The current economic contraction longest since 1929 Economics Theory

The current economic contraction began in December 2007 with unemployment at 5.0 percent. Joblessness climbed slowly month after month until it peaked at 10.1 percent in October 2009. Today, according to the June report from the Bureau of Labor Statistics, unemployment stands at 9.5 percent. Congress, the White House, and the media have hammered away at this near double-digit jobless rate for months in part because President Obama insisted that joblessness would not climb above 8 percent if his stimulus package were approved. Thus, most Americans including those who have not been personally touched by the economic slump are aware that the last time joblessness reached 10 percent was in the early 1980s. However, the public probably does not know that the current contraction very likely is the longest on record since the 43-month contraction in August 1929-March 1933.

The official agency that dates the business cycle in the United States is the Business Cycle Dating Committee of the National Bureau of Economic Research. Unlike many others, the Committee does not define a recession as two consecutive quarters of a decline in GDP. Instead it defines a contraction as a significant decline in economic activity across the economy that lasts more than a few months as indicated by real GDP, real income, employment, industrial production, and wholesale-retail sales. It has not yet determined the date of the trough in economic activity that identifies the end of the current contraction.

If the Committee determines that the trough came in May 2009 the current contraction would have lasted 17 months and would become the longest on record since 43-month contraction in August 1929-March 1933. Longer than the 16-month contractions in November 1973-March 1975 and July 1981-November 1982.

Since the jobless rate to date has not fallen below the May 2009 rate of 9.4 percent, Mayo Research Institute expects the Dating Committee to fix the end of the contraction sometime later in 2009, possibly October when joblessness hit 10.1 percent. An October 2009 trough would make for a contraction that lasted 22 months. What sets this contraction apart from the other 12 contractions since 1929-1933 is a combination of a very high unemployment rate and a nearly two-year duration.

Concerns about the size of the federal deficit and the public debt, the still fragile housing and commercial real estate markets, continuing bank failures, cash-laden investors shying away from shaky financial markets, sagging consumer confidence, the weakening of the euro, the future of deepwater drilling, contagion related to the sovereign crisis in Greece that may spill over to Italy, Spain, Portugal, and Ireland, already scheduled higher tax rates starting in 2011, not to mention geopolitical instability in Mideast, make for fears that any economic expansion following the current contraction will be cut short. In other words, we may be headed toward a double-dip recession.

There are two instances of double-dip recessions since the end of World War II: the April 1958 trough that was followed by an expansion phase that lasted only 24 months; the July 1980 trough followed by an even shorter 12-month expansion phase. In sharp contrast the last three expansion phases lasted 92, 120, and 73 months.

With the two double-dip recessions, tax cuts were the prescribed remedy though in the first case President Kennedy’s Keynesian economic advisers justified the cuts in the early 1960s as necessary to strengthen aggregate demand. In the second case President Reagan’s supply-side advisers, having lost confidence in Keynesian economics, argued the need in the early 1980s to bolster aggregate supply.

Is the United States headed toward a double-dip recession? NO, if the necessary market corrections already have taken place and prices across the board have declined sufficiently to clear away surpluses in labor, resource, product, and financial markets. YES, if those surpluses remain in place and further corrections are necessary.

It could be argued that the very duration of the current contraction has provided all the correction needed. But keep in mind that the huge contraction that ended in March 1933 did not provide all of the correction necessary to haul the U.S. economy out of the Great Depression. That 43-month contraction was followed by a 13-month contraction that got underway in May 1937.

Even the best economic analysts see the future as if “through a glass, darkly.” Even so, Mayo Research Institute hazards two forecasts, both based on the historical record. First, whether a double-dip recession is in our immediate future or not, we can say with considerable confidence that the jobless rate will remain high for several more years because economic history demonstrates that labor markets respond slowly to market corrections. To illustrate, it took 14 years for the August 1983 jobless rate of 9.5 percent to drop to 4.9 percent.

Second, whether there is a double-dip recession in our immediate future or not, we can say with even more confidence that there is another contraction further down the road. Leaving aside the war years of the early to mid 1940s, we experienced two contractions in the 1940s, two in the 1950s, one in the 1960s followed by another that began at the very end of the decade and extended into the next, one other in the 1970s, two in the 1980s, one in the 1990s, and two others more recently.

