Simon Arcus: The Wheel of Fortune Recovery

Image/ Wikimedia Commons

One of the 'take home' messages of a paper released yesterday by the NZ Institute of Economic Research was the economy can expect a 'long period of subdued growth' even when the recession is halted. Hardly uplifting news, but implied discussion of recovery reflects a change in sentiment in some quarters which might be called 'incrementally optimistic'. The economic chatter in the US and Australia of late has an undertone that the steep decline brought on by the credit crisis is slowing and there are embryonic signs of amelioration.

On 16 March US Federal Reserve chairman Ben Bernanke, referring to 'green shoots' in the markets, predicted that America's worst recession in decades will likely end this year before a recovery gathers steam next year. Only two months earlier British Business Minister Baroness Vadera had been roundly lambasted for making a similar comment. Though home foreclosures in the US are at a record number and US unemployment at its highest in 25 years a number of economic commentators are surprised by the length of what was thought by some to be a 'fool's rally' in the US stockmarket.

Of course, all bets are off if we see an unexpected failure of another American behemoth like a major bank or financial institution but that is looking increasingly unlikely.

A recovery is certain - sooner or later. But as some economists have observed, the synchronicity in economies during the crisis means the way US recovers could be highly influential in our own recovery. That may be in a 'shape' we have not experienced before.

In the television show 'Wheel of Fortune' you pick letters from a selection which inevitably determines how well things play out for you in the game. Our own possibilities in the recession game are limited to four important letters. They are V, W, U and L and their 'shapes' correspond to the type of economic recovery.

In a 'V' shaped recession an economy experiences sharp recession but quickly recovers. There was initial hope the recession in the US could follow a 'V' pattern but this was quickly abandoned when the scale of the crisis was realised. A 'W' shaped recession is a sharp downturn which is followed by variance in recovery. Growth spikes like that of the last two months meet serious dips on the way to recovery. There are those who say the US is actually in a 'W' movement partly caused by US tax rebates. The average rebate is over US$2500 each year and as consumer spending flows into the economy positive economic growth may be seen in Q 2 or 3. But such a positive 'blip' is unsustainable and followed by a negative growth in later 2009.

In a U-shaped recession, the economy takes a much longer period of time to recover. Some believe that the US is in a U-shaped recession for three broad reasons. First, the housing crisis can only resolve very slowly. Second, the household sector is more directly affected this time where the corporate sector usually bears the brunt. Household consumption appears to be declining which is not always the case in a recession. Third, the US is experiencing its most severe financial crisis since the Great Depression and losses have spread well beyond the subprime market that ignited the disaster.

Worst case scenario is an L-Shaped Recession which is a sharp recession, followed by years of stagnant growth. A clear example of an L-shaped recession is Japan in the 1990s. After huge contraction in the housing and equity markets, the country suffered a decade of growth stagnation and/or recession. In a recent address at the Peterson Institute for Institutional Economics, the IMF's former Chief Economist Mike Mussa observed that only one truly L shaped recession had been recorded in the US and that was in the unusual conditions immediately following the Second World War.

Entwined with the question of recovery in New Zealand and the US is 'whither inflation'? In his annual letter to shareholders this week, Warren Buffet accepted the need for Government stimulus measures but said their impact is "anyone's guess, though one likely consequence is an onslaught of inflation." By contrast, Paul Krugman cites factors such as falling wages, high unemployment and a thrift mentality in the US as indicative of deflation.

It is too early to say what shape the recovery will take or how inflation will fare though the NZIER makes the interesting observation that the peak in unemployment is approaching. Nonetheless, some tentative and sensible optimism would be a welcome break from the outlook of the last six months.

Simon Arcus is a lawyer who has lived in Sydney and Auckland