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History tells us to expect slow economic revival

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After green shoots, false dawns and any other overused metaphor you can think of to describe spring’s awakening (sorry) for the U.S. economy, is this the real deal?

The green shoots from years past have turned brown. The dawns are late and the dusks early this time of year. And in the spring, will it grow?

OK, enough indulgences. The question is: Four-and-a-half years after the recession ended, is the U.S. economy finally going to achieve a respectable and sustainable path of growth? Recent economic data provide reason for optimism. History argues for a more cautious approach.

Believe it or not, some folks are saying that the current expansion is in danger of expiring of old age. And it is old, compared with the average postwar business cycle of 58 months, according to the National Bureau of Economic Research.

The business cycle per se isn’t the reason the economy has been shuffling along at an average growth rate of 2.3 per cent since the 2007-2009 recession ended. It’s the hangover from the financial crisis that makes digging out such an ordeal.

Economists Carmen Reinhardt and Ken Rogoff laid it all out in their 2009 book, This Time Is Different: Eight Centuries of Financial Folly, telling us to expect a slow return — a crawl, actually — to normal. Their study of eight centuries of financial crises found that stocks and real gross domestic product return to their pre-crisis levels relatively quickly. Not so for real house prices and employment.

"Employment is the last to recover," said Reinhart, a professor at Harvard’s Kennedy School of Government.

Recently Reinhart has turned her attention to the behavior of real per-capita GDP during and after systemic banking crises. Her study of 100 crises found that it takes an average of eight years for that measure of income to reach the pre-crisis level.

"Of the 12 developed countries that had systemic crises, only two — Germany and the U.S. — have gotten back to their 2007-2008 per-capita income peak," Reinhart said.

And something else: double-dip recessions are fairly common in recoveries from systemic crises. (Reinhart treats any renewed downturn before the economy reaches its prior peak as a double dip.) For the United States, five of nine episodes were associated with double dips.

Short of some external event, the odds of that happening now are slim. There is no chance the Federal Reserve will do anything to impede growth. Monetary policy will continue to provide support, probably until well after it’s needed (just to be safe). Fiscal policy is still a crapshoot. But even if you believe that automatic discretionary spending cuts have been crimping growth, the relaxation of those cuts is imminent.

Some economists have argued that an economy growing at a sub-2 per cent rate leaves it vulnerable to a shock that could tip it into recession. Heck, when growth is that slow, all it takes is a big drawdown in business inventories to tip GDP into negative territory.

"There’s no compelling reason to believe we’re headed to another downturn," Reinhart said.

Household deleveraging — almost $900 billion since the peak in the first quarter of 2008 — has stalled for the moment, she said. With the household debt service burden, or the ratio of debt payments to disposable personal income, down to a record low, it seems the threat from another round of deleveraging is limited.

So what’s standing in the way of robust growth? Recent economic reports on employment, consumer spending, industrial production and housing have inspired renewed optimism of faster economic growth next year: three per cent, perhaps.

Maybe. Since the recession ended, real GDP growth topped three per cent in only four quarters. Even a decade after a financial crisis, GDP growth remains one percentage point lower than pre- crisis levels, according to Reinhart. And the unemployment rate doesn’t usually go down to pre-crisis levels, she said. That was true in 10 of 15 recent busts in developed economies.

"We don’t see a real reason to think there will be any spark of recovery," Reinhart said.

In other words, it’s a long slog. It doesn’t mean the U.S.’s best days are behind us, or that everything that can be invented has been invented. Secular stagnation doesn’t describe what ails the U.S. economy. We’re still hungover from the last binge.

We desperately want to believe that the current cycle is similar to those we lived through, or heard about from our parents. That’s a false model, according to Reinhart. The sooner we accept that, we can lower our expectations. And who knows? One of these days, we just may be surprised.

Caroline Baum, author of Just What I Said, is a Bloomberg View columnist.

— Bloomberg

 

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