Lessons from History on the Double-Dip Recession
In early August, The Economist put America's chances of a double-dip recession in the coming year at 50 percent. If anything, things look even bleaker some two months on. The recovery that began in 2009 is in danger of petering out. In the first two quarters of 2011 the United States achieved an annualized growth rate of just 0.8 percent, far below the 2.5 percent annual expansion that economists consider the minimum necessary to make a dent in the present unemployment rate of 9.2 percent. On a per-person basis, inflation-adjusted GDP now stands at virtually the same level as in the second quarter of 2005. If this trend continues the United States is in the sixth year of what could go down in history as its version of Japan's "lost decade" of the 1990s.
Comparing the current situation with other recessions in America's modern history offers little comfort. Recessions punctuated America's postwar history with a regularity that may seem surprising in view of the period's association with the "long boom." From 1949 (the date of the first downturn) through 1982, there were eight recessions: in 1949, 1953-54, 1957-58, 1960-61, 1970, 1974-75, 1980, 1981-82. This made for an average of one downturn every four years or so.
Most of these downturns were policy-induced, with the primary trigger being Federal Reserve monetary tightening to restrict inflation. As a result, it was relatively easy to reverse course, so that these downturns tended to be short-lasting and shallow, with the exceptions of 1974-75 and 1981-82. In most instances, monetary easing and the beneficial effect of automatic fiscal stabilizers produced speedy recovery. Only two recessions turned into double-dip recessions, and again the root cause was public policy. Recovery from the 1957-58 recession was short-lived because of Dwight D. Eisenhower's insistence on balancing the Fiscal Year 1960 budget to reassure foreign dollar-holders that inflation was under control, thereby preempting a threatened run on U.S. gold reserves (a concern in the age of dollar fixed-rate convertibility into gold). However, this denied the recovery its needed fiscal adrenaline, with the result that a new downturn in late 1960 was an instrumental factor in the GOP's loss of the presidency in that year's election. The double-dip recessions of 1980 and 1981-82 were the result of the Federal Reserve's monetarist experiment to choke off double-digit inflation. In the latter downturn unemployment surpassed 10 percent of the workforce for the first time since the Great Depression, but economic recovery was relatively speedy once the Fed reversed course in late 1982. In the second full year of recovery, economic output jumped forward by 5.6 percent compared to its anemic growth of 1.6 percent in the second year of the current recovery cycle.
In comparison, recessions have been much less frequent in recent times—with only three downturns since 1982: 1990-91, 2001, and 2007-2009. Low inflation was one reason for this pattern. The Fed's conquest of runaway price instability through the monetarist experiment of 1979-1982 enabled the central bank to adopt a relatively relaxed stance on interest rates over the next quarter-century. However, inflation concerns did not entirely disappear—interest rate hikes helped to precipitate each of the three post-1982 downturns.
If America is heading for a double-dip recession, this will raise questions as to whether it is now in a depression. A recession is defined as the economy undergoing two quarters or more of negative economic growth (that is decline in output), but it is also characterized by relatively speedy recovery. A depression is marked by the abnormality of its long duration, large increases in unemployment, and steep falls in the availability of credit.
It's far too early to suggest that the US is in a new depression even if there is a double-dip downturn: output loss, jobless growth, and credit scarcity do not match those of America's previous depressions. On the other hand there are pessimistic markers of comparison. The nineteenth-century depressions were set off by financial crisis in 1837, 1873 and 1893, as was the Great Depression of the 1930s by the 1929 Wall Street crash. Downturns precipitated by financial crises historically tend to last much longer than recessionary declines.
In line with this, the IMF's World Economic Outlook, released last week, suggested that recovery in the U.S. and other advanced economies faced not one but two potential feedback threats.
One involves the interplay of growth, deficit reduction and the banks: weak growth leads to bigger budget deficits, in turn leading governments to further fiscal tightening, which lowers growth, which puts pressure on bank balance sheets with the result that banks lend less, leading once more to weaker economic activity and bigger deficits. In the case of the U.S., the spending cuts mandated by the debt limitation deal could affect short-term growth. More seriously, failure to extend the soon-to-expire unemployment insurance benefit extensions and temporary 2 percent payroll tax reduction into 2012 and the expiry of stimulus spending from the 2009 bill could trim 1.7 percentage points off expected growth in 2012. This has parallels with Herbert Hoover's futile and disastrous efforts to balance the budget through fiscal retrenchment in 1932.
The other feedback threat reflects concern that the deepening European debt crisis could have knock-on effects for other economies—even those outside the Eurozone, like the U.S. and UK, where policymakers already detect strains on banks stemming from Europe. This has prompted concern that a Greek debt default could do in 2011 what the failure of Lehman Brothers did in 2008. The historic parallel with this is the collapse of Austria's largest bank in May 1931, which set off a string of bank failures throughout central Europe. The international effects of this, among other things, were to force Britain off the gold standard and to increase uncertainty in U.S. financial circles, choking off any glimmer of economic recovery.
If America does manage to avoid a new recession and achieve stronger growth, it will be a testimony to the underlying strength of its economy. At present its political leadership in both the executive and legislative branches does not appear to have the same reserves.
If a new recession does occur, it would do considerable damage to Barack Obama's reelection prospects: the hopes of 2008 that he would be the new FDR have long since evaporated; the danger the 44th president now faces in terms of personal reputation is to go down in history as the new Herbert Hoover.
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