Tuesday, January 13, 2009

This Recession Was Brought to You by the Letters U, V and L

A popular question [1] for economists lately has been what shape this recession will take. Will it be a “U,” a “V,” or maybe an “L”? Could we even find ourselves caught up in the roller coaster of a “W,” just when we think we’ve finally voted out that letter once and for all? What’s with the alphabet soup?

This categorization is a kind of verbal shorthand for describing the shape of the ups and downs of the gross domestic product and the broader economy. It’s not an exact science, which is part of the reason there’s so much debate [2] about which type the United States is experiencing. There’s no governing body or think tank tasked with crunching the numbers and officially declaring a recession one letter or another.

In general, V-shaped recessions are those that last for a few quarters, while the more unpleasant U-shaped recessions can drag on for up to a couple of years. It’s the difference between a head cold that clears your system in a week and a case of bronchitis that leaves you hacking into tissues all month.

V-shaped recessions are also considered to be shallower and less devastating in their scope, although this isn’t reflected in the letter-labeling. (No one’s asking about uppercase versus lowercase U’s and V’s, at least not yet.) V-shaped recessions are those in which GDP and correlating metrics like employment and sales don’t slide as much.

A V-shaped recession is what happened after the tech bust earlier this decade: GDP bounced back in a period of months rather than years. A U-shaped recession, on the other hand, is what the United States saw between November 1973 and March 1975: a 16-month slog the 1975 Economic Report of the President [3] characterized as “severe.” In describing U-shaped downturns, MIT economics professor and former IMF chief economist Simon Johnson used the visual [4] of a bathtub with steep, slippery sides.

Since World War II, the U.S. economy has tended more toward U-shaped recessions. Out of 11 recessions since 1945 (not counting this one), we’ve had six U’s, three V’s, and a W, which we’ll get to in a minute.

So, where are we now? Given that, as per the National Bureau of Economic Research’s recent announcement [5], we’ve officially been in recession for a year already and that prominent economists don’t think the big picture’s going to improve until at least the middle of next year, it’s safe to say we’ve already missed the boat for a quickie V-shaped recession.

There may be a silver lining to this gloomy prospect, though. Anirvan Banerji, director of research for the Economic Cycle Research Institute [6], points out that following the last two recessions, there was no large-scale domestic job creation (in fact, outsourcing spiked). By contrast, when the United States came out of its last two big U-shaped recessions—in 1975 and again in 1982—new jobs were created. While past results are no guarantee of future performance, as the disclaimer goes, there’s historical precedent to be hopeful.

Economists’ big worry is whether we could be headed for yet another letter of the alphabet: L. An L-shaped recession is when the economy falls off a cliff—and stays there for as long as several years. If this happened, it would more closely resemble the Depression or the Japanese economy during the 1990s (the only true L’s within the past century). NYU economics professor Nouriel Roubini puts the probability at one-third, with the greater likelihood being a U-shaped recession. But don’t start breathing into a paper bag just yet. L-shaped recessions are very rare; economists point out [7] that the Fed is policing the current economic downturn much more aggressively than its Japanese counterparts did in the 1990s, and Fed Chairman Ben Bernanke is well-known for his study of the government’s missteps in the 1930s.

There’s also yet another alphabetical term used to characterize recessions: W-shaped, which is a pair of back-to-back V’s. Think of them as “oops” recessions, since they happen when a nascent recovery is derailed—usually by poor monetary-policy decision-making—and the economy hits another trough before turning up again. For instance, the twin V-shaped recessions of the early ’80s are more properly considered a single W. In this case, the economy was collateral damage in the Fed’s battle against inflation. While cartoonists have a field day [8] with this, it’s not actually a Dubya-specific phenomenon.

By martha.c.white

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