Don’t Count Your Recoveries Before They’re Hatched

Ben Bernanke, the Federal Reserve chairman, sees “green shoots.” President Obama sees “glimmers of hope.” And the stock market has been on a tear. Are we out of the woods? Is the recession about to end? The recent news is certainly better but there are many reasons to be cautious about the economic outlook.

The International Monetary Fund (IMF) has just issued its gloomiest forecast ever. It says world GDP, which has never shrunk since the Great Depression, will shrink 1.3% in 2009, and then inch up to 1.9% in 2010. Growth of less than 2% indicates a global recession. So, serious recovery will not come before 2011.

The IMF sees world growth being strangled by what it calls negative feedback loops. The financial crisis first reduces cash flow to producing sectors. This causes a recession, with producing sectors slashing production and employment. But the recession then makes the financial crisis worse — more corporations and individuals default on bank loans. The banks respond by cutting credit further, and this hits production and employment further. This is the negative feedback loop.

The current global recession is likely to be unusually long and severe and the recovery sluggish because it sprang from a financial crisis. New IMF analysis shows recessions tied to a financial crisis, like the current one that has its roots in reckless lending for the U.S. housing market, are more difficult to shake because they are often held back by weak demand. Worse still is that today's recession combines a financial crisis at the heart of the United States, the world's
largest economy, with a broader global downturn making it unique.

The 2001 recession officially lasted only eight months, ending in November of that year. But unemployment kept rising for another year and a half. The same thing happened after the 1990-91 recession. And there’s every reason to believe that it will happen this time too. Don’t be surprised if unemployment keeps rising right through 2010.

Why? “V-shaped” recoveries, in which employment comes roaring back, take place only when there’s a lot of pent-up demand. That’s not what’s going on this time: today, the economy is depressed, loosely speaking, because we ran up too much debt and built too many shopping malls, and nobody is in the mood for a new burst of spending.