Monday, April 07, 2008

Roubini on Shape of Recession

by Bill McBride on 4/07/2008 06:13:00 PM

Note: A "V" shaped recession is usually short, and fairly shallow like in '90-'91 and '01. Both of those recessions lasted 8 months. A "U" shaped recession is longer and possibly deeper.

A "W" shaped recession is a double dip (like in '80 and '81/'82). And an "L" shaped recession is like the experience in Japan in the '90s.

Professor Roubini writes: The US Recession: V or U or W or L-Shaped?.

My view is ... a U-shaped recession as I expect that the economic contraction will last at least 12 months and possibly as long as 18 months through the middle of 2009. This view is based on the fact that the last two recessions – in 1990-91 and 2001 – lasted 8 months each and today the macro and financial conditions are worse – relative to those two previous recessions - in at least three dimensions:
1. We are experiencing the worst US housing recession since the Great Depression ...

2. In 2001 it was the corporate sector (10% of GDP or real investment) to be in trouble. Today it is the household sector (70% of GDP in private consumption) to be in trouble. ...

3. The US is experiencing its most severe financial crisis since the Great Depression. This is not just a subprime meltdown. ...
Could the US recession end up being W-shaped, i.e. a double-dip recession? This view is presented by those who argue that the recent fiscal stimulus – that will provide a tax rebate to US households in May-June – could lead - after negative growth in Q1 and Q2 - to a positive economic growth in Q3 and possibly part of Q4 to be followed by a relapse into a second recession by year end or early 2009 when the effects of such fiscal stimulus fade out. Such a W-shaped recession – effective a U-shaped recession with a small temporary upward blip in the middle of it (thus a W-shaped one) cannot be ruled out. ...

Finally, could the US experience an L-shaped recession, i.e. a protracted period of economic stagnation like the one experienced by Japan in the 1990s after the bursting of its housing and equity bubble? My view is that a protracted economic stagnation – bordering on an economic depression – is unlikely in the case of the US as the policy response of the US is already more aggressive than the one of Japan. ...

This will turn out to be the most severe recession and financial crisis that the US has experienced for decades. Thus, the current conditions and valuations in US equity and financial markets – that currently price a mild and shallow recession – will be proven wrong as the bottom of the real economic contraction and the bottom of the financial and credit losses are ahead of us rather than behind us. ...
My major area of disagreement with Roubini is the severity of the recession. I also think the recession will linger (at least the effects of the recession). And a double dip is very possible.

But to say this will be the "most severe recession" in decades suggests job losses - and a corresponding increase in the unemployment rate - that I don't see on the horizon. The good news is that manufacturing employment is holding up better than usual in a recession due to a combination of a weak dollar (strong exports) and relatively strong global growth. This doesn't mean the recession won't be painful for many - I think it will be. And the recession could be severe if manufacturing contracts sharply (probably due to a global recession), but I think this is less likely than Roubini.