How the Last Recession Shaped Up - Analyst Blog

The recession is over. Or is it? Economic data assert it is safely behind us, but to most Americans, the change is not yet palpable. We are still reeling under the losses incurred during the recession, and trying to make better sense of what we have just been through.

In retrospect, what does our harrowing experience look like? Economists commonly describe the course of a recession as a V, U, W, or an L, denoting the ups and downs as they occur. Which of these does the latest phenomenon resemble? A look at the movement of the economy in the third quarter of 2010 would help.

A Laggard Recovery   

According to the National Bureau of Economic Research (NBER), the recession officially ended in June 2009. The U.S. economy grew at an annual rate of just 2% in the third quarter of 2010, up slightly from 1.7% in the prior quarter, states the Bureau of Economic Analysis. However, the growth was still too weak to whittle down the unemployment rate of 9.6%.

A sharp contraction in imports and increased private inventory investment and personal consumption expenditures (PCE) helped improve the real GDP in the third quarter. However, this increase was partially offset by lower exports, a slump in residential fixed investment and lower nonresidential fixed investment.

Consumption witnessed the fastest growth of 2.6% since 2006. This, however, is difficult to be sustained as high unemployment and low wages will force consumers to tighten their purse strings.

Concerns also prevail in the slow growth in business investment. Besides, with the expiry of a tax credit for home buyers, the expected housing investment recovery has been aborted.

Low Consumer Confidence Index

The Consumer Confidence Index (CCI) is a qualitative indicator designed to measure the degree of consumers' optimism on the state of the economy. The survey-based index measures the direction of the economic movement based on people's feeling. A higher CCI implies chances of increased personal consumption expenditures, indirectly resulting in economic growth.

Though the US, CCI climbed for the first time in three months in November 2010, the current calibration still hovers around its lowest levels in the last two years.The University of Michigan's preliminary confidence survey index rose to 69.3 in November, up from 67.7 in October.

However, we can see that borrowing is still decelerating, reflecting the fact that consumers are still not ready to return to the pre-recession spending level as their assessment of future conditions is a little cautious.

Concerns also persist about the self-fulfillment of such prophesies; they can end up as regressive expectations. Sometimes predictions misguide consumer behavior, precipitating an economic downturn.

The Curve of the Matter

Is the latest recession curve best compared to a V, U, W, or an L? On a graph representing economic growth or recession, each of these letters will measure the percentage change in real GDP in the vertical axis and the time in the horizontal axis.

The V-Shaped Recession:  This is the most optimistic situation for an economic recovery, when an economy slumps sharply but recovers as quickly (within a few months). When the current recession started in the United States, many economists expected it to take a V shape. The recovery, though, failed to kick-start.

The U-Shaped Recession:  Under this situation, after a sharp fall, growth remains stagnant for an extended period (usually around 12−24 months) before curving upwards. Many believe that the United States is currently experiencing a U-shaped recession. However, the down phase has been too long-drawn to remain in the category.

The W-Shaped Recession:  This is what is more commonly known as the "double-dip” recession. A sharp downturn is followed by a temporary recovery and then a second sharp fall before rebounding fully. These downturns start like a V but repeat quickly again. The current recession has laid double-dip fears to rest as the GDP is yet to grow to the pre-recession level.

The L-Shaped Recession:  This is the worst-case scenario for an economic recovery. Under this situation, following a sharp recession, growth remains stagnant for a very long period (about 7−10 years). Though the recovery phase of the current recession does seem more protracted than the usual U-shape, an L-shaped recession seems fairly unlikely as the U.S. economy has already started recovering, though at a slow pace.

Although the financial industry is still grappling with liquidity and confidence challenges, it is now comparatively stable with financial support from the U.S. government. The government had taken several measures, including programs offering capital injections and debt guarantees, to stabilize the financial system.

Once plotted, the recessionary curve shows a defined upward bias, though gradual, that stops it from being an out and out L but is too flat to be called an U. What it does resemble is a flattened U, a half circle with a wide arc, concave to the horizontal axis.

The Shape of The Future 

Though the worst of the recession is behind us, the purchasing power of the Americans has not rebounded yet. The movement of the economy in the rising arm of the curve will depend on the aggressiveness of the U.S. government through effective policy measures. However, the banking system is not yet out of the woods due to persistent problems, and shifting the government's strategy to catalyze growth would become a major challenge ahead.

In addition, the continuation of bank failures has resulted in a wave of consolidation in the industry. When Washington Mutual was in the red in 2008 as the largest bank failure in the U.S. history, it was acquired by JPMorgan Chase & Co. (JPM). The other major acquirers of failed institutions since 2008 include U.S. Bancorp (USB) and BB&T Corporation (BBT).

If the current pace of consolidation continues, we will see the emergence of a handful of large banks, exposing the industry to an oligopolistic market, which is not desirable. Lower competition will disturb the basic financial services that are the life blood of the economy, further flattening the curve.

However, we should not expect the U.S. economy to rebound without utilizing all its resources. For many years, outsourcing has been a lucrative business practice and there needs to be a viable alternative for the fund outflow to be stopped. The current shape makes us optimistic about the economy's rallying round fully, though the timing is difficult to predict.

 
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