would be even worse without it", you are damning the foresite and understanding of economists who did not see a train wreck in the making. It is lose-lose for the Fed and Treasury on this one.
Posted by: wally at April 20, 2009 08:27 AM
Following MarkS advice, I read "The Quiet Coup".
This is the best article I have read on our current economic crisis. It is good because it contains both an reasonable explanation of what went wrong and a useful set of advice for how to fix the problem.
OBAMA NEEDS TO READ THIS ARTICLE AND THINK ABOUT IT.
Posted by: ReformerRay at April 20, 2009 09:34 PM
Interesting graph - the policy response charts (last two on the bottom right) tie in nicely with the messages from O'Rourke/Eichengreen comparing now (2009) with then (1929).
Posted by: Ronan L at April 22, 2009 04:40 AM
I hate to spoil the optimism but I see a major problem going forward. If economic activity picks up there will be a serious problem with energy supply. Production from existing fields is falling and will continue to fall. To prevent a decline we will need trillions of new investment and I just don't see that happening. At the same time the increased activity will come with massive inflationary pressures as the supply of money and credit is growing faster than the supply of real goods and services.
Sadly, I do not see a pick-up of real economic activity. Much of what I expect to see will be driven by subsidies and handouts that divert investment into politically popular but wealth destroying activities that push such things as "green jobs" or "biodiesel." That should make things worse rather than better and the most optimistic scenario has us postponing the inevitable and necessary liquidation for a short period.
The bottom line is that sound economic theory leads us towards one conclusion. We will have an inflationary depression that will kill the purchasing power of the USD. That means that the smart play is to hedge by having exposure to precious metals.
Posted by: Vangel at April 22, 2009 03:48 PM