Wednesday, September 9, 2009

Do Double-Dip Recessions Really Happen?

As mounting evidence is pointing to a respectable pace of GDP growth in the second half of the year (probably around 3%), voices of disbelief that this is indeed the beginning of a much-awaited sustainable economic recovery also seem to be growing louder.

The argument those doubters are making is that the next couple of quarters will prove to be a fake recovery and the economy is at a considerable risk of slipping back into recession shortly afterward. A closer look at the pattern of past recessions and ensuing recoveries shows very little support for the concept of a so-called double-dip recession, as such an episode has never actually happened in, at least, the last 75 years or so (i.e since the Great Depression).

The implicit reasoning of the double-dip camp seems to be that this recession has definitely been not of the "run-of-the-mill" variety- in terms of contributing factors, severity, and duration. This suggests that one has to be open to the possibility that a more unconventional pattern lies ahead, which may deviate from historical precedent. Granted, this is a seemingly legitimate point. Still, the odds that the slowly unfolding economic recovery will prove to be a simple interlude on the way to another significant leg-down in the economy are extremely slim.

Let's consider the following.

The average duration of the last 13 economic expansions- going back to the mid-1930s) has been approximately 60 months, with an extremely wide range of 12 to 120 months (

The closest approximation to a double-dip recession that one can find in that period is the 1980-82 episode, in the sense that, within a year after the end of the shortest-lived recession on record in July 1980, the U.S. economy slipped into another recession in July 1981, the latter lasting until November 1982. Reasonable people have attempted to make (cautiously) the point that this was essentially one long, "two-stage" recession, from January 1980 to November 1982, with a fake-out recovery in-between.

Intellectually intriguing as this argument may seem, it does suffer from a major flaw, which undercuts its historical legitimacy when it is attempted to be superimposed on the current economic environment. The 1980-81 initial recovery and subsequent second recession were not a case of a feeble recovery in the second half of 1980 that never quite took hold and ultimately fizzled by mid-1981. It was quite the opposite. This was in fact a case of an extremely robust recovery in the second half of 1980, that stoked fears that the Fed's titanic struggle against inflation would be jeopardized. As a result, then Fed Chairman Paul Volcker tightened aggressively again sending short-term rates to above 20% by the spring of 1981 and, predictably enough, throwing the economy into a second tailspin.

In other words, the 1981-82 recession did not happen simply because the economic recovery in the second half of 1980 just fizzled. Instead, it was the result of a very determined campaign by the Fed to finish off the project of rolling back inflation at the calculated cost of causing a second recession.

Beyond the clinical review of basic historical facts, there is a more solid explanation as to why double-dip recessions are extremely rare, if possible at all.

The reality is that once an economic recovery gets underway, it is not easily derailed, as a classic expansionary dynamic takes hold that ultimately propels economic activity forward. The expansionary dynamic in question consists of a combination of pent-up consumer demand, in conjunction with a need to replenish badly depleted inventories, both of which lead to a pick up in production. In the current environment, the upturn in growth already underway in Asia and, to a more moderate degree, the Eurozone, adds another source likely to provide impetus to the fledgling economic recovery in the U.S. Moreover, the bulk of the fiscal stimulus spending approved earlier in the year still lies ahead and stands a good chance of becoming the cohesive element that will pull everything together to create an expansionary dynamic.

One can question how strong the forward momentum of the economy will be once we get past the second half of this year, as there are indeed considerable headwinds (see, reluctance of banks to lend) to deal with. But, sounding the alarm of a "double-dip" recession ahead is just going a little too far...


1 comment:

  1. Interesting commentary. It seems the most likely outcome is lackluster growth. And I question how the expansionary dynamic can effect the consumer. The degree of wealth destruction, with an unlikely material reversal (at least on the housing side), seems to paint a pretty clear picture for a higher savings rate and a low contribution to growth. And with that headwind, can we expect animal spirits to return to the corporate sector given over-capacity?