Economy: No Double-Dip Recession

The economic recovery that began in the second half of 2009 will be sustained, but the rate of U.S. GDP (Gross Domestic Product) growth will be lower in 2011 than in 2010. The lower growth rate reflects waning federal fiscal stimulus, the continuing downturn in non-residential construction, less spending by many state and local governments, less inventory building, and somewhat less robust growth in businesses’ spending for capital equipment and software.

The quarter-to-quarter fluctuations in the pace of GDP growth probably will be less pronounced in 2011 than in 2010, and this should reduce uncertainty regarding the sustainability of the recovery. I don’t expect a back-to-back – double-dip – recession, but the economic recovery will be subdued.

In 2011, private final demand rather than fiscal stimulus or inventory building will be the primary driver of GDP growth. The Federal Reserve will support growth in private demand by maintaining a monetary policy stance – characterized by near-zero short-term policy interest rates and quantitative easing.

The recovery won’t be vibrant because we are going to continue to see restraint in consumer spending. Many households will still be de-leveraging and reluctant to take on much risk. GDP growth of our major trading partners will slow and reduce the rate of growth of exports by at least one third. Even though much progress was made over the last several years, capital still must be reallocated from overcapitalized economic sectors – housing and commercial real estate – to more productive uses.

Despite ample liquidity, the banking system is not completely fixed. We will continue to feel aftershocks of the financial panic that seized up the credit markets in September 2008.

Due to disappointing revenue collections and depleted reserves, many state and local governments will continue to reduce spending, creating fiscal drag in 2011. Meanwhile, Europe’s banking and sovereign wealth problems have not been fully resolved: Equity capital and its public sector equivalent are needed to resolve the crisis.

Inflation-adjusted U.S. GDP will expand by 2.2 percent, below both the 2.7 percent growth expected in 2010 and the long-term trend rate of approximately 3 percent. The pace of GDP growth will not approach its trend rate until the fourth quarter of 2011. It will take eight quarters for GDP to surpass its previous peak.

So in terms of inflation-adjusted GDP, the economic recovery will not be complete until after the second quarter of 2011. It will be 2014 before the labor market replaces the 8.4 million jobs lost to the recession. Only then will the U.S. economy be fully healed.

The upside and downside risks to the relatively sanguine baseline forecast for the U.S. economy are well balanced, primarily because several imbalances that led to the Great Recession have been fully or partially corrected.

Housing has corrected, non-residential real estate has mostly corrected, the current account deficit has partially corrected and household balance sheets have partially corrected. Over-priced property-type assets have been re-priced. Home prices may have declined too much relative to long-term market fundamentals.

The federal fiscal situation has worsened dramatically, offsetting some of the beneficial de-leveraging that has occurred in the private sector.

Only limited progress has been made towards reducing imbalances associated with fiscal deficits in several European countries. Thus, fiscal imbalances in many developed economies have grown in the wake of the Great Recession and constitute a significant risk.

Nonetheless, the recession reduced many imbalances in the private sector, which means that the economic recovery is unlikely to abort unless major policy errors are made.

In 2011, the downside risks will equal the upside risks. The major downside risks are that the financial crisis intensifies and job growth fizzles out. With the financial system still under considerable duress and very little momentum in terms of GDP growth, the risk that a major negative policy or external shock will produce a back-to-back recession will be higher than normal.

Historically, policy mistakes are the primary causes of back-to-back or double-dip recessions. Let’s hope that the Bush tax cuts are not allowed to expire.

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