Part I: The Great Recession of 2009: Where are we going?

Most analysts now believe the recession is either already over or at least kicking its last gasp. They might be right. But, I remember having this conversation 6 months ago; back in March when the PMIs first turned up. The end of the recession wasn’t in the data then and it is not obvious it is in the data now, although the odds have shifted towards recovery. The difference between now and then is time. We now, I believe, have sufficient data on hand to judge both the severity of the downturn and to compare this downturn to previous recessions. The comparison may shed light on both the likelihood of a near-term recovery and the potential shape of that recovery.

We examine, in turn, key elements of U.S. demand, running from investment to imports to exports to consumption. For each series, we plot data 12 quarters on either side of the end point of post-war U.S. recessions. The zero date is the last quarter of the NBER recession. The solid line is the average behavior of all post-war recessions excluding 2009. The dotted line shows the behavior of investment in the worst post-war recession defined as the recession with the largest peak-to-trough decline in the particular series being shown. All points on the dotted line belong to the same recession. The dashed line shows data for the current recession. We plot the data as if 2009Q2 is the end of the recession. All lines are indexed to 100 at last date of the recession. The indexing scales the graphs to show cumulative percent changes from the zero date. For example, a value of 120 in period -4 indicates a 16 percent fall in the series in the last year of the recession. While a value of 120 in period 4 indicates a 20 percent rise from the end date o the recession. All series are real.

We begin with machinery and equipment investment. I have long advocated that this recession is a manufacturing recession (see this post); therefore, in my view, the recession is unlikely to end without a recovery in this sector. Investment is one of the most volatile components of GDP, typically falling almost 10 percent over the last year of the recession. Post-recession, investment grows robustly recovering in level terms one year after the end of the recession.

The worst investment recession was 1958. Investment fell a little more than 18 percent with the decline occurring in a single year. Investment recovered in level terms just in time for the 1961 recession. Despite the faster-than-average growth upon exit, investment did not recover in level terms to its pre-recession peak until almost 2 years after the end of the recession.

The current recession has solidly replaced 1958 as the worst investment recession. Investment has, to date, fallen more than 20 percent from its peak 6 quarters ago. Investment does not currently show any signs of life; however, investment turns on a dime and typically turns up only once the recession is over. If history is a reliable guide, investment is likely to surge robustly in coming quarters. I believe a typical recovery is more likely than the sluggish recovery experienced after the 2001 recession. It seems a global manufacturing reshuffling is once again underfoot. Even though this reshuffling is likely to destroy capital (the shutting down of American car plants for example), it may also breed investment.
Like investment, trade has plummeted more in this recession that at any time in U.S. post-war history. Unlike investment, however, trade shows a clear, leading, end-of-recession pattern. The decline in imports tends to slow in the quarter or two before the actual end of the recession. Following the recession, imports tend to grow very rapidly, in part reflecting the strong trend in trade over the last 40 years. The worst import recession was in 1975.

In the current recession, imports have also surpassed all previous records, falling over 20 percent. As of the second quarter, imports still declined but the pace of decline was somewhat smaller than in previous quarters. This may signal the end of the recession or it may just be one of the inevitable bobbles in the data. In former case, the recession would end following the third quarter.

Of course given the above focus on investment, capital imports may be even more important than overall imports. The largest capital import recession occurred in the 2001 recession as the United States shed one-third of all manufacturing jobs and the tech expansion dissipated. The current recession has exceeded this high mark. Capital imports lead the cycle more strongly than overall imports. In past recessions, capital imports stopped falling entirely, on average, one to two quarters before the end date. Currently, capital imports have not yet truly flattened.

However, while NIPA capital imports did not stabilize as of the second quarter, capital imports have since leveled out. The following figure shows real capital imports to Japan, Canada, the Euro Area, and the United States. Only in Japan are capital imports actually rising. But, in all three other regions, capital imports have stopped falling. This may be a sign of the recession ending. If historical patterns hold true, this leveling would indicate a fourth quarter recovery rather than a third.

This post continues in Part II