What we don’t know with any measure of certainty is when that contraction will take occur. Mayo Research Institute is inclined to think that next expansion phase will not run as long as the last three which averaged 8 years because all three were driven by the job-creating, entrepreneurial energy of the ICT revolution. Based on the 9 other expansions since the end of World War II, our best guess is that the coming expansion will peak in approximately 4 years. If as we suggested earlier the latest trough is dated sometime around May-October 2009, it follows that the coming expansion phase will top out sometime in 2013.

The historical record establishes clearly that economics has not yet figured out how to prevent a contraction. Further, economics is split on how best to cure a contraction with Keynesians, monetarists, supply-siders, and neoclassicals offering different remedies. At best we are able to alleviate some of its effects through programs like unemployment insurance until the slump ends and expansion sets in. Some argue, however, that by putting off the necessary market corrections alleviative measures such as extending the maximum duration of unemployment insurance benefits from 26 to 99 weeks make the contraction even worse.

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So what exactly is a 'double-dip' recession? Economics Theory

Concerns are rising that the economy is at risk of slipping into a "double-dip" recession.

High unemployment, Europe's debt crisis, a slowdown in China, a teetering housing market and sinking stock prices are all weighing on a fragile U.S. recovery.

So what exactly is a double-dip recession?

Robert Hall has an idea of what one looks like but no precise definition. He's chairman of the National Bureau of Economic Research, a group of academic economists that officially declares the starts and ends of recessions.

In Hall's view, a double dip is akin to a continuous recession that's punctuated by a period of growth, then followed by a further decline in the economy.

The NBER doesn't define a double dip any more specifically than that, says Hall, an economics professor at Stanford University.

In econo-speak, Hall explains: "The idea — hypothetical because it has yet to happen — is that activity might rise for a period, but not far enough to complete a cycle, then fall again, and finally rise above its original level, only then completing the cycle."

Hall says the closest the United States has come to a double dip was in 1980 and 1981. But the NBER concluded that those were two distinct, though closely spaced, recessions — "not a double dip," he says.

Not so, says Sung Won Sohn, professor at California State University, Channel Islands. Sohn says the back-to-back recessions of the early '80s fit his definition of a double dip: A recession followed by a short period of growth followed by a recession.

Brian Bethune, economist at IHS Global Insight, has a view similar to Hall's: A period in which the economy shrinks, starts growing again and then shrinks again — for at least six months.

"There is no mathematical formula; it's a judgment call," Bethune says.

The NBER has declared the economy fell into a recession in December 2007. It hasn't yet pinpointed an end to the recession. It said in April that it would be "premature" to do so.

Many other economists say the recession ended in June or July of last year. The economy returned to growth again in the third quarter of 2009, after four straight quarters of declines. More recently, the economy has added jobs in each of the first five months of this year.

Still, the threats to the recovery from overseas and at home are growing. So are the risks that the recovery will fade out. Economists say the odds of that remain low but have crept up since a couple of months ago. Analysts are downgrading their growth forecasts for the second half of this year.

In determining the starts and stops of recessions, the NBER reviews data that make up the nation's gross domestic product. The GDP measures the value of goods and services produced in the United States. The NBER also reviews incomes, employment and industrial activity.

The panel, based in Cambridge, Mass., tends to take its time in declaring when a recession has started or ended.

It announced in December 2008 that the recession had actually started one year earlier — in December 2007.

And it declared in July 2003 that the 2001 recession was over. It had actually ended 20 months earlier — in November 2001.

In President George W. Bush's eight years in office, the United States fell into two recessions. The first started in March 2001 and ended that November. The second started in December 2007; its end date is pending the NBER's determination.

The timing of the NBER's decision likely means little to ordinary Americans now muddling through a sluggish economic recovery and weak job market.

Many will continue to struggle. Unemployment usually keeps rising well after a recession ends. After the 2001 recession, for instance, unemployment didn't peak until June 2003 — 19 months later.

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How to fix US deficit: Stick to the law

I haven’t had a chance to digest CBO’s long-term outlook yet (released earlier today), but luckily I did see Ezra Klein’s post on it, which featured two charts which highlight the difference between CBO’s current-law baseline, and their “alternative fiscal scenario” which is more of a “policy-extended” baseline–similar to the one the Obama Administration uses as the baseline relative to which they measure the costs (or savings) of their budget proposals.

