Tuesday, August 23, 2011

What happened to the recovery?

The recession officially ended in June 2009 and was followed by a modest recovery in late 2009 and 2010 (which is normal when an economy recovers from a financial crisis).  However, the recovery ground to a halt in 2011.  While growth in the second half of 2010 was just below 2.5%, it fell to less than 1% in the first half of 2011.  The economic weakness was across the board, as growth in consumption declined from 3% in the second half of 2010 to 0.1% in the second quarter of 2011, reflecting consumers who were already deleveraging and then were hurt by a spike in gas prices.  Business investment grew more modestly as investment in equipment rose moderately after experiencing double-digit growth in the first 1.5 years of the recovery, suggesting that firms had been making up for the severe decline in equipment investment that took place during the recession.  Similarly, export growth has moderated from the bounceback that took place following the end of the recession.  Nondefense government purchases have experienced declines, particularly at the state and local level as state and local governments reduce spending to balance their budgets.

What happened?  Recoveries following financial crises tend to be weak.  Stimulus from fiscal and monetary policy provided a temporary boost, but did not solve the underlying problems faced by the economy.  As consumers continue to struggle with high debt, underwater mortgages, high unemployment and underemployment, and stagnant wages, consumption will remain weak (or worse when faced by shocks such as spikes in oil prices or significant declines in the stock market).  Government will be a drag on economic growth as we enter the age of austerity (the only question is how much of a drag).  Exports, which are dependent on the state of the global economy, will grow at a slower rate due to the slowdown in the global economy, which is very weak in Europe and moderating in areas that had been experiencing rapid growth (Asia and Latin America).  Given the limited demand for their products, growth in business investment will be modest.

Currently, the debate is whether the US will experience weak economic growth over the next couple of years or have an outright recession.  The signals are mixed as some indicators suggest weak growth (for example unemployment claims) while others indicate that there is an increasing risk of recession (such as significant declines in various regional purchasing manager's indexes).  Whether we have a "growth recession" (anemic economc growth) or a recession (decline in economic activity), the average person may not notice the difference.