Tuesday, February 26, 2013

The Post-Great Recession "Recovery" - This Time it Really is Different

A recent publication from the Bank of Canada supplies a concise review of the impact of the Great Recession on the American economy and how this recession and post-recession recovery were different.

The review begins by noting that, in general, GDP growth after recessions tends to be higher than the potential growth rate of the economy because of pen-up demand from both consumers and businesses.  This means that the deeper the recession, the bigger the post-recession growth rate.  Such has not been the case since the end of the Great Recession in June 2009 as shown on this graph:

At the peak of the Great Recession, the economy contracted by 8.9 percent, however, immediately after the recession, growth ranged between 2.2 and 4 percent.

Looking back at the 1980 recession, GDP contracted by 7.9 percent but over the following quarters, rose by 7.6 and 8.6 percent.  The same thing happened in the 1981 - 1982 recession where GDP contracted by as much as 6.4 percent but rose by between 7.1 and 9.3 percent over the following quarters as shown here:

As we all know, in general, most economic indicators have shown modest improvement at best since the "end" of the Great Recession; unemployment is elevated, housing prices are still depressed.  Even Ben Bernanke's prolonged experiment with zero interest rates is not working its magic like it should.

Let's open by taking a quick look at some statistics from the most recent recession and how the American economy was impacted.

1.) U.S. residential investment dropped 60 percent from peak to trough and, as a share of GDP, feel from 6.3 percent to 2.3 percent.

2.) Consumer spending, exports and business investment dropped by 24 percent.

3.) Over 8.5 million jobs were lost and the official unemployment rate peaked at 10 percent.  If all marginally attached workers and part-time workers out of necessity are added in, the rate hit 17 percent, a new post-World War II record.  Nearly 40 percent of America's 12.2 million unemployed have been looking for work for more than 26 weeks.  As well, the mean duration of unemployment is just below record levels, standing at 35.3 weeks as shown here:

4.) GDP growth has averaged just over 2 percent since the end of the Great Recession nearly four years ago and the level of per capita GDP has not yet reached pre-recession levels.

Let's compare real GDP during and after the Great Recession to previous modern economic crises including Spain (1977), Norway (1987), Finland (1991), Sweden (1991) and Japan (1992) which are known as "The Big Five" and the Great Depression:

The current recovery (in red) seems to be following the pattern of recovery in the "Big Five" (in blue) however, GDP levels are well below the range of past United States recessions (grey shaded area).

Why has the "recovery" been different this time?

One word - households.

From the Federal Reserve, here are a couple of graphs that summarizes the problem for us.  First, a graph showing private residential fixed investment from 1947 on:

Let's look at the detailed data from 2005 on:

Private fixed residential investment is defined as purchases of private residential structures and residential equipment that includes single- and multi-family homes, manufactured homes and home improvements.  In the post Second World War era, private residential fixed investment peaked at $813.4 billion in the last quarter of 2005.  It then fell rapidly, reaching a low of $330 billion in the second quarter of 2010, a drop of 59.3 percent.  It has since recovered to $404.6 billion but is still 50.3 percent off its all-time high.  To put these numbers into historical context, in the first quarter of 1996, private fixed residential investment was $336.9 billion and was $406.8 billion in the third quarter of 1998.  Keep in mind that in 1996, the United States population was just over 265 million, nearly 48 million lower than now. 

Basically, Americans are neither buying nor building homes.  This keeps hundreds of billions of dollars out of the economy and, as a result, keeps many sectors of the economy from creating jobs, none more so than the construction industry.

How soon will this situation improve?

There are several issues that must be resolved:

1.) The number of vacant housing units is still elevated as shown here:

2.) An estimated 20 percent of mortgage holders are "underwater" or in a negative equity position.

3.) Housing was overbuilt during the period from 2000 to 2006 resulting in a significant oversupply as shown on this graph (blue line):

4.) Household deleveraging has had a significant impact on consumer spending and consumption growth.  Since the end of the recession, consumption growth has averaged only 2.1 percent after falling 3.4 percent from peak to trough.  This decline is significantly greater than other recessions and the post-recessional growth in consumption is significantly lower than average as shown on the orange line this graph:

5.) Financial firms, once burned, are less than inclined to lend funds to consumers even with the provision of liquidity.  That said, while financial firms are less than willing to lend funds to those that are seeking mortgage financing, they are more than willing to increase the supply of consumer credit for auto loans and other consumer forms of credit as shown on this chart:

While household deleveraging appears to be responsible for the slow recovery from the Great Recession, Washington has to take some of the blame since the measures used to prod the economy and financial sector back to life pushed the deficit-to-GDP levels to new records.  The current high and unsustainable debt level of the federal debt makes it increasingly unlikely that Washington will be able to provide meaningful assistance when the next major downturn occurs and households may still not have recovered from their nasty experiences in 2008 - 2009. 

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