In theory, CBO’s deficit assumptions project the effects of settled law. And if you do that, revenues pretty much pay for spending over the next few decades.

Note that the chart shows that under CBO’s “extended baseline” scenario, reflecting current law, “primary balance” is achieved, where there is no “fiscal gap” between non-interest spending and revenues. That doesn’t mean the federal budget is perfectly balanced, because interest costs take total federal spending above revenues, but it does mean that the deficit is pretty small–as a matter of fact, less than 3 percent of GDP by 2015, which means it’s economically sustainable (because at 3 percent, the stock of federal debt is growing at about the same pace as the economy).

Coincidentally, this picture above could also be labeled “2015 Goal of President Obama’s Fiscal Commission”–because the commission’s goal is also to achieve “primary balance” and a “sustainable” level of deficits by 2015.

So CBO is showing us we don’t have to do anything to achieve fiscally-responsible policy over the next 25 years. It’s already set by laws we’ve already passed. Congress can go home. They don’t need to pass any deficit-reducing legislation, and President Obama doesn’t have to sign it.

Well, unfortunately life is not so simple. As Ezra warns:

But current law is not likely to advance unmolested. You’ll notice, for instance, that there’s a big jump in current-law revenues next year. That’s because the Bush tax cuts are slated to expire totally. But few expect Congress to allow them to expire totally. They’re likely to preserve the bulk of the cuts, rejecting only some of the cuts that helped out the rich.

Ah, but here’s where the President’s fiscal commission can help us stick to the “simple” solution of holding onto current law. They can make it simpler to hold onto this fiscally-responsible, current-law policy over the longer run by giving their blessing to letting go of current law (only) temporarily–letting Congress and President Obama enact a (popular) tax cut to help the recovering-but-still-weak economy: an only temporary extension of the bulk of the Bush tax cuts. In exchange, the commission could require that the federal government get back on track in a couple years, recommitting to the picture above by getting back to the current-law baseline level of revenues. That doesn’t have to mean sticking to current tax law, but it does mean that any deviations from that “script” will have to be revenue-neutral. And that sounds a lot like an exercise in fundamental tax reform, which could boost the strength and sustainability of our federal revenue system even beyond the next 25 years.

In fact, this was a strategy that Bob Bixby, the Concord Coalition’s executive director (and my boss), recommended to the President’s commission today. From his written testimony:

That leaves us with tax policy. Sticking to the CBO current-law baseline on taxes, 19.7 percent of GDP, gets the budget deficit to the commission’s target. Legislatively, that represents the easiest option, as policymakers simply need to do nothing and let current law play out.

However, that does not mean current law represents the most desirable policy path to achieve the baseline level of revenues. If reverting to the pre-2001 era tax policy (with its higher marginal tax rates) at the beginning of 2011 is deemed undesirable for political reasons, or out of economic concern for raising marginal tax rates during the early stages of economic recovery, tax policy could be reformed to achieve the same revenue levels without raising marginal tax rates.

The commission might find fertile common ground on steps to improve the tax code in ways that would increase efficiency and thus increase revenues. A thorough scrubbing of the system to identify preferences that serve no compelling use or that could be altered in a resetting of priorities is long overdue.

The fact that the commission’s short-term goal is to achieve a lower deficit by 2015 and not sooner suggests a tax policy strategy that could acknowledge the concern of many economists about the dangers of “unwinding” our currently stimulative fiscal stance too quickly. The 2001 and 2003 tax cuts that President Obama has proposed to permanently extend could instead be extended only temporarily. If done for one or two years, this would be long enough not just to allow for a more solid economic recovery, but also long enough to develop a more fundamental reform of the federal tax system that could more efficiently achieve current-law revenue levels by 2015.

This would provide an opportunity to enact a tax policy that meets the commission’s 2015 goal, while earning bipartisan support, while also building a tax system capable of remaining adequate and economically efficient over the longer term — boosting our chances for economic growth and a more sustainable fiscal future.

