Economic Recovery?

Let me start by saying that this recession has led me to believe that there are only two possibilities for viewing economists and the discipline:

a) We never had a clue what we were talking about, our assumptions were all wrong, our models were wrong, and we got away with it because we were really lucky until now.

b) The structure of the economy has completely changed and our previously correct assumptions and models are now wrong.

Either way, I guess I'm saying that economists don't really have a clue what the hell is happening with the economy right now and it seems that no one wants to admit it.

The National Bureau of Economic Research typically uses the benchmark of two consecutive declining quarters of GDP growth in determining when the United States is entering a recession. The recession beginning in December of 2007 is rare in that it represents one of the few recessions dated without the declining GDP benchmark. Unlike the 2001 recession, which was declared a recession without two successive quarters of declining GDP, the 2007 recession has proven to be long and deep.

Generally it is more common for economists to reach consensus that we are in a recession than to reach consensus that we are recovering. There are multiple reasons for this but largely it has to do with which indicators different economists find most important.

GDP Growth: Those arguing that the economy is recovering right now are staking claim to the rise in GDP the last the quarters. Unlike most economic recoveries though, this GDP growth is not being led by consumers or private domestic investment which not only makes it unusual as recoveries go but also tenuous. Contributing to GDP growth was a spike in manufacturing prompted by record low inventories that will not be sustainable moving forward unless consumer spending recovers and drives manufacturing activity.

Housing Market Recovery: Other indicators garnering a lot of attention in this recession are new housing starts and housing sales, considered to be indicators of economic health because of the decimation of the housing market entering the recession. Unfortunately, these indicators are not universally indicating recovery with tremendous volatility in the numbers from month to month and considerable differences in housing market health geographically. Foreclosures are still increasing driving down prices in many markets and the tenuous stability in our housing markets is likely to fall apart completely when the homebuyer tax credit expires this spring. Housing market equilibrium will require some stability in employment since income and employment are the leading drivers of housing demand. An additional concern about housing market stability is that the impacts of the Federal Reserve’s decision to quit buying mortgage backed securities are unknown, even to its chair, Ben Bernanke who declared on February 25th that he is unsure of what it will do to markets and mortgage rates. In order for the housing market to indicate that the economy is recovering it first will need to achieve stability, and without stabilization in employment and declines in new foreclosures, this appears to be a considerable way off.

Employment: Often employment is considered a lagging indicator, meaning that economic recovery starts to gain speed before employment losses are recouped. This has been true in many of our recessions prior to 2007, but this recession has witnessed a sharper and more sustained decline in unemployment than the others. This means that pronouncing economic recovery from this recession based strictly on GDP may mean that employment recovery could be as far off as three or four years, representing the longest lag in modern history. According to calculations by the Department of Commerce, the United States economy would have to grow at five percent for the next year to reduce unemployment by one percent. In the fourth quarter of 2009 the economy grew at almost six percent, but the forecasts for the next year are much lower than that pace, indicating that employment will not be reaching pre-recession levels anytime soon.

Consumer Spending: Consumer spending is fundamentally the best indicator that the economy is recovering but it only indicates recovery it is sustained, one quarter of growth is not enough to indicate the economy is turning around. People have to increase their spending on goods for an extended period of time before it signals the rest of the economy to pick up the pace. There is a lag between demand at the counter by the consumer and the translation through the signals of the market economy to the producers to increase production. Despite the lag it is a remarkably efficient system and the best indicator we have that economic recovery will be sustainable across manufacturing, distribution, retail, services, and all industries that make up our economy.

Using consumer spending as a barometer we know that true economic recovery is not here yet. Until employment worries decline and labor markets stabilize, consumer confidence will remain shaken and consumer spending cannot be the harbinger of economic recovery. Unlike other recessions, employment may not be as much of a lagging indicator as a vital component of economic recovery.

It is important to consider that despite claims to the contrary, the United States economy has long relied on consumer spending to drive economic growth and recovery. Not only has this been sustainable for more than fifty years (see figure at top), it will continue to drive our economy moving forward. Economic recovery is not real without the consent of the consumer.