Technical recovery won’t feel like a recovery to most
Everyone is trying to gauge when a ‘recovery’ is going to occur in the United States and globally. Some see imminent recovery. Other like myself see a late-2009 or early-2010 recovery. Yet others, including most readers of this site, see no recovery for quite some time. So, naturally, we should ask: just what is a ‘recovery’ anyway? Below, I want to answer this question and introduce the term ‘technical recovery.’
In the U.S., the National Bureau of Economic Research is the arbiter of recession. In announcing the beginning of this recession, the NBER issued a statement with some informative FAQs. Below are some highlights. The link to the full text is here.
Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER’s recession dating procedure?
A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. As an example, the last recession, in 2001, did not include two consecutive quarters of decline. As of the date of the committee’s meeting, the economy had not yet experienced two consecutive quarters of decline.
Q: Why doesn’t the committee accept the two-quarter definition?
A: The committee’s procedure for identifying turning points differs from the two-quarter rule in a number of ways. First, we do not identify economic activity solely with real GDP, but use a range of indicators. Second, we place considerable emphasis on monthly indicators in arriving at a monthly chronology. Third, we consider the depth of the decline in economic activity. Recall that our definition includes the phrase, “a significant decline in activity.” Fourth, in examining the behavior of domestic production, we consider not only the conventional product-side GDP estimates, but also the conceptually equivalent income-side GDI estimates. The differences between these two sets of estimates were particularly evident in 2007 and 2008.
Q: Isn’t a recession a period of diminished economic activity?
A: It’s more accurate to say that a recession—the way we use the word—is a period of diminishing activity rather than diminished activity. We identify a month when the economy reached a peak of activity and a later month when the economy reached a trough. The time in between is a recession, a period when economic activity is contracting. The following period is an expansion.
I would like to highlight the term ‘diminishing activity’ and the answer to the last question above because this is the crux of the matter. The NBER is looking to date the period when economic activity is diminishing, not when it is diminished. That means that economic activity MUST be LOWER when an economy ends recession and starts a recovery than when it entered the recession. Recovery starts from a position of diminished economic activity. I attempted to get this point across in detail in my post “Economic recovery and the perverse math of GDP reporting.”
So when Nouriel Roubini says that a recovery in 2010 will be so slow that it will feel like a recession, this is what he is talking about. Most people will not think of this as recovery any more than they did in 2002 or 1991.
The period just following recession until the previous level of output before recession is re-attained is what I will term a ‘technical recovery.’ This is a time during which economic activity is increasing, but the economy is still operating below levels of the recent past. Unemployment will still be rising and many businesses will still be going bankrupt. Because this period will still be very painful for many, it seems perverse to call it a recovery. So, let’s use the term ‘technical recovery’ to describe this phenomenon. That way, we all understand the reality behind the numbers.
I actually expect a weak “recovery” and declining equity markets despite the “recovery.” I think the markets would sell off during this “good news.”
That’s pretty much my view here as well, especially given the size of the rally from March. The problem with a selloff in such a fragile economy is that it could create a feedback loop with the real economy that brings down the level of economic activity to a point where we re-visit crisis.
If we can get through September reasonably well, then the weak recovery should be the most likely outcome.
I do not know if a decline in stock prices and corporate bonds would affect the real economy significantly…
I doubt the that difficult to get equity financing would affect the real economy. Maybe a wealth effect caused by declining stock prices (since many people are long beta for retirement in the US relative to other countries such as Germany and France) would lead to decreased consumption, but I think that has already taken place. Maybe wider corporate bond spreads would make it hard for firms to raise debt capital, but I doubt anyone would borrow during the Richard Koo balance sheet recession.
I just do not want any more bad news on the real economy although my parents would benefit from declining stock prices since they took my advice to open short positions on the S&P 500 in the first week in June when it was obviously overbought. I think equities need to fall more and offer large cash yields; to me they are overvalued compared to the “bubble” asset of treasuries. 10 Year Treasuries at 2% might be justifiable in a deflationary environment and was justified by the fundamentals, but the technicals do not justify that because the 2% coupon does not compensate for upward yield volatility. I suppose one reason why Japanese government bonds have low yields because the volatility on that asset class is low . (although the JGBs bubble popped in 2003 causing a large 100 basis point rise in interest rates)