And so, Ezra’s take-away lesson from the CBO report is (emphasis added):

Either Congress can pass and implement policies that will bring the long-term deficit under control or it can’t. Those are the only two choices here. But there’s no real mechanism for getting the deficit under control aside from Congress passing laws and then sticking to them.

I’ll have some of my own analysis of the CBO long-term outlook report later this week. There have been some changes to the two baselines CBO defines, some of those changes a bit puzzling and even intriguing.

(My Concord colleague, Josh Gordon, blogged more comprehensively about the CBO report and Bob’s testimony on Concord’s Tabulation blog today. As he emphasizes, our recommendations for achieving longer-term fiscal sustainability are not just “stick with current tax law” or the “stick with the current-law revenue baseline.” The largest longer-term challenge remains health care spending. But the biggest and most reliable “2015 lever” is clearly tax policy, and no matter how great the health-reform lever eventually works decades from now, we’ll still need the tax system to support that not-so-outrageous-but-still-expensive health care system over the longer run.)

A look at global economic developments Economic Theory

A look at economic developments and activity in major stock markets around the world Thursday:

SHANGHAI — Slowing global demand and a retreat from stimulus policies led to a weakening in China's manufacturing in June for a third month.

Reports from Market Economics also indicated that manufacturing sector growth in India, South Korea, Australia and Taiwan was slowing.

In Asian markets, Japan's benchmark Nikkei 225 stock index closed down 2 percent, South Korea's Kospi index shed 0.7 percent, Australia's S&P/ASX 200 tumbled 1.5 percent and markets in Singapore, Malaysia and Taiwan also fell.

BERLIN — The European Central Bank said it is lending 111.2 billion euros ($136.7 billion) to banks in a six-day tender, completing an effort to smooth over the expiry of a record batch of loans.

The ECB said 78 banks subscribed to the operation, conducted as 442 billion euros in credit granted a year ago to support banks during the financial crisis expired.

That came after the central bank said Wednesday it would lend a lower-than-expected 131.9 billion euros to banks for three months. Neither the banks nor their nationalities were identified.

The outcome of the longer-term auction suggested that banks' cash needs are easing despite lingering worries about the impact of the eurozone debt crisis. More than 1,100 banks subscribed to last June's unusual 12-month operation.

LONDON — The industrial sector's growth cooled slightly in the 16 countries using the euro and the United Kingdom, according to manufacturing surveys.

European stocks fell. The FTSE 100 index of leading British shares closed down 2.3 percent, Germany's DAX dropped 1.8 percent and France's CAC-40 fell 3.

TOKYO — Major Japanese manufacturers, riding high from a booming Asia, haven't felt this good for a long time. Business confidence improved for a fifth straight quarter and was in positive territory for the first time in two years.

LONDON — The Bank of England says the amount of secured credit available to households increased slightly in the second quarter, but lenders say it might be more scarce in the July-September quarter.

BERLIN — A small rise in retail sales offered a hopeful sign for Germany's long-sluggish domestic demand, even as the country's economy minister mounted a robust defense of its export-heavy recipe for success.

MADRID — Spain successfully raised 3.5 billion euros ($4.3 billion) in an oversubscribed bond sale, a reassuring sign for markets a day after ratings agency Moody's warned it may join others in downgrading the country's debt.

BEIJING — A Chinese company canceled a $2.5 billion project to develop a bauxite mine in Australia, blaming difficult conditions in the global industry.

TIANJIN, China — Workers at a Japanese-owned electronics factory in the northern Chinese city of Tianjin were on strike over pay and benefits for a third day, the latest in a spate of labor disputes as an increasingly restive work force demands better conditions.

STOCKHOLM — The Swedish central bank raised its key interest rate for the first time in two years, saying the economy is recovering strongly from last year's global downturn.

The Riksbank raised the key repo rate by a quarter percentage point to 0.5 percent.

ATHENS, Greece — Prices of consumer goods and services have risen overnight in Greece, as a new sales tax hike takes effect in an effort to boost government finances.

SINGAPORE — Singapore real estate prices jumped to a record high in the second quarter as the city-state's economic recovery broadened.

NAIROBI, Kenya — Five nations in East Africa implemented new economic rules to boost cross-border employment and trade.

The new steps push forward a larger plan to integrate the economies of Burundi, Kenya, Rwanda, Tanzania and Uganda, which together form the East African Community